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October 8, 2024

7 Reasons to Incorporate Your Startup

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Do you want to incorporate your startup? Looking for a balance between pros and cons? 

The benefits of incorporating are numerous. The purpose of this article is to cover the numerous reasons you may want to incorporate your startup and to show you why it is usually better to incorporate much earlier than later. 

Liability Protection

Business owners and shareholders are limited in liability when a business is incorporated. The concept of limited liability defines owners or shareholders as being financially responsible for the actions of their companies only to the extent of their investment.

Business partnerships and sole proprietorships have unlimited liability if they are unincorporated. Owners and partners of unincorporated businesses may be held liable if they cannot pay their debts.

An incorporation provides the owner with limited liability, protecting his or her personal assets from lawsuits and being held personally responsible for the company’s debts.

Separates Personal and Business Assets

When you incorporate your startup (and establish and maintain the corporate veil), you must separate your private and professional affairs. In order to understand your startup’s financial health and performance, you need to separate your personal accounts from business accounts. With an LLC for startups, you’ll enjoy tax advantages, asset protection, and flexibility in managing your business. 

Furthermore, a corporation or LLC must actually exist as a separate legal entity in order to qualify as a separate legal entity. Having mixed personal and business accounts could put your personal assets at risk (such as your home, your car, and other valuables) if you are sued. The process is referred to as piercing the corporate veil in business law.

Avoid Ownership Disputes

Additionally, if you have more than one founder on your startup, you should incorporate. The distribution of ownership, shares, and vesting conditions will need to be agreed to by you and your co-founders before incorporation. Making this decision early helps you avoid future disagreements or misunderstandings regarding each founder’s share.

After incorporation, the startup equity is divided among co-founders, employees, and other key stakeholders, with restricted shares subject to vesting granted to them.

Transferability of Ownership

Incorporation also facilitates the transferability of ownership in a business. Transferability of ownership is extremely important when you want to take on investment or sell your stake in the company.

Some transferability may be possible with LLCs. The ownership of an LLC can be transferred without dissolving the company in most states, although some prohibit the transfer. Nevertheless, both state laws and LLC operating agreements may impose numerous restrictions on transferring ownership. 

To admit a new member into an LLC, for instance, other members may need to approve the transfer of ownership. Compared to S corporations, C corporations provide much easier ownership transferability. Unless the shareholders’ agreement specifies otherwise, C corporations typically allow shareholders to transfer shares to others with limited restrictions. One of the reasons why C corporations are so popular with investors is because of this.

Attract Investors

Being incorporated will likely be necessary if you intend to attract investors. There is a good chance that your investors will want you to be incorporated – or rather demand it. By incorporating, personal liability is protected, tax benefits are provided, and shares can be easily transferred between shareholders.

The majority of investors prefer that you be incorporated as a C corporation. Most angel and venture capital investors invest in C corporations, because LLCs and S corporations cannot be financed by non-human investors (such as angel funds, venture capital funds, etc.). C corporations are likely to be the only option if you want to raise money from angel investors or venture capital firms.

Issue Stock

When you want to sell shares to investors, you must incorporate your startup. Companies issue stock for a variety of reasons, not just to attract investors. Early employees, advisors, suppliers, and vendors of startup companies are sometimes compensated with shares of stock or stock options in the company in the early, cash-strapped days. 

Stockholders and shareholders of LLCs do not hold stock or issue stock. To issue stock options or shares of stock in your company, you need to incorporate as a corporation.

Continuity

Additionally, LLCs and corporations have perpetual existence beyond the life of their owners, which makes incorporation a smart business decision. A corporation can last for an unlimited period of time. 

Sole proprietorships and partnerships are informal business structures where the business is directly tied to its owner(s) and terminates with the owner’s passing. 

Alternatively, incorporation designates a business as a formal legal entity separate from its owners. Despite the exit of the owners or shareholders, the corporation will remain in existence.

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