One legal issue faced by every entrepreneur is forming their company, which begs the question when to form the company. Entrepreneurs who do not converse regularly with a lawyer have a tendency to put this task off until the eleventh hour or neglect it all together. Common excuses include: “I am too busy with the product,” “our founder relationship is too fragile to introduce legal formalities,” or “paying that much for a lawyer does not make sense right now.” Sound familiar?There are many reasons why creating a legal entity is beneficial to your company. Yoichiro (“Yokum”) Taku has written a good blog post highlighting the advantages of incorporation and general formation. When to form your company, however, depends on where you are in entrepreneurial process. Do you have a team? Are you ready to start building your product? Or are you still on the couch looking for a co-founder, a dog and the idea? The last thing you want to do is blow $1500 (or more) on forming a company when the chances are still high that you will not take the concept beyond a hobby or the back burner.The legal advice on this topic varies amongst startup attorneys and depends on the founder meltdowns they have witnessed (or not witnessed) in their careers. We have not discovered a standard industry answer for this, but we are working on it. Some attorneys maintain that entity formation should begin the second any work or collaboration on the company begins. Others, take a more liberal approach, and say that formation can happen up to the point of fundraising (although this is a very small camp).
One of the more creative and quantitative approaches we have found is a decision matrix created by Ryan Roberts, an attorney who maintains a good blog called The Startup Lawyer. Please consult an attorney before making any final decisions.
One answer we have heard consistently from attorneys, even risk averse extremists, as the absolute last moment to form a company is the second before you begin product development (i.e. people start coding). This isn’t to say that formation cannot happen before this, but the major concern that attorneys have is the ownership of IP–it should all belong to the company…period.
An increasingly common story in this age of “founder dating” services and mixers is product development without company formation. Some of this is done in the spirit of collaborating to explore the founder relationship, but too often people jump the gun and begin development on one person’s idea before understanding the sustainability of the founding relationship. These relationships rarely pan out and one founder walks away with two months of code. Yes, that could happen despite a company being formed, but probably less often when you begin product development with a properly formed company and the understanding that the company and only the company owns the code.
Now that you have decided to form your company, the next decision you will have to make is what type of legal entity to form. Check out Choosing A Legal Entity For Your Startup.