Startup companies are at the forefront of revolution and innovation. Great-minded entrepreneurs and individuals that have recognized a need for a certain product or a service typically form their startups with a very loose business structure, but for more successful ones, a time comes when this issue needs to be addressed.
Today, we are going to talk at length about startup incorporation. We’ll discuss the types of startup incorporations, reasons why you should approach it, and the benefits (and drawbacks) that are to be expected. Let’s dive right in!
Why Should You Incorporate Your Startup?
There are numerous reasons why startups should be incorporated, so before venturing any further, let’s briefly dive into the most notable ones:
Improved odds of securing capital
One of the main challenges the vast majority of startups face revolves around finances. Given that startups are businesses at their earliest stages, there’s much to be done, and pretty much every task and action costs more than an individual or a small group can handle.
By incorporating your startup, you will essentially rise above hundreds of your contemporaries didn’t by showcasing that your brand is more committed and your solutions worth consideration.
Limit Personal Liability
A business without a thoroughly defined structure is, in most countries, regarded as an entity with unlimited personal liability. This means that if your company gets sued, you will personally have to answer for any debts along with your partners.
The case with all forms of incorporations is completely different. An incorporated startup is a separate legal entity and is both taxed, sued, and held responsible for its business and financial endeavors.
A Stronger Foundation
Businesses with a loose structure are formed and dissolved just as easily. Incorporations, on another hand, generally outlive their founders and can be regarded as an asset that can be passed on for generations.
What Types of Incorporations Can Startups Evolve Into?
Incorporating your startup involves deciding on the type of business it should evolve into. There are several types of incorporation types, all of which come with unique advantages and drawbacks, including:
Corporations that have chosen to pass their corporate credits, losses, income, and deductions via shareholders for the purposes of federal taxes are called S Corporations.
Only shareholders are liable, but the corporation can have numerous employees and other members. The main draws of S Corporations are that they can be registered as corporations, limited liability companies, or general partnerships and that they can avoid double taxing. Additionally, S Corporation’s shareholders cannot be partners of your startup or any other corporation.
C Corporations are as flexible as S corps, with the main difference being that there are far fewer limitations in terms of shareholder profiles. The hierarchy of a C Corp is more regimented and pre-determined, requiring a BOD as its main operating body. With the advantage of building the infrastructure with enhanced flexibility comes the drawback of possible double taxation.
Both S and C corporations can be limited liability companies, but not the other way around. The main purpose of this business structure is to assign specific roles and levels of liability between founders, members, and employees. Its main benefit is personal-level taxation while its drawback is heaps of paperwork and a stretched-out filing process.
NFP corporations resemble C Corps more than they do S corps – a BOD governs the corporation while angel donators and a host of financial backers generally form the majority of shareholders. The main difference between ‘traditional’ and NFP corporations is that the latter are exempt from taxation. They’re not generally suited for startups, as the company needs to be committed to a public cause.
When Should You Incorporate Your Startup?
There are several typical scenarios where startups should evolve into a corporation. Some entrepreneur-founders of startup companies make this decision early on when they are confident that their product is ripe for the market.
Others delay this decision when a breakthrough technology is required for their product/service to reach its full potential, or when they are financially capable to withstand a qualitatively different form of taxing.
Be it as it may, the right time to incorporate is when at least some of the following conditions are met:
- Several founders and co-founders exist – in general partnerships and businesses with a looser structure, the roles of members aren’t thoroughly predefined. If this condition is met, it’s always a good time to incorporate a startup.
- There is a need for staff augmentation – family members and close friends may not be the experts that will take your startup to the next level. A corporation is more likely to attract talented professionals, as basic startups rarely offer consistency when it comes to the financial security of its employees.
- Additional protection against IP infringement is required – startups on the verge of designing a breakthrough product/technology/service can patent and protect their intellectual property more easily as a corporation, mainly because of clarified distribution of ownership among founders and co-founders.
- Need for additional funds and raising capital – startups can easily hit a plateau if they’re benefitting from a group of mid-tier investors (that are typically dispersing their investments among dozens, if not hundreds of different startups). If your startup is progressing very slowly, you can attract angel investors or venture capitalists of a higher caliber as a corporation.
When Not to Incorporate a Startup?
A few cases can occur when incorporating a startup may not be the most prudent decision. For example, if a startup is entering a fairly stable, slow-paced markets, such as the industry of florists or the nursery market, there is no pressure for the company to enter the stage as prepared as entering, for instance, online retail, food processing, or the crypto industry. Additionally, the administrative burdens and ongoing costs of incorporated startups may eventually lead them to ruin, so without a decent seed capital, it’s usually best to opt out of incorporating your company.
Incorporating a startup is an excellent way to limit the liability of owners, more efficiently split generated income, and protect intellectual property from potential infringement. On another hand, the initial costs of incorporation, nearly inevitable short-term losses, and different kinds of taxes may dissuade some from approaching this option.
Either way, startups that evolve into S or C corporations have sufficient flexibility to adapt to new circumstances and change tactics when necessary. LLC is also a viable solution that tackles the issues regarding personal liability without interfering with the core structure of a startup substantially. Stay safe, guys!
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