For most entrepreneurs, incorporating and incurring legal fees is at the bottom of an extremely long and ever-growing task list. They are usually (and justifiably) concerned with things such as:
- What’s the next milestone in our product development cycle?
- When will our user interface wireframes be completed?
- How much will these things cost?
However, there are compelling reasons to incorporate early in your company’s life.
Reason One: Protect Yourself With Limited Liability.
First, you should be concerned about your liabilities – a corporation or LLC protects your personal assets in the event that your startup is unable to pay off debts, or there is a lawsuit against you that implicates your company. The more developed and complex your startup is, the greater the exposure to liability, so incorporating early is a means of pre-empting these concerns and keeping yourself safe.
Reason Two: Buy Your Stock Cheaply.
When a company is created, stock is often given as part of compensation – this is especially so for founders, co-founders, and early employees. However, stock is not simply given out for free – the recipient of the stock must always pay the fair market value of the stock at the time they receive it.
What does this mean in practical terms? Simply that the earlier you incorporate, the lower the fair market value for your stock will be. A startup that incorporates immediately can issue stock at a value of $.001 per share. However, one that incorporates only after they have significant traction and/or revenue would be forced to issue stock at a value of somewhere like $.1 – .5 per share. Clearly, this has significant implications when a co-founder plans to purchase 2 million shares of his stock.
Reason Three: Stay Ready for Investment!
Though incorporation is not usually an extensive process, it can often take weeks to months to become official with the Secretary of State and execute all necessary agreements. Investors want to move fast, as it truly benefits all parties involved. For the interested angel or venture capital firm, the faster they move, the faster their returns will manifest. Arguably however, it is far more important for you:
- Being the first mover in a specific market opportunity is often beneficial, and a large part of why some companies form in the first place.
- Timing could be your competitive advantage.
- The investment might fuel strategic scaling and expansion.
- The investment might be necessary to keep the company afloat.