When to Incorporate: Everything You Need To Know
Deciding when to incorporate involves clearly considering the characteristics of your business, the timing involved, the cost, and other factors.3 min read
2. Protecting Personal Liability
3. Shielding Intellectual Property
4. Preparing for Third-Party Funding or Acquisition
5. Taking Advantage of Tax Benefits
6. When You Should Not Incorporate
Deciding when to incorporate involves clearly considering the characteristics of your business, the timing involved, the cost, and other factors. If you incorporate too early, you will be responsible for paying the hefty fees although your company may have not yet made a profit. If you wait too long, however, you can lose valuable intellectual property such as your business name and risk your personal assets. In most cases, it's best for companies to incorporate as soon as they are able to do so. These are just a few of the signs that it may be time to incorporate your company.
Establishing Co-Founder Relationships
Some business owners begin preparing for incorporation long before it is necessary to do so. This can be beneficial as it sets expectations for co-founders and investors right away, which can avoid the conflict experienced by start-ups like Facebook. This may be the best route for your company if you can clearly envision its future, are solidly entrenched in the planning process, can cover the costs associated with incorporation, and/or own intellectual property (IP) that you want to legally protect.
For example, co-founders can disagree on serious issues such as how to split business equity. When you incorporate, you settle all these issues in the corporate bylaws so disputes are resolved before you are overly invested in the company.
Although you may not be able to afford to pay early employees handsomely, incorporating allows you to recognize their sweat equity in the form of stock. If you don't incorporate, you cannot make enforceable promises to compensate co-founders and other initial partners with shares of stock.
If you are a sole proprietor and are planning to add a partner to your business, it's a good time to form a limited liability company (LLC) or corporation. This establishes decision-making authority and ownership shares for your company.
Protecting Personal Liability
Many business owners decide to incorporate to protect their personal assets from business liability. When you incorporate, your business becomes a separate legal entity with its own debts and obligations. This protects your home, vehicle, and accounts from being seized to satisfy a business lawsuit or debt. When you are operating as a sole proprietorship and partnership, business and personal assets are legally considered one and the same.
Shielding Intellectual Property
The valuable intangibles that distinguish your business from its competitors are collectively known as IP. Incorporating prevents a co-founder from starting a competing business with the IP developed for your existing business. However, you can also protect IP with legal remedies such as trademark, copyright, and patent registration if you aren't yet ready to incorporate your business.
Preparing for Third-Party Funding or Acquisition
If you want to court investors who can help fund the growth of your business, you need to be incorporated. Some business owners prefer to grow a business and then sell it to a larger corporation, which allows them to avoid high income and capital gains taxes. However, you need to hold stock in the company for at least one year before doing so, which means incorporating as soon as possible so you'll be prepared for acquisition when the time comes.
Taking Advantage of Tax Benefits
In some cases, you may be able to save on business taxes by incorporating. However, this varies based on your income tax bracket, whether you take a salary, how the income of the business is invested, and other factors. Consult with your tax advisor before incorporating for this reason.
When You Should Not Incorporate
In some circumstances, it doesn't make sense to incorporate your business. These include when:
- You can't afford to do so. Incorporation carries substantial upfront and ongoing costs, which vary depending on your state. You also put yourself at risk of interest and penalties for late report filings.
- You don't want to face the deadlines and requirements associated with running a corporation.
- Your business is at risk. It makes more sense to invest the funds in improving your operating to bolster your startup and improve its chances of survival.
- You see your business as a hobby or side hustle and don't ever plan to hire employees or go public.
If you need help deciding when to incorporate, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.