How I Incorporated My Startup
heyhamza.com
heyhamza.com
A few observations from the dark side (I am a business lawyer):
1. Filing the certificate is only the first of several steps you need to take to complete an incorporation (you also need to set up its management structure, capitalize it, enter into any shareholder agreements as are appropriate, adopt bylaws, and comply with securities laws, among other things, or else your corporation is only half-baked).
2. Even if you complete an incorporation, you still need to do this in a distinctive way for a startup as opposed to what you would do if you were incorporating a typical small business - meaning, the process leaves the founders vulnerable to a fair number of legal risks unless they take pains to put strings on the stock issuances in case someone bolts without earning his piece, to assign IP rights into the company to make sure no individual founder later claims such rights as his own, to enter into work-for-hire arrangements to make sure that the rights to any continuing work done on the company's technology will belong to the company and not to any individual founder, etc. (summarized in more detail here: http://grellas.com/faq_business_startup_001.html).
3. There are also issues about which entity might be best for your situation (corporation or LLC) and which state (Delaware or other).
I don't want to be misunderstood here. I have never discouraged clients from taking any self-help steps they see as helpful to them and I will refer them to resources that help them in this. And often an initial bare-bones corporate or LLC setup makes infinitely more sense for founders than does anything more elaborate and more expensive.
But such steps must always be understood for what they are. If you have an inexpensive method for filing a Delaware certificate of incorporation at the hand, that is helpful and broadens your options as a founder in getting your entity technically formed on the cheap. Just don't forget that it is at that stage only an incomplete formation. Just as lighting the stove in only step one in cooking your dish, so filing the charter document does not really make you "incorporated" until you have done the rest of it as well. Nor does it necessarily mean that you have made your entity choice in the right way.
Forgive me if this sounds like self-promotion (I have assiduously tried to avoid this in my HN comments) but it does pay normally to at least meet with a skilled attorney to get some strategic advice on how to do your setup. The cost of doing an initial meeting is usually nominal and will at least let you make the choices you do make with open eyes on what the trade-offs are. It is commendable to conserve cash. It is not commendable to do so in a way that leaves you potentially flying blind on important choices affecting your startup.
Is there any advantage to waiting to get to that step until after speaking to an attorney, or should people just go ahead and at least get minimally covered?
Might it depend on whether equity distribution is a major concern (you want your company to survive the first dispute among its principals) versus actually transacting business?
Here is the basic trade-off:
On the one hand, it is a drain to have to pay lawyers or to have to comply with pure legal formalities when you need to focus your energies and resources on building a business.
On the other, if you skate along, and then something goes wrong which you have not covered legally, you get into a potentially tricky situation that can easily become more expensive to deal with than would otherwise have been the case had you invested some money and effort into covering the formalities in the first place.
My rules of thumb for founders on this are:
1. If you are a sole founder, you normally can take the "minimum steps" to get a bare-bones entity in place and defer more complex items until later. In that situation, you don't need to worry about what I have called "strings on stock" (i.e., restricted stock) or about IP formalities because these areas tend only to lead to problems when you have multiple founders and the risk exists that one or more of them may act opportunistically in the absence of clearly defined legal rights.
2. If you are a team, and you have a high level of trust among each other, you can also sometimes go with a bare-bones setup while you remain in, say, an early development phase (or otherwise are not actually transacting real business) and nothing of too high value is yet involved in your venture. In such cases, as you build varying degrees of value into the business, you do take some legal risk that someone will act opportunistically but this is normally an acceptable level of risk, both because it is remote and because the fallout from a worst case is not likely to be major. Hence, you can often wait before taking the more formal steps. Of course, all of this changes once you have built something that already has high value or excellent prospects of acquiring value. At that point, in my view, it is imprudent to rely on too informal of a setup.
While you can wait in such cases, it still helps, in my view, to speak to an attorney preliminarily up front just to get a strategic perspective on your options. Having done that, founders can usually make good judgments about whether or not to take other immediate legal steps or to defer them. The point is that they can then do so in an informed way (assuming the attorney is knowledgeable, which is not always the case unfortunately).
Concerning legal formalities associated with equity distribution, I have had lots of founders over the years come in having done a half-baked job on this when set something up themselves (a "quickie LLC" or some such thing) and it normally is no significant problem either completing or correcting this sort of thing as long as the founders remain in harmony. So, founders can take their own cut at this sort of thing and often come out OK but this often is as much dumb luck as anything else. Again, if any sort of value is involved, I think that founders should try to do things right at the stage when they do their key stock grants (or start doing real business).
(I've done the diy and professional routes both without problems. The diy co raised vc no problem and survived minor disputes.)
Specifically our attorney helped us with the following issues:
- What is the structure of the shareholder agreement?
- What happens if a co-founder leaves?
- Filling out the 83(b) Election Form (so that you pay capital gains taxes on the shares you're about to be issued now rather than later)
- Mutual confidentiality agreement amongst co-founders
- Proprietary rights agreement
Believe me, I know what it's like to be a starving startup. Any cash outlay is terrifying. But you must be able to separate fear from the decision making process. $2500 is not a lot of money. And if you can't bring yourself to pay that much for something as important as an attorney, are you really starting a business? Or is it just a side project that you hope will become a business? There is a serious difference.
One last thought. We (http://www.shoefitr.com) didn't incorporate until we quit our "real" jobs to go full time. This gave us time to mitigate some technology risk and get comfortable working with each other before shelling out $2500. I think that's ok too. But if you're at the full-time stage of things, consult a professional.
I would really like to put off incorporating but I need a merchant account so I can bill people based on their usage.
Also even PayPal let me bill people based on usage, I hear horror stories about pay pal every day.
$2500 is not a lot of money. And if you can't bring yourself to pay that much for something as important as an attorney, are you really starting a business? Or is it just a side project that you hope will become a business? There is a serious difference.
That's a bit obnoxious ... $2500 is a fairly large chunk of money for a new business. Even on a reasonably high developer's salary, the average person would have to save aggressively for a couple months to pay that.
It's a bit heavy handed to imply that if you don't have $2500 to blow on attorneys upfront, you aren't actually starting a business. Especially when there are boilerplate documents that get you pretty damn close without you paying a dime:
One very important step five to add: check with your state's Secretary of State office to see if there are any additional steps that must be taken. Many states require foreign-registered LLCs and corporations to submit an "application for authority to transact" or otherwise register with them.
Depending on where you're located, a local business registration fee or license may be required as well.
It's also important to apply for an EIN number, which is generally required before opening a bank account in the business' name, and for tax purposes: https://sa2.www4.irs.gov/modiein/individual/index.jsp
There may be other steps that I'm missing, but as with any guide to navigating these waters, always ask for help in your particular situation, and don't be afraid to (indeed, please do!) consult a lawyer.
Definitely important to check on the rules specific to your state.
In addition to just acquiring permission to operate, there are sometimes tax specific requirements too. For example, in New York there is a separate, state-level S-corporation election. Even if you are already a federal S-corp you need to submit to the state in order to be treated as an S-corp on your state taxes.
Would it be worth going back and getting an EIN? Would I be able to change the bank account? What would the benefits of doing that be?
If it's just you or you and a friend starting something basic, a local business attorney should be able to keep you in check for $100-$150 an hour a few times a year. Early on I actually found some local contests for startups and won $4,000 in attorneys fees once, and once I got bigger applied for another one and received $10,000 in fee credit.
Look around, there are lots of people willing to help young startups. Offer to use an attorney on deferred payment status until you close at least a $1MM series A or have $1MM in revenue. From my personal experience many will do this for the chance at having you as a longtime client when you make it big.
Good luck!
One comment: You don't NEED to incorporate in delaware, unless you have specific liability reasons for doing so. Incorporating in your own state is usually cheaper and easier, so unless you have specific protection you want that only a delaware corporation corporation can provide (or nevada, they're also good), don't bother and just use your home state.
Also don't forget that there are upkeep costs for a corporation or LLC, certain paperwork (usually annual) that you have to keep up with and file each year to maintain the corporation.
Delaware wouldn't be my choice though.
Nevada, Washington, and Wyoming do not have state corporate income taxes.
Of course, international-based companies don't usually incorporate in Delaware because that would subject them to US federal income (and other) taxes, in addition to the taxes of their home country, on their full income, rather than just the income derived from their US operations. This is why multi-national corporations have separate subsidiaries in each country.
However if you're going to be seeking VC then it probably makes sense to incorporate in Delaware. However if you're like me and bootstrapping it, there is no need to go with a Delaware Corp.
The OP didn't mention anything about having the papers notarized. This is typically required, but perhaps not in Delaware? Also, as others noted, you'll often have to file for "foreign corporation" status in your home state.
Once you have filed "foreign corporation" status in your home state, you will probably need to check whether your product or service is subject to sales tax. Then you will need to get a sales tax account. Depending on your jurisdiction, this may include both state and city or county sales tax accounts. You should also call up the IRS or file online to get a Tax ID number (TIN/EIN).
Setting up an LLC in California will cost you $800/year..so this out of state C-Corp seems like a cheaper option
http://www.sos.ca.gov/business/be/name-availability.htm#chec...
I remember taking the DMV test there, and it was all pencil and paper stuff, and then it took something like a month to get the license.
In Oregon, it was all computer-screen driven, and licenses were issued in very short order.
The business name search is all on-line in Oregon, as is all filing, at least for LLC's. http://egov.sos.state.or.us/br/pkg_web_name_srch_inq.login