When to Incorporate

There are many new and confusing issues that first-time entrepreneurs face when they get ready to launch a business.  The need to create a corporation is at the top of that list.

I recently had a conversation about incorporating start-ups with Chris Sloan, an attorney with Baker Donelson, who is Co-Chair of the firm’s Emerging Companies Team:

 

JC:  Does every business really need to incorporate?

CS:  No, it’s a function of the size of the business and the risk involved.  One of the primary benefits of incorporating is the liability shield that protects your personal assets.  In some cases, the business may be so small that it will not make sense.  In most cases, though, it’s a good idea.

JC:  Some bootstrapping entrepreneurs postpone incorporating to save their limited start-up capital. Are there some businesses that can postpone this expense and incorporate sometime after they begin actual operations?

CS:  The time to incorporate, in most cases, is the first time you are required to do something officially in the name of the business.  It could be a contract, a permit, leasing space, hiring employees, etc.

JC:  These are many do-it-yourself incorporation options available for bootstrapping entrepreneurs. What cautions would you offer people who are planning to incorporate without an attorney?

CS:  If you are expecting your business to grow rapidly, particularly with outside capital, or you have more than one co-founder, the “do-it-yourself” options for setting up those types of entities are both limited and, in my experience, not great.

JC:  What are the key things a business owner needs to do after they incorporate?

CS:  First, you’ll likely want to obtain an employer identification number from the IRS; it’s corporate version of your social security number.  Second, you might need a business license and a sales and use tax permit; you can check with your local county clerk’s office.  Lastly, make sure you keep good corporate records.  That includes shareholder and board meetings, a capitalization table, and ownership transfer records.  Good corporate housekeeping is easy if you start early and stay current, but I regularly see businesses that don’t.  It can be messy and expensive to clean up, and it will happen at the most inconvenient times, such as during an investment or acquisition.

JC:  I work with a lot of businesses with multiple founders.  What are other key legal steps these business needs to take care of in addition to incorporation?

CAS:  If more than one person is founding and going to be actively working for the business, it is extremely important to have an agreement addressing dispute resolution and transfer restrictions, among other topics.  This is usually called an operating agreement in an LLC or a shareholders agreement in a corporation.  Also, we strongly recommend that co-founders have a reciprocal vesting agreement in place addressing how long they have to work for the company to fully earn their equity; if they leave, for any reason, any of the unvested equity goes away.

 

The legal steps of starting a business are not that complicated on the front end.  But if you skip any steps, the impact and cost can be profound later down the road.