Incorporating your startup is a necessary and critical piece in your company’s evolution. Forming a C-Corp is recommended for those who plan to raise capital from outside investment. While incorporation details vary from country to country and state to state, this guide outlines the steps if the founder is a US citizen incorporating a US business.
Why should I incorporate?
If you start a new business tomorrow, by default, your business is either a sole proprietorship (if you’re solo) or a general partnership (if you’re two or more people).
In both cases, there is no legal distinction between you and your business, and you are held personally liable for all debts and obligations.
If you have a formal agreement with someone, and you fail to deliver, they can sue you and a court can force you to pay them damages out of your own personal savings.
This can happen if:
- You promised payment, but your business ran out of money so you couldn’t pay them
- They pay you for something, but you don’t deliver in time or at the agreed quality
- You accidentally cause someone harm while doing business
If the courts decide you owe more than your business has, you can be forced to sell your assets, enter multi-year repayment plans, or declare personal bankruptcy.
If you don’t want to put your personal finances at risk, you need to incorporate a company that is a separate legal entity from yourself. If the company is sued or goes bankrupt, your personal assets are protected.
The most important piece of business financial advice is to have a clear separation between your personal funds and your business funds. If you’re constantly using your personal credit card and bank account to make business transactions, or are using your business cards to make personal transactions, someone can argue that you’re not actually a separate entity from the business, and you can go back to being held personally liable. These actions can “pierce the corporate veil.”
When should I incorporate?
The earlier the better!
What are the pros and cons of incorporating early?
Pros:
- Presenting a professional image to customers, suppliers, and investors
- Establishes a competitive edge
- Greater ease in obtaining financing and funding
- Sole proprietorships can be considered risker due to lack of separation
- Limited liability protection
- As a sole proprietor, there is no difference between your personal and business asses
Incorporating before these milestones is advised:
- Before you sign contracts - To have limited liability protection
- Before hiring employees - To protect your assets
- Before your first fundraise
Cons:
- More expensive
- One-time incorporation filing fees
- Ongoing fees for incorporations
- ~$100 Delaware registered agent fee
- ~$300+ Delaware franchise fee
- Any state franchise fee (e.g. California is ~$800/year)
- Any state tax filings
- Compliance requirements
- Maintenance of records, annual reporting, shareholder meetings
What type of entity should I choose?
In this decision, you are not only choosing your type of legal entity, but you are also electing a tax designation.
The most common types of corporate entities in the US
- Pros:
- Personal liability protection
- Unlimited number and types of shareholders
- Funds, trusts, and organizations can invest
- Earnings can be retained in the corporation
- Easier to raise money - can sell shares to investors
- Cons:
- More complex and more requirements - board of directors, corporate tax filings
- Double taxation - the corporation has to pay taxes on its profits each year, and individual shareholders also pay taxes on their personal profits when they receive dividends or sell their shares
- A C-Corp is right for you if:
- You want to retain and reinvest profits
- You plan to build a large company with outside investors
- You are looking to raise institutional or venture capital
- You plan to take the company public
- Pros:
- Personal liability/asset protection
- Simple and easy to start
- Management/ownership flexibility
- Cons:
- Difficult to raise capital
- Pass-through taxation - profits and losses are reported on the individual tax returns of the owners
- Can only accept investments from individuals, not funds, trusts, or organizations
- An LLC is right for you if:
- You plan to start a small owner-managed business
- You desire flexibility in designating ownership in the business
- You are not seeking angel or venture capital investments
- Pros:
- Limited liability protection
- Perpetual existence
- Flexible accounting methods - can choose the method that results in the lowest taxable income
- Ease of ownership transfer
- Cons:
- Can only have one class of stock
- Can only be owned by a US citizen of resident individuals
- Can’t have more than 100 shareholders
- Pass-though entity - profits and losses are reported on the individual tax returns of the owners
- An S-Corp is right for you if:
- Want a less formalized entity than a C-Corp but more formalized than an LLC
- Do not plan to have more than 100 shareholders or more than one class of stock
Other types of entities
If you want your business to have a legal obligation to do more than just make money, or you’re a licensed professional, you could also consider starting a:
Benefit corporations are obligated to balance making money and making the world a better place.
Nonprofit corporations are dedicated to charity, education, religions, or other tax-exempt purposes.
Professional corporations are for licensed professionals (e.g. lawyers, doctors, accountants) to practice their profession.
Is my decision final?
No - You can convert an LLC into an S corporation or C corporation, or convert an S corporation or C corporation into an LLC.
However, you typically have to involve both lawyers and accountants, and spend thousands to tens of thousands of dollars, so it’s usually best if you can start with the right entity from the beginning.
Where do most companies incorporate?
Most founders choose to incorporate in one of two places: Delaware, or their home state.
Benefits of incorporating in Delaware:
- Tax Benefits
- No corporate income tax for businesses that are registered in Delaware, yet don’t do business there
- No sales tax, investment income taxes, inheritance taxes or personal property taxes
- While companies do have to pay a franchise tax, this is minimal in comparison to to other states’ income tax
- Privacy
- Only the registered agent needs to be disclosed in association to the company; not the officers, directors, and shareholders
- Expediency and Ease
- Offers same-day business filings
- Allows one person to hold many positions
- Corporation Court
- Corporate lawsuits in Delaware are resolved by the Court of Chancery, a court made up of judges who specialize in corporate law
- They use judges rather than juries and prioritize corporate-related cases so that lawsuits can be settled quickly
- There are many established and predictable legal precedents that may benefit corporations
- Better for Fundraising
- VC’s and angel investors generally prefer you incorporate in Delaware
Benefits of incorporating in your home state:
- Usually Less Expensive
- If you plan on primarily doing business in your home state, then local incorporations typically are less expensive than incorporating in Delaware and then registering in every additional state you do business in
Where should I incorporate?
When you incorporate, you have to incorporate in exactly one state or territory. It’s important to note that you can’t incorporate at the federal level nor can you incorporate in multiple states. Where you incorporate is a major factor towards the jurisdiction that legal disputes for your company could get resolved in; also, investors may have strong preferences towards certain jurisdictions that have more legal precedents.
How do I create a Founder’s Agreement?
If there are multiple founders in your company, you should create a founder’s agreement early on. The purpose of a founder’s agreement is to address any possible issues that may arise within the company.
Founder’s agreements should include the following:
- Equity
- Vesting
- IP Ownership
- Founders’ Roles
- Decision Making
- Capital
- Issuance of Shares
- Non-Competes
- Non-Disclosure
- Founders’ Exits
Founder’s Agreements Templates
Templates for founders agreements can be found online, but it is always advised to consider hiring a lawyer to help draft or review your founders’ agreement.
How do I incorporate?
Once you have chosen your legal entity, location, and have created a founder’s agreement, you are ready to formally incorporate!
To make the process easier, most people use an online incorporation service to help them through the process. It is still advised to seek outside legal review in addition to the online incorporation service.
Online Incorporation Services
- Stripe Atlas
- Northwest
- ZenBusiness
- Incfile
- Clerky
- Gust
- LegalZoom
- Rocket Lawyer
Steps to Form a C-Corp (Name, Registered Agent, Directors, etc.)
You can use the Delaware One Stop Shop to register, or you can use an incorporation service (see previous toggle).
Prior to naming your company, you should look online to ensure there is not already a registered trademark for the business name, especially within your business’ industry.
- Search existing trademarks on the USPTO website
- To file trademarks, you can use various online services such as Trademark Engine and LegalZoom
- What is a registered agent?
- Someone appointed by the company to receive legal documents and other official notices for your organization. Technically, anyone with an office that is located within the state and open to receive deliveries during business hours may serve.
- Who should I choose?
- While you can choose an employee, owner, or officer, it is advised to choose a professional service to ensure the highest level of protection
- Nationwide providers that grow with your company as you expand operations are the best solution
- Nationwide registered agent providers
- The board can initially be as small as just one director, usually the startup founder and/or CEO
- As the startup grows and evolves over the course of several funding rounds, the board will expand to include more members
What other corporate items do I need?
Virtual Business Phone Number
Now that landline phones have become virtually obsolete, companies need to seek out other communication tools to handle business and customer phone calls. Virtual business phone number apps allow business to manage business calls on their own phones.
Virtual Mailbox
Most companies do not have an office when they are first starting, so many founders opt for a virtual mailbox as their business mailing address.
What is qualified small business stock (QSBS)?
The qualified small business stock (QSBS) exclusion is a U.S. tax benefit that applies to eligible shareholders of a qualified small business (QSB). Because founding, investing in, and working for a startup can be riskier by nature, the QSBS exclusion helps encourage people to take that risk.
The QSBS tax exclusion is set forth in Section 1202 of the U.S. Internal Revenue Code. When shareholders sell or exchange their qualified stock, the exclusion can provide a break on capital gains tax—potentially up to 100% exclusion of tax on capital gains.
More resources:
- IRS website here
- Read more about this on Carta here.
- Watch a video from experts at Silicon Valley Bank here