3 ms·

My local incubator's advice was "incorporate as soon as you can afford it, maybe slightly sooner than that". Incorporating limits your liability. If your busin

by cbhl 12y ago

My local incubator's advice was "incorporate as soon as you can afford it, maybe slightly sooner than that". Incorporating limits your liability. If your businesses screws up before you're incorporated, then you are a sole proprietor, then you can lose everything (say, your house, if you own one). Granted, it was a college incubator, so they gave that advice knowing that a bunch of students were at an exploratory stage that doesn't warrant the overhead (fees, taxes) of a company.

dkrich 12y ago
There are a couple of distinctions to make here, both practical and probable. First, forming an LLC does not protect you from liability in and of itself. The idea of creating an LLC is to create a legal entity that is separate from yourself. However you still must act as if you are separate from the business by creating a separate bank account and using it for all business purchases, for example. If you form an LLC but then buy all your supplies and hosting with your personal credit card, in the eyes of the law you are a sole proprietorship. Ideally this would be done early on, as there isn't much downside. However there is some. First, there are filing fees and a lot of times you must pay a representative for your business (especially if you are filing in a different state). Then if you want to dissolve your LLC, this can cost hundreds of dollars. Practically speaking you won't get sued unless you're already successful. The reason is quite simple. If you don't have anything worth going after (assets, an insurance policy, etc.), no lawyer is going to take the case without charging sizable fees. For most people, paying an attorney out of principle isn't going to be a realistic option. Therefore, I would say it really depends on your business and the potential liability. If you are starting a company that catalogs baby pictures, your potential liability is probably pretty low. I wouldn't worry about filing for an LLC before I had a decent set of customers. If you are starting a company storing sensitive financial data, I'd definitely file for an LLC and probably take out a large insurance policy to boot (see how those are correlated?).
nostrademons 12y ago
I've talked to a couple lawyers about this and their advice, somewhat surprisingly, was that you don't need to incorporate until you're past the "project" stage. Specifically: 1.) You're handling money. As soon as money's involved your liability goes up significantly - plus, the corporation needs its own bank account. 2.) You have investors. They need an entity to be able to invest. 3.) You need the business to continue if one of the people involved backs out. If you're a few guys in a garage, your startup is probably screwed if any of you back out, and so having a formal shareholder agreement and property owned by the corporation doesn't really gain you anything. If you're an operating unincorporated business with something of value and your tech cofounder backs out, he holds the business hostage, because he owns the IP. 4.) You're doing anything that's risky and may piss people off, eg. spammy marketing campaigns, crashing peoples' conventions, abusing another company's API, scraping data where the ownership is unclear. You can get a lot of protection from lawsuits simply by not pissing people off; people who aren't mad at you and don't think you've wronged them don't sue you. But if you're doing something that's a grey area, you really really don't want your personal assets at risk. The main downside of incorporating is that then you have to deal with all the administrative details of being a corporation. You have to pay yourself minimum wage, or else you're in violation of minimum wage laws. You're taxed on the income you receive as wages (even though it's just a transfer from yourself to yourself), so the IRS is taking 15% or so of your runway off the top. You have to file both corporate and individual taxes, which is a big distraction when you want to be working on your product. You need to have at least nominal board meetings (in the beginning, this can be just you and your cofounder sitting down at the table), where minutes are kept. It also costs a few hundred in fees, which is money you don't get back if the startup never finds any customers (as most don't). Basically - you can and should be "just a person working on a project" when you're building. When you release it to the world and let people who you don't personally know use it, it's probably time to incorporate.
- rottyguy 12y ago
  Thanks. Just a point of clarification on (1). Is that just for taking IN money as opposed to just paying out for things like purchasing computers, software, freelance to design your website, etc?
  - nostrademons 12y ago
    Yes, but you probably also want to incorporate if you're paying out money. The business relationship a third-party supplier has is with the entity that pays them. If you buy something from a supplier on your personal credit card, they're unhappy with the transaction, and they sue, they sue you and not the corporation. You're probably fine if you're buying commodity products like, say, web-hosting. You might get into trouble if you do it with negotiated purchases like contractors. YMMV; again, "not pissing people off" is a pretty good legal defense, and I certainly know folks that have hired artists or app developers before incorporation without anything bad happening.
- dkrich 12y ago
  Just to clarify- if you are incorporating as an S-Corp or C-Corp you do pay taxes off the top, but if you file as an LLC you have pass-through taxation, meaning that you only pay tax on your income, the business doesn't have to pay taxes on top of that.
  - adventured 12y ago
    Further clarification: that depends on your election as an LLC. You can elect to be taxed as a corporation as an LLC, in which case the taxation will not be pass-through as a disregarded entity or partnership, and you'll need to file the normal 1120 corporate return. http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/LLC-Filing-as-a-Corporation-or-Partnership http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employ...

by cbhl 12y ago

dkrich 12y ago

There are a couple of distinctions to make here, both practical and probable. First, forming an LLC does not protect you from liability in and of itself. The idea of creating an LLC is to create a legal entity that is separate from yourself. However you still must act as if you are separate from the business by creating a separate bank account and using it for all business purchases, for example. If you form an LLC but then buy all your supplies and hosting with your personal credit card, in the eyes of the law you are a sole proprietorship. Ideally this would be done early on, as there isn't much downside. However there is some. First, there are filing fees and a lot of times you must pay a representative for your business (especially if you are filing in a different state). Then if you want to dissolve your LLC, this can cost hundreds of dollars. Practically speaking you won't get sued unless you're already successful. The reason is quite simple. If you don't have anything worth going after (assets, an insurance policy, etc.), no lawyer is going to take the case without charging sizable fees. For most people, paying an attorney out of principle isn't going to be a realistic option. Therefore, I would say it really depends on your business and the potential liability. If you are starting a company that catalogs baby pictures, your potential liability is probably pretty low. I wouldn't worry about filing for an LLC before I had a decent set of customers. If you are starting a company storing sensitive financial data, I'd definitely file for an LLC and probably take out a large insurance policy to boot (see how those are correlated?).

nostrademons 12y ago

I've talked to a couple lawyers about this and their advice, somewhat surprisingly, was that you don't need to incorporate until you're past the "project" stage. Specifically: 1.) You're handling money. As soon as money's involved your liability goes up significantly - plus, the corporation needs its own bank account. 2.) You have investors. They need an entity to be able to invest. 3.) You need the business to continue if one of the people involved backs out. If you're a few guys in a garage, your startup is probably screwed if any of you back out, and so having a formal shareholder agreement and property owned by the corporation doesn't really gain you anything. If you're an operating unincorporated business with something of value and your tech cofounder backs out, he holds the business hostage, because he owns the IP. 4.) You're doing anything that's risky and may piss people off, eg. spammy marketing campaigns, crashing peoples' conventions, abusing another company's API, scraping data where the ownership is unclear. You can get a lot of protection from lawsuits simply by not pissing people off; people who aren't mad at you and don't think you've wronged them don't sue you. But if you're doing something that's a grey area, you really really don't want your personal assets at risk. The main downside of incorporating is that then you have to deal with all the administrative details of being a corporation. You have to pay yourself minimum wage, or else you're in violation of minimum wage laws. You're taxed on the income you receive as wages (even though it's just a transfer from yourself to yourself), so the IRS is taking 15% or so of your runway off the top. You have to file both corporate and individual taxes, which is a big distraction when you want to be working on your product. You need to have at least nominal board meetings (in the beginning, this can be just you and your cofounder sitting down at the table), where minutes are kept. It also costs a few hundred in fees, which is money you don't get back if the startup never finds any customers (as most don't). Basically - you can and should be "just a person working on a project" when you're building. When you release it to the world and let people who you don't personally know use it, it's probably time to incorporate.

rottyguy 12y ago
Thanks. Just a point of clarification on (1). Is that just for taking IN money as opposed to just paying out for things like purchasing computers, software, freelance to design your website, etc?
- nostrademons 12y ago
  Yes, but you probably also want to incorporate if you're paying out money. The business relationship a third-party supplier has is with the entity that pays them. If you buy something from a supplier on your personal credit card, they're unhappy with the transaction, and they sue, they sue you and not the corporation. You're probably fine if you're buying commodity products like, say, web-hosting. You might get into trouble if you do it with negotiated purchases like contractors. YMMV; again, "not pissing people off" is a pretty good legal defense, and I certainly know folks that have hired artists or app developers before incorporation without anything bad happening.
dkrich 12y ago
Just to clarify- if you are incorporating as an S-Corp or C-Corp you do pay taxes off the top, but if you file as an LLC you have pass-through taxation, meaning that you only pay tax on your income, the business doesn't have to pay taxes on top of that.
- adventured 12y ago
  Further clarification: that depends on your election as an LLC. You can elect to be taxed as a corporation as an LLC, in which case the taxation will not be pass-through as a disregarded entity or partnership, and you'll need to file the normal 1120 corporate return. http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/LLC-Filing-as-a-Corporation-or-Partnership http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employ...