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When Should I Incorporate A Startup

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The corporate entity form is an extremely common form of organization for startup businesses. The decision of when to incorporate a startup is generally driven by the stage of the business operations and growth. The decision is also contingent upon company transactions, such as investor financing, merger, acquisition, or public offering. Making the decision to incorporate at the correct time can make operations more efficient and can generate extensive value for the company.

Incorporation Based Upon Stage of Business Development

Most businesses begin as a sole proprietorship business or general partnerships. The reason is because one or more individuals began undertaking commercial activity with the purpose of generating a profit of loss. Such activity is, by default, a sole proprietorship business or general partnership when there are two or more individuals involved who share the profits or losses.

Later, the business owners will generally organize as a limited liability company (LLC). The LLC entity form provides personal liability protection to owners while allowing the business the same flexibility that characterizes a general partnership. At this point, the business does not need the formalized control structure characteristic of a corporation.

When the business grows to the point that it needs the formalized structure to govern the organization, it will generally organize as a company incorporation. The separation between the roles of shareholder, director, and officer provides a level of formality that is useful in a larger, more complex organization structure. These formalities are characteristic of a corporation and include annual and special meetings, voting rights, and disclosure or information rights.

Incorporation Based Upon Investor Financing

Companies seeking outside startup investors will provide ownership of the company in exchange for contributed capital. The startup investors will generally require specific rights in the company that provide advantage over the founders or existing owners. While it is possible to incorporate these rights into a limited liability company ownership interest, it is far more common for the business to organize as a company incorporation and authorize preferred stock. The characteristics of the preferred stock will be laid out in the articles of incorporation and bylaws. Further, the investors receiving the preferred shares may also be subject to shareholder agreements As such, when the business reaches a shareholder agreement with outside investors, it will reorganize the business entity as a corporation (generally in Delaware) and issue preferred stock to the investors.

Incorporation Based Upon Merger or Acquisition

When a company undergoes a merger and is acquired by another company, there are multiple structural methods of doing this. One company can sell all of its stock to the other company. One company can sell all of its assets to the other company and then dissolve. The companies can form a third business entity and transfer all company share to the new entity. Ownership of the company incorporation is then transferred to existing owners. The mechanics of the transaction is often driven by tax consequences. The internal revenue code allows for non-recognition of taxes (generally non-recognition of gain on the sale of stock) if the transaction is carried out appropriately. To achieve tax deferment, it is more difficult (if possible at all) to structure the merger with LLC interests. The companies must generally exchange stock, which is the ownership interest of a corporation.

Incorporation Based Upon Public Offering

Companies undergoing a public offering must meet the requirements of the Securities and Exchange Commission (SEC) and those of public exchanges where the stock will be sold. This may require a dedicated ownership interest that meets the characteristics of common shares. It is difficult to structure the interests of a partnership or LLC to meet these requirements. Further, the corporation cannot generally have additional classes of shares (such as preferred stock) at the time of the public offerings. As such, it is more common and far more straightforward to undergo a public offering as a corporate entity form.

LawTrades Knows Incorporation

Incorporating a startup is a big stage in the life of a business. There are many considerations for when and how to incorporate. Waiting too long to incorporate or incorporating too early can sacrifice advantages and company value. Don’t try to navigate this area of law alone. The legal professionals at LawTrades are expertise in corporate law and the law of business entities. We can help you understand when it is best for a company incorporation and help you with the incorporation process.