You probably think incorporating your startup is a big accomplishment. And you should. It is. Incorporating is a necessary step in developing a viable business. But only do it for the right reasons and at the right time.
incorporating can bring baggage that burns money, time and relationships
From working in the legal space, we see founders incorporating way, way too early. That’s a problem because incorporating can bring baggage that burns money, time and relationships. Here’s a short list of problems:
- Incorporating generally costs about $500 (US). Spend that on ramen and your buffer subscription.
- Incorporating immediately creates paperwork that costs to file (think of annual returns).
- It creates unnecessary discussions, decisions and fights (e.g., who’s the CTO).
- When you want to do simple things such as adding a cofounder to the team, how do you do it compliant with your legal structure? Better head to the lawyer and fork over another $750 or swing by RocketLawyer and try to patch something together.
- Here’s a big one: Founders/partners that might not work well with each other immediately create a complex legal framework that binds them together. Why get married when you can date a bit before?
So when should you incorporate?
There are generally four reasons to incorporate:
- Revenue management. The startup is generating significant revenue and corresponding expenses. A corporation allows you to offset those expenses a net out a profit.
- Liability. A corporation is a legal person. That means if someone wants to sue your business, they sue the corporation not the shareholders personally. There are some exceptions to this rule, but we aren’t going there now.
- Grants and Tax Programs. Most governments these days provide grants and tax incentives for innovative businesses. They usually require a corporation to participate.
- Investment. Investors will not invest in a “startup”, they need to invest in a corporation where they can structure their investment.
Unless your business fits into one of these reasons, you probably shouldn’t be incorporating unless you have money to burn. If the reason you want to incorporate is to create a formal legal framework around your startup and cofounders, there’s a cheaper and easier way: a pre-incorporation founders agreement.
there’s a cheaper and easier way: a pre-incorporation founders agreement.
How a pre-incorporation founders agreement works
At Paper, our super-strong founders agreement does several important things:
- It declares who the founders are and what the team is working on (a tech and business model description);
- It declares that the team will incorporate if it is determined that there is a viable business;
- It declares what the equity distribution will be on incorporation (e.g., 40% to Jimmy and 60% to Mark);
- It declares what the vesting schedule is (e.g., after incorporation, Jimmy and Mark’s equity will be issued to them monthly for a period of 4 years);
- It also contains cliff and cease vesting clauses. In the event that a co-founder bails on the startup, the other cofounder(s) can stop issuing equity to that co-founder and even claw back equity. This protects the startup from a situation where a big chunk of the company is held by someone that isn’t contributing — that would make the business un-viable and un-fundable;
- It compels all the cofounders to execute full transfers of their claims and interest in any technology or assets developed pre-incorporation to the startup;
- It declares whether advisors are receiving equity or not.
As you can see, a founders agreement transcends the pre-incorporation to corporation divide. That is because it is an agreement among the founders, who remain post-incorporation. Founders agreements are private contracts, so they do not come with heft government filing fees and annual paperwork. With Paper, you can add a cofounder with a button and a few fields. No lawyers.
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