When Should Founders Incorporate their Business?
The official start date for your startup is the date you incorporate the business. This is obviously important for tax purposes, but may also dramatically influence how potential investors, customers, and competitors look at you.
My rule of thumb expectation is that it should take two months to set up the legal entity, six months to finalize the business plan, and by the end of the first year have a prototype product ready for customers. At this point every potential investor will listen. Timelines which vary dramatically from these will be questioned, and need to have good explanations.
For time and effort considerations, I tell clients that a sole proprietorship or partnership is the simplest setup, because it basically requires no legal forms. Incorporation as an LLC, a C-Corp or an S-Corp is more complex, but has the great legal advantage of limiting liability to the entity, away from personal assets.
A C-Corp is the most complex, and is recommended when you need multiple classes of stock, expect venture investments, or have over 100 shareholders. But even this one can be done in a month in most states.
For more specific considerations, you should consult your attorney, or at least visit one of the many sites which focus on this process. Many startups defer the incorporation decision until they have an investor lined up, but that can raise significant tax issues, as I outlined in another article on founder’s stock.
Aside from the tax considerations, there is nothing wrong with tinkering and honing an idea for years (on your own funding), before you incorporate a company and take it to market. But once you incorporate the company, all measurements start and you need to keep the process moving.
Consequently, if you approach investors for funding, and they find out your company was formed five years ago, but gone nowhere due to your other activities or false starts, they will likely assume that you are a procrastinator, or worse yet, that you have failed to make progress despite your best efforts. No investment will be forthcoming, and competitors have likely closed in.
On the other end of the spectrum, remember that you only get one chance for “first impressions” with investors, So don’t rush it by trying to sell your “idea” to investors with only a verbal spiel, before you even have a company or a business plan. Save these discussions for friends, family, and trusted business advisors.
In conjunction with the timings above, here are my recommendations on the sequence of events:
- Focus and solidify your product idea and company name before incorporating.
- Incorporate before spending big money on development or assets to limit liability.
- Assemble the core team for development using personal, friends, or family funding.
- Move quickly to prepare the case for external funding, if angel investors are required.
- Build a minimum product, add sales, and test the market quickly, then iterate.
- Scale the business, getting venture capital funding as required.
Obviously, timings can vary dramatically when technology or regulatory constraints are involved. The key is to show everyone a record of continuing momentum. If investors or customers lose confidence in you, or you run out of cash, the momentum can stop on your startup as quickly as it starts.
Your timeline and momentum is the message you scratch in the sand for investors. Don’t let the passage of too much time blow it away.
|Author(s)||Marty Zwilling (other articles by Marty Zwilling)|
|Original Publication Date||April 3, 2012|
|Related categories||Nuts & Bolts|
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