Why:
The main advantages to forming a corporate entity are limited liability protection; the ability to issue equity (which helps compensate founders, incentivize employees and solicit investment); and the means to centralize and protect all intellectual property (IP) and assets of the entity.
How:
Structures: There are various corporate structures to consider, such as a C corporation, S corporation or limited liability company (LLC) (see What Form Should My Company Take? “C” Corporation, “S” Corporation or LLC? for more on these different structures). The most common entity choice for a startup looking to raise venture capital financing is a C corporation, typically incorporated in Delaware (see Why Incorporate in Delaware for more).
Delaware C corporation: Incorporating a Delaware C corporation requires preparing basic incorporation and founder documents (see Incorporation in 6 Steps for more) and paying filing fees (and yearly taxes going forward) in the state of Delaware, and additional fees in any jurisdiction where the company will foreign qualify to do business (which will include the state where your corporation is physically based unless you are physically based in Delaware) (see Where Should You "Qualify to do Business" for more).
When:
The decision as to when to incorporate is ultimately a cost-benefit analysis based on when the advantages of incorporating outweigh the associated administrative work and costs.
Before you set up your corporate entity, make sure you are ready by asking yourself the following, simple questions:
If your answer is “myself,” then you might want to cancel your checks to the state of Delaware. Successful entrepreneurs do not incorporate themselves; they incorporate businesses — i.e., providers of products or services. If you cannot define with a reasonable degree of specificity (a) your product or service and (b) a plan to take it to market, then forming a corporation may be premature. However, if you are starting to engage in activities that could generate personal liability or are generating IP necessary for the business while the business plan is crystalizing, those factors may warrant an earlier incorporation.
A corporation must have a formal management structure that requires clearly identifying the individuals who will run the corporation, and their respective roles. At a minimum, a corporation needs at least one director and a president, treasurer and secretary. Now is the time to perform your ‘people diligence’ and determine the relationships that you are ready to formalize with members of your team. One person can serve as the sole director and can hold all required officer positions; or, you can spread these roles among different team members, whichever approach better fits the nature of your team.
A corporation without ownership of its key assets is usually not an attractive investment. All key assets — including IP — will need to be assigned or licensed to the corporation if not developed by the corporation. This is typically done by having all founders sign proprietary information invention assignment agreements (PIIA) in connection with their receipt of equity in the company. These PIIAs essentially provide that the founders assign to the company anything they have done for the company prior to its incorporation. Additional assignment documentation may be necessary if, for example, the founders have already filed a patent or purchased a domain name individually that pertains to the company’s business. In addition, if there are assets that a university or other public organization owns related to the company’s business, starting negotiations to have these assets assigned to the company early is especially important, because the process may require greater lead time.
The goal for most founders in deciding to incorporate is to be in a better position to attract investment. As a result, think clearly about exactly what funds are needed, to avoid giving up too much equity too early, over-complicating your cap table or over-burdening the corporation with debt. Each of these problems can cause investors to walk away from even a great idea or a stellar founder team.
The Bottom Line
Incorporation is designed for businesses that are ready to scale. The main advantages of the corporate form are attracting investment and limiting liability. The questions discussed above can serve as a guidepost for your business to determine whether you are ready to incorporate.
