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When is the right time to incorporate a startup?

April 16, 2024
Minh Mai

The day you incorporate your startup is an exciting one. It represents the transition from an idea in your head to a manifestation of something — an entity —  in the real world. Its creation is something to celebrate.

However, understanding exactly when to incorporate a startup is important. The timing of your incorporation can make a big difference in many aspects of your startup, including legal liabilities, tax structures, and investor relations.

Here’s what you need to know to get the timing of your incorporation just right.

What does “incorporating a startup” mean?

Incorporating your startup means completing the legal steps necessary to form a corporation out of your business. Prior to this point, the business has been something less formal, like a sole proprietorship or informal partnership. 

An unincorporated business isn’t legally distinct from its owners, while an incorporated business becomes its own legal entity. Most of the time, for startups, incorporation is the process of becoming a limited liability company (LLC). 

Incorporation is a significant step for startups, as that separate legal identity provides both legal and financial protections to owners and shareholders. It also shows a level of seriousness or commitment and suggests that the business is on a path toward viability.

Why you should consider incorporating your startup

There are numerous reasons why incorporating your startup is a wise move once you reach certain milestones. Liability protection, various potential tax benefits, financial capability, and credibility are among the most important.

Liability protection

Incorporating your business limits your liability by separating your personal assets from business debts and obligations. It isn’t fun to think about, but there’s a chance your new venture could incur a costly lawsuit or even fail entirely — and you don’t want your personal income and possessions on the line if that happens! 

By incorporating, you’re turning your business into a separate legal entity, protecting yourself (and any other startup founders) from personal liability for debts and other financial obligations.

Of course, liability and risk can vary widely depending on your industry. So be sure to consider the legal landscape of your industry as you evaluate whether incorporation is the right protective measure at this point.

Here’s an example. When you first launched your product, you weren’t storing any customer information. But, based on user feedback, you realized that storing some sensitive information, like names and phone numbers, could actually create a much better user experience. Storing that new data is an indication of increased risk, which could signal that it’s a good time to incorporate.

Alternatively, say you’re handling significant amounts of customer money as a financial advisor or a vendor with large contract values. In this case, litigation is a real possibility if things go south with a client or customer. 

You don’t want your personal savings, retirement, or even property to be on the table if the worst should happen, and incorporation generally prevents those kinds of worst-case scenarios.

Tax benefits

Incorporating your startup may also net certain tax advantages that aren’t available to sole proprietors.

Say you’re the only employee at your startup, and you form an LLC and elect to be taxed as an S-corporation. This allows you to pay yourself a salary, which is subject to payroll taxes, but also distribute additional profit as dividends, which are not subject to payroll taxes.

On the other hand, as a sole proprietor, all profits and losses pass through to your personal income tax and are subject to the self-employment tax rate.

There’s also the C-corporation route, but unless you’re ready to start selling shares of stock, then you’re probably not going to benefit from becoming a C-corp.

Of course, we’re not tax professionals or accountants, so please take this as general information. We highly recommend consulting with a tax professional for personalized advice in this area.

Curious if you can file taxes with a virtual address? You can! However, we recommend consulting a tax professional in your actual state for specific details. 

Credibility with investors

When you reach the stage where you’re talking with investors and seeking to secure funding rounds, you definitely need to incorporate. Because incorporation shows a level of professionalism and commitment, it should be a given by the time you’re courting investors.

Generally speaking, you won’t be able to secure a business bank account without an EIN from the IRS — something only an entity can obtain. And investors aren’t going to dole out funding rounds into your personal checking account.

Of course, many founders pay for personal expenses from their own bank accounts, especially early on. But once money starts moving into or out of your business consistently, it’s important to ensure there is a clear separation of financials. 

A dedicated business bank account is going to make it much easier to pay taxes, reconcile your books, and keep track of your general funds.‍

When should you incorporate a startup?

Incorporation is the right move for just about any startup — eventually. The question is when to make the move. 

Here are a few business milestones that signal it might make sense to incorporate.

Pre-revenue phase

It may seem like a needless hassle to incorporate before you’re making money, but if you’re meeting certain conditions, pre-revenue might be a great time to incorporate.

If you’re in a high-risk industry (where your own personal assets could be at risk) or will need outside funding before revenue is possible, then incorporation at this stage is wise. The same is true if you aren’t the sole founder, as co-founder relationships can lead to dysfunction if not formally defined.

Another common scenario is hiring employees with the promise of sweat equity — future returns in the form of shares or dividends in exchange for work now at low or no pay. If this is the case, you need to incorporate so that those shares and dividends are actually possible.

Finally, some early-stage startups (especially software and tech entrepreneurs) rely on intellectual property (IP) that provides significant stakeholder value. This is another situation where you’ll want to incorporate early so you can start protecting your IP.

At funding rounds

You’ll also need to incorporate before entering funding rounds. Venture capital and angel investors expect to see a level of seriousness, and incorporation signals commitment and professionalism. 

There’s also the practical matter of where they actually put their money. To have a business bank account, you need a legal business entity, which means you need to incorporate.

Business growth and expansion

Sometimes a business gets started as something less official. Maybe it’s a hobby or an experiment that evolves into a real profit-making venture. 

Maybe it’s a software project you developed on the side that suddenly blew up or went viral. You didn’t intend for it to become a full-time job or a company with dozens of employees, but it seems like things are heading in that direction.

If it’s time to establish a more formal business structure, enter a new market, or expand your business in any other way, then it’s definitely time to incorporate.

Before hiring employees

It’s not impossible to hire employees before incorporating, but it does make managing your business more complicated. Remember, your sole proprietorship and you are legally the same entity, which means you’re responsible for all liabilities — including payroll taxes, unemployment, and workplace risks.

That’s why many startups elect to incorporate before hiring employees outside the founders. It’s better for the business, not you personally, to be on the hook for business costs and liabilities. 

Remember, incorporation provides a level of protection — not just to your employees, but also to you. It also shows a greater level of professionalism, which might be necessary as you seek to attract the right kind of talent.

How to begin the process of incorporating a startup

If you’ve evaluated the current state and phase of your business and concluded that it’s the right time for incorporation, here’s how to begin. You can also check out our full guide on how to incorporate for more details.

Choose the right business structure

As we mentioned earlier, incorporation isn’t a single step that looks the same for every startup. You’ll need to decide which business and taxation structure makes the most sense for your context.

Most small companies and startups will structure themselves as LLCs, though there are a few other options for business structure (namely general partnerships and limited partnerships). 

There’s also the question of your tax designation. Most businesses with fewer than 100 employees elect to be taxed as S-corporations. If you’re larger than that, plan to be soon, or intend to issue stock shares of the company, you’ll likely need to register as a C-corp. 

Register your business name

You’ll also need a business name that’s unique (at least within the state where you’re incorporating) and legally compliant. Branding is important here, but legal protection and compliance matter even more.

You can search these databases to make sure the name you want isn’t already taken:

You should also check with your Secretary of State’s office (or whichever agency is responsible for business registration in your state).

The process for registering your business name varies considerably from state to state. We recommend consulting this guide from the Small Business Administration.

Quick note: You’ll most likely want to register in the state of Delaware in addition to the state where you do business. Venture capitalists often require business owners to be registered in Delaware due to the state’s favorable corporate tax policies.

File incorporation documents

Next up is dealing with your business formation documents. Filing incorporation documents happens at the state level, and you can likely find step-by-step instructions on your Secretary of State’s website. There are also online services that can take care of this for you, or you could elect to work with a lawyer.

You’ll typically need the following information:

  • Corporation name and address
  • Registered agent
  • Business purpose
  • Directors and officers
  • Number of shares
  • Class of shares
  • Incorporator

Obtain licenses and permits

Depending on your industry, you may need certain permits, licensures, or certifications to incorporate in your state. These requirements vary considerably from state to state, and the process of obtaining them is different in each state as well.

Start by finding your Secretary of State’s website, small business development office, development services agency, and/or other similar groups. There, you’ll typically find a list of industries that require additional permitting or licensure, as well as how to properly register your business in your state.

While each state will vary, here’s an example of the proper licensing resources for the state of Ohio:

Choose to secure your startup’s future with incorporation

Incorporating is an exciting process for any business founder. The trick is understanding when to incorporate. Too early, and it may cost you time and money you didn’t need to spend. Too late, and you may expose yourself to unnecessary risk.

Whatever your decision on incorporation, Stable is your ideal partner for managing operational challenges, streamlining processes, and supporting business growth. 

At Stable, we provide permanent virtual addresses and mailboxes, so you never have to worry about handling business mail again. We’ll digitize all your mail, so you can view it online, forward it, shred it, and even deposit checks from anywhere in the world.

Want to set up a premium virtual business address + mailbox in less than 3 minutes? Get started with Stable now!

Disclaimer: Stable is not a legal or accounting firm. Therefore, we cannot provide legal or tax advice. You should consult legal and tax professionals for advice on how to meet ongoing obligations that apply to you and your company.

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