Incorporate your startup only when you’re forced to

http://joel.is/post/32520533327/incorporate-your-startup-only-when-youre-forced-to

by Adrock • 14 years ago

38 48 14 years ago

SwaroopH2• 14 years ago

Joel, good points but I would advise going with at least an LLC/LLP when more than one founder. Makes things more official and easier to do business (payment gateways, etc). Also, it takes around $100 and 5 minutes on an online form to set it up. Easy!

minouye• 14 years ago

Generally good advice but be advised fees and setup will vary state to state. In California, the process can take several months and you'll be on the hook for a minimum $800 franchise tax each year the LLC is in operation.

danshapiro• 14 years ago

Incorporating as an LLC makes it harder and more expensive to do properly later as a C-corp. I believe it can add >10k to the total costs vs. doing a C-corp from the start.

HeyLaughingBoy• 14 years ago

Yeah, but...

If I get to the point of needing my LLC to become a C-corp, that $10k will be a drop in the ocean.

tptacek10• 14 years ago

Living an extra mile away from your lawyer also makes it harder and more expensive to do business, because you'll pay extra for gasoline.

The question is, "how much more expensive", and the answer W.R.T. plain-vanilla LLCs where the transition to C-Corporation is uncontested by all the members and all the members are still active is, "not very".

I'm sure you can easily rack up more than $10k in conversion costs if you let things get complicated, but I'd like a cost breakdown or even just a citation to a source for the idea that LLCs add $10k to C-Corp costs in the common case.

SwaroopH2• 14 years ago

My point is against doing nothing. Having incorporated recently, I firmly believe incorporation is the way to go. Although, my lawyer is friendly, gets thing done fast and charges very low.

burntwater• 14 years ago

And in NYC it can cost over $1,000 because of publication requirements. There are ways around it, but it took me some digging to find (and still costs several hundred).

tptacek10• 14 years ago

We were a Delaware LLC headquartered in NYC and did not run into any $1000 publication requirement; we did the online Delaware thing, and because we're in a legal-heavy sector of the industry, we've had our stuff looked over pretty carefully since then.

aoprisan• 14 years ago

If you want to offer paying plans for your startup, it's better to incorporate and open a separate bank account for the business. The same goes for business expenses, it's better to incorporate to open a bank account and have all those expenses on the company bank account vs. your own personal checking account, for tax purposes.

herval• 14 years ago

That's a bad piece of advice if you have partners. It's the fastest way of getting screwed by an ill-intentioned one, or getting your IP stolen, or worse (At least in a few countries I know the laws - not entirely sure about the US)

bengi2• 14 years ago

Just for liability purposes it's worth dealing with incorporation early. If you have co-founders, you're a de facto general partnership until you opt for something better.

tptacek10• 14 years ago

If you have partners, get vesting taken care of immediately. Don't do business with partners that won't agree to vest.

You can set up a vesting (or equivalent buyback) structure with an LLC, but it might not be "LegalZoom-easy".

The longer you wait on vesting, the harder it is to get it set up. Don't wait.

yumraj• 14 years ago

IANAL: But from what I've heard and figured out, one should at least do an LLC to avoid personal liability, otherwise if some nut decides to sue you, you can even lose your personal assets.

genwin• 14 years ago

And you can be sued by a nut on day one, for any reason. I've read that if an LLC has only one member, judges are free to ignore the "limited liability" part. It might be necessary to incorporate.

tptacek10• 14 years ago

I don't think this is true, at least in the broad sense you've suggested here. There are lawyers on HN that will correct me when I say this:

There are, in many states, special-case rules for "single member" LLCs. There are also special rules in places for single-shareholder corporations. Those special-case rules largely impact the manner in which equity in the company is handled when resolving debts.

Meanwhile: there is a very widespread misunderstanding of how liability protection in corporations of all sorts work. The protection you get from a Corp/LLC is from contract liability: third parties cannot attach themselves to the assets of company owners to settle debts. But liability shields afford no protection against torts, including contracts entered in bad faith. If you own a company and the company enters into fraudulent contracts, you can still lose your house in the ensuing legal drama.

janezhu• 14 years ago

An LLC also helps if you're planning on releasing an iOS app under your startup's name, not your personal name.

DenisM4• 14 years ago

Also, do not take your legal advice from a random blog.

Talk to a lawyer. Many have open office hours or offer first hour for free. There is nothing to lose and everything to gain.

tptacek10• 14 years ago

This is usually good advice but it can be tricky with incorporation. Company founders meeting a lawyer for the first time over incorporation issues often find themselves convinced to pay thousands of dollars to establish a C Corporation structure. Most new startups do not want C Corps; at least, not until they have investors and thus multiple share classes.

You can get an LLC from Delaware almost as easily as taking a ticket at a butcher shop. It's a commodity product. That cheap-o Delaware LLC isn't a miracle cure for investment or employee equity or vesting issues, but it solves the core problem that incorporation is meant to solve: making it absolutely clear to your external business partners that they are dealing with a company, and not with someone and their home mortgage.

Silhouette3• 14 years ago

Company founders meeting a lawyer for the first time over incorporation issues often find themselves convinced to pay thousands of dollars to establish a C Corporation structure. Most new startups do not want C Corps; at least, not until they have investors and thus multiple share classes.

If that is true, then surely the problem there isn't that the founders took legal advice, it's that they took advice from a bad lawyer?

I'm not an expert on US matters but familiar with the UK, and over here if you're getting someone to set up a new legal entity for your business, it will probably be an accountant rather than a lawyer. An accountant might therefore be better placed to advise on options for business structure in the early days, or you could join one of the specialist small business support organisations (FSB, PCG, etc.) and start by reading their standard guidance before you take formal advice from whoever else might be relevant.

DenisM4• 14 years ago

It doesn't have to be expensive though.

My lawyer (used to) costs $500 for the S-corp/LLC formation, including the one hour consultation and all the registration fees. He also explains LLC vs. S-corp choice, the latter being a perfectly viable option in a large number of cases.

It is of course best to come prepared to make the most of your money.

tisme3• 14 years ago

That's advice that is applicable only to a limited subset of the startup class, the ones without a product and without cashflow.

If you're going to do b2b you'll never be forced, it's just that nobody will be doing business with you and your circle of friends.

VC's and angels don't like it when you incorporate early because that means that you've probably done a whole bunch of homework already and thus are a tougher negotiator.

Not incorporating when running a company is a great way to get into a lot of trouble. Fixing a bad incorporation at a later state is costly (but it can be done).

As soon as you start dealing with money and responsibilities to outsiders you should incorporate.

notJim• 14 years ago

The author is the founder of Buffer, which has both a product, and cash flow, and in fact had both quite early on. I also suspect that many of their customers are businesses (but I'm not sure.) So his experience would seem contradict what you're saying.

Why do you think it's necessary to incorporate early if you're taking money for a service/product?

tptacek10• 14 years ago

It's painful to do corp-corp business without a corporation. Many large corporations will, when dealing with sole proprietorships, do crazy things like withhold taxes. Some companies may refuse to work with you altogether and instead demand that you work through a subcontracting arrangement with an existing vendor. Other companies will require you to maintain different liability insurance coverage, or have insurance requirements that are not easily available to new sole proprietorships.

(I've seen friends deal with this nonsense even after they got LLCs; I've also seen this nonsense resolved with LLCs).

Since early '05, I've been a principal at a business that bills large contracts year-round to companies of all sizes --- more on the 1000+ employees level, but lots of startups and small tech companies too. The idea that incorporation helps deal with corp-corp business is not a myth, and no appeal to "that guy's company must be doing business with corporations and he deferred incorporation" changes that.

jdh• 14 years ago

Just FYI us VCs aren't sitting around just hoping some rube will come by who is not incorporated so we know we can take advantage of him in a negotiation.

Our model isn't leveraged around finding naive people to take advantage of. No price is cheap enough for a bad team or deal...

tisme3• 14 years ago

Not all VCs are equal, and I apologise for lumping in the good with the bad. But there are plenty of examples of venture capitalists (and angels too) taking advantage of inexperienced entrepreneurs. And in that case it helps a lot if you get to write the contract.

bengi2• 14 years ago

This is Lean Startup taken to an impractical extreme. I know, I know, those two hours you spend on LegalZoom filing as a Delaware C are hours you're not spending outside the building talking to customers blah blah blah, but not everything that doesn't involve "learning" is waste.

mrschwabe• 14 years ago

Just as important, perhaps even a more noteworthy first step for up & coming startups is to establish a separate bank account!

It's true, no need to rush into incorporation. But there should be an urgency to setup a separate bank account (any kind of account, a savings would do) so you can make your bookkeeping simple. The money you spend on your startup as a sole proprietor can be tax deductable. And besides that, its a good practice to show potential investors or lenders exactly how much you have invested yourself. Having one account where you can pull that data makes these kinds of bookkeeping/accounting tasks incredibly easy.

For credit card transactions, try to get a new card just for the startup - or even use an existing card but make sure to dedicate that card exlusively to the startup so months and god forbid, years later, you're not having to go line-by-line through stacks of statements picking & deciphering what was business and what was personal (not fun).

tptacek10• 14 years ago

Counterpoint: http://news.ycombinator.com/item?id=1725008

Read that whole thread carefully before you decide whether or not you're willing to spend ~$150, the equivalent of a month's Starbucks habit, to do business as an LLC with contract liability protection. That thread is a perfectly ordinary situation that business founders routinely find themselves in.

If you're not going to be entering into contracts and you're not going to be conducting business transactions as a vendor to other businesses and you're not going to be employing people, I don't have a strong opinion about whether you incorporate. On the other hand, those are pretty important things for a business to do.

To that, I will only add that the meme that incorporation harms your chances of being funded is, in a word, horseshit. If your corp structure is simple, as with a Delaware or home state LLC, and your ownership structure is simple, then the cost of converting it to a C Corp is a small constant factor added to the cost of incorporating as a C Corp to begin with. If your structure isn't simple, you clearly didn't have a choice between incorporating or not. There are corporate structures that make it very annoying to get back to the "clean slate" investors want you to be at, and my gut is that this is the concern animating things like "don't incorporate if you don't have to". If your company is amazing, people will invest even if some crazy guy in the woods claims to own 90% of it; if it's not amazing, an LLC isn't going to push you off the bubble.

Corollary: if you don't know the difference between a C Corp and an LLC, then your default position should be "get an LLC ASAP", because you don't know enough to be making this decision based on some dude's blog post.

Late edit: I went and looked for LLC->C conversion costs and found a Quora post from a startup lawyer suggesting ~$1000, and, as I expected, that the costs mostly involve working around the need for unanimous consent from all the members of the LLC, which in small new LLCs where all the members are still active, unanimous consent isn't a big deal.

georgemcbay2• 14 years ago

"Read that whole thread carefully before you decide whether or not you're willing to spend ~$150, the equivalent of a month's Starbucks habit, to do business as an LLC with contract liability protection."

YMMV on the $150. In California that covers the upfront costs for setting up an LLC, but be aware that one year later (and each year after that until you dissolve the LLC) you will receive a tax bill from the state of $800, regardless of whether or not your LLC made a penny.

tisme3• 14 years ago

$150 or $1000 might be enough to swing the decision about where to incorporate for some instances but for most that is a rounding error. And anyway, all expenses that you are going to have should be part of your businessplan when you're at the go/no go stage. If $800 scares you then you're not doing business.

staunch• 14 years ago

And lest you think you can avoid that fee (a "franchise tax") by incorporating in a different state, it applies to any company operating in California

juddlyon• 14 years ago

While your at it, don't buy insurance, wear a seatbelt, or back up your files. Most likely nothing bad will happen if you consider the odds.

fourply• 14 years ago

This is just flatly bad advice. Entity selection and the decisions that come with it should be made very early in the process or it can have very negative unforeseen consequences down the road.

Education and clarity is important in any new business venture, especially one that involves multiple parties. If nothing else, a good buy-sell agreement is crucial in avoiding misunderstanding and back blood if one party wants out.

Liability protection is also hugely important. What startup doesn't need a bank account? Separation of entity an personal assets and liability is a big deal and should be meticulously maintained and documented from inception. This discipline is hard to pick up late in the game, and there's no reason for it.

Also, if your attorney is recommending a C corp as your best choice of entity, you either have a very unusual situation or a bad attorney.

dools• 14 years ago

I've even employed full time staff as a sole trader in Australia and never found it a hindrance in getting work. My accountant always told me to avoid incoporation until I was consistently netting over $100k because having a company is such a headache. So I'd tend to agree with the OP but I'd also say get a few professional opinions and especially make sure they're relevant to your country of operation!

tptacek10• 14 years ago

I have no idea why Australia would be this warped, but that is ludicrous advice in the US. If you're grossing over $100k, your liability exposure has doubtless scaled with your receivables. Businesses routinely experience abrupt downturns. For the sake of less than 0.1% of revenues, you'd have that exposure attach to your house? Insane.

rprasad2• 14 years ago

It's a headache for your accountant for you to incorporate. However, it's a nightmare for you if you don't. Don't let his laziness put your finances in jeopardy.

I strongly suggest you find another accountant, because your current guy will get you screwed over when the tax man comes to collect.

bitwize• 14 years ago

Hello, unlimited liability, goodbye house, car, clothes on your back.

omegant• 14 years ago

Is there any book or reliable source explaining all the process of incorporating? Pros and cons, vesting, stockoptions etc...

tylermenezes• 14 years ago

You need to incorporate if you want to release on the app store under a name that's not that of one of your co-founders. So that's about half of the companies.

rprasad2• 14 years ago

While you're at it, don't hire a lawyer after you've been arrested until just before your sentencing hearing. That way, you can save a whole bunch of money. After all, the overwhelming majority of people plead guilty anyway, so what's the point in having a lawyer until the stage that really matters?

Incorporate your startup only when you’re forced to

Related Stories