Why You Should Incorporate Sooner Rather Than Later
Most growth ventures seeking financing or considering an exit in the future will incorporate. When time and cash are tight in the early days of a new business, however, founders are often tempted to put off incorporation until it is absolutely necessary. Despite these pressures, we usually advise founders to incorporate as early as possible for several reasons.
Agree with your co-founders while you still agree
During the incorporation process, founders decide how many shares will be issued to each co-founder and who will run and control the company. We also encourage founders to ensure the relevant intellectual property is assigned from the founders to the company, and agree on how the share and governance structure may change as investors enter the picture and as the founders’ roles change in the company.
These are important issues that go to the heart of a business and the relationship between the founders. Founders will need to decide on these things eventually, but the longer they wait the greater the risk that a conflict arises between the founders in the meantime. Without any legal agreements to govern how that conflict will be handled, any such disagreement has the potential to completely stall a new venture.
Incorporating early will ensure that some key issues are worked out and documented before the venture gets too far along. In general, it is much easier for founders to agree on these matters early on in a venture’s life. After devoting hundreds of hours of time and energy into an idea and product, founders often find it more difficult and time-consuming to address these issues, since the stakes are higher and the relationships between the founders have inevitably grown more complex.
Prevent tax complications
When a company is first incorporated, its founders are issued shares in return for a payment. With most companies we incorporate, the payment is usually a nominal value, such as $0.0001 per share. A completely new venture usually doesn’t have any intrinsic value, making this nominal value justifiable.
If a founder were to first build some value into the business through a sole proprietorship or partnership before incorporating, the co-founder could be issued shares at the fair market value (requiring a cash outlay that is usually not desirable for the founders) or at a nominal value. Unfortunately, however, the issuance of shares for anything below fair market value would trigger some tax consequences for the founder. While lawyers and accountants could help minimize the impact of some of these consequences with some additional documentation, it would certainly be more expensive and time-consuming than if the company were incorporated at the beginning of the venture’s life.
Reserve your company name
Incorporating early can make sure that you can reserve your company name with the provincial or federal authorities (depending on whether you incorporate provincially or federally). Since company names are assigned on a first-come, first-served basis, many companies want to register as early as possible to claim their preferred name.
Importantly, founders should note that registering a company name is different than registering a trademark. To ensure that a company is not infringing on a trademark or can own a trademark on a particular name, founders should seek the advice of a lawyer or registered trademark agent.
Benefit from limited liability early on
Incorporating early can allow founders to enjoy the benefits of limited liability early on. Running a business and entering into contracts through the corporation from the beginning will reduce complication and minimize a founder’s personal exposure the financial risks of a new venture. This point may or may not be a major consideration depending on the type of business you are building.
Show investors you have your act together
When dealing with potential investors, a company and its leaders want to appear organized, decisive, and professional by having the corporate structure in place. Being able to show investors an industry standard legal structure will not only make a company and its founders more marketable to investors; it will also allow a company to negotiate and close potential investments more quickly and efficiently.
Incorporating and implementing founder agreements early can also give the company a strategic advantage in negotiations with investors. If companies wait until an investor is in the picture before finalizing the founder agreements, the investor may have an easy opening to dictate some of the terms of these agreements. If the company instead has these agreements in place before the investor arrives, the onus is on the investor to ask for certain changes as part of a negotiation.
Convinced that it’s time to incorporate? Contact us today!