Not sure why and how you should incorporate your startup? Considering several alternatives? Incorporating a new startup is usually a very technical and mostly simple process that requires filling out documents and signing standard forms. There are, however, several elements to consider with your advisors before rushing into this process.
Why should you incorporate?
It’s easier and more acceptable for technology ventures to create their businesses as entities, rather than as individuals. Entities are entitled to better management, decision making mechanisms, allocation of rights and obligations, and much more.
Additionally, conducting your venture’s business as a company creates a “protecting wall” against liability, which separates you, as a shareholder and officeholder, from creditors, clients, and employees of the company. This wall can be “removed”, but it generally requires court intervention and substantial legal efforts.
How should you incorporate?
There are several forms of incorporation. A venture can be incorporated as a regular corporation, an LLC (in the US, treated as a pass-through entity for tax purposes), or a partnership. The protective wall principle does not necessarily apply to all of these, but each has its own respective advantages and disadvantages.
Before choosing how and where to incorporate, consider these four major elements:
- Taxation:Taxation can be a very complicated issue, one that many lawyers, accountants, and entrepreneurs tend to avoid. This is mostly because of the uncertainty involved in establishing a venture with unclear business feasibility, market success, sales and, in most cases, secured equity investments. Nevertheless, taxation is perhaps one of the most important factors to consider before incorporating an entity. The type of entity you’ll choose to incorporate (LLC, corporation, partnership, etc.), the jurisdiction in which the venture is incorporated and how it’s funded, will all have implications on taxation.Additionally, it is important to point out that in recent years, global efforts are made, particularly between the members of the Organization for Economic Co-operation and Development (OECD), to set applicable tax regulations that will bypass possible tax benefits achieved by offshore incorporations.
- Investors: There are many investors who will not invest in offshore entities. Sometimes due to the legal documents approved by the stakeholders supporting those investors. Such documents sometimes allow for investments to be made only in particular jurisdictions.If you intend to approach potential investors, even if they have already invested in your venture’s domain and may be interested in investing more money, make sure to understand their policies in advance. You can do this by checking their past investment track record. Usually, a quick skim through their website will show you where they’ve already invested. If there are any strategic investors that you would like to approach further down the road, investigate them as well. Note that this should be your first consideration if you operate in a very unique market.The structure and type of entity that you’ll incorporate should be one that investors in your venture’s domain are used to seeing and to working with. For example, VCs and angels operating in the technology sector don’t usually invest in unlimited partnerships and occasionally refuse limited partnership investments as well. Most of these investors feel much more comfortable working with limited liability companies and some will often show sensitivity to incorporation jurisdiction, as it may have tax implications that they might want to avoid.
- Employees: You want your venture to be in the vicinity of talented, equipped, and well-educated manpower. The ability to form a talented team and to harness it, could be a venture’s X factor. Startups with commercially poor, undeveloped products can still get sold for tens of millions of dollars just because of their high quality teams.Although talented staff can be employed in remote locations and subsidiaries or other commercial structures can be used, it is very important that a company’s core team will be located, at least initially, in the same area.
- Clients: Find out where your clients are located. You need to stay close to your market, and know it very well. Even with the web, emails, and video conferences, the ability to sit in front of a major potential customer can have a significant impact.
In conclusion, before you decide how and where to incorporate, you should carefully consider your entity’s structure, human resources availability, and other considerations such as customer and supplier locations.
Many of today’s start-ups and young entrepreneurs re-incorporate their companies overseas and then transfer the original company’s assets to the new incorporated entity, which is known as “corporate inversion”. Unfortunately, they suffer great legal and taxation costs because they didn’t put enough thought into the aforementioned factors. Make sure you do.