If you founded a startup but have not already incorporated your company, you are probably considering doing so. Incorporation is one of the first steps in setting the appropriate legal groundwork for your startup. Before you incorporate, a few things to consider are whether a corporation is the right type of entity for your business; where you should incorporate; what type of corporation you should form; and whether you are willing to maintain your corporation.
Should You Incorporate?
Many startups incorporate as Delaware corporations without considering whether a corporation in another state or even a completely different business entity, such as a sole proprietorship, partnership, or LLC, is more appropriate.
For example, if you are a one-person operation with merely an idea, you may wish to operate as a sole proprietor or if you have a business partner, a partnership, while getting your business off the ground. You may have started operating and decide you need to isolate yourself from the risks of the business, but opt for a LLC instead of a corporation because you do not plan to raise equity capital.
Once you’ve considered all your options and conclude that a corporation fits your needs, you must decide where you should incorporate and what type of corporation you should form.
Where Should You Incorporate?
Startups tend to incorporate in Delaware because Delaware has a well-established body of corporate law that is known to be business-favorable and professional investors prefer Delaware as a state of incorporation. Delaware is also suitable for high-growth companies that eventually plan to do an IPO.
If none of this applies to you, incorporating in your home state and re-incorporating in Delaware if and when your circumstances change may be more suitable.
What Type of Corporation Should You Form?
Once you decide the place of incorporation, you must decide what type of corporation you should form.
Some startups form S-Corps because they hear it protects them against “double-taxation,” but later find that they cannot accept professional investments or authorize more than one class of stock, sending them scrambling to convert into C-Corps.
Other founders have a social purpose in mind and find the the purpose of a corporation — maximize shareholder value — at odds with their social purpose. A social purpose or benefit corporation may have better suited their need.
Are You Ready to Maintain Your Corporation?
Some founders are misled into believing that incorporation requires merely filing a few forms with the Secretary of State and executing a generic set of bylaws. Not only is that incomplete and may not offer adequate protection, you cannot simply set up a corporation and forget about it. Failing to maintain your corporation may subject you to penalties, including losing any protection against personal liability that a corporation would otherwise give you.
You must maintain your corporation with the Secretary of State and internally. Depending on where you incorporate, you may be required to file reports and pay taxes each year.
Delaware, for example, charges an annual franchise tax and requires an annual report. Like Delaware, California also requires you to file an annual report and pay annual franchise taxes, including a mandatory minimum franchise tax of $800 even in a year where you make no money.
In addition to requisite annual filings and taxes, you are also expected to follow corporate formalities when running your corporation, including holding annual meetings, giving proper notice to shareholders and directors of meetings, and maintaining meeting minutes, amongst other things.