It's not uncommon for founders to wait to incorporate or form an LLC until they have moved further in the process, usually once they determine the business is viable. At some point, you will want to incorporate or form an LLC to gain liability protection. There are also some cases in which early incorporation is a good idea.
When You Should Incorporate Your Startup
You have a lot of decisions to make when you are in the early stages of your startup, including hiring staff and developing your product and marketing ideas.
The following are situations in which you should incorporate your startup early to protect yourself.
1. You are getting funding from a crowdfunding website
While many startups believe they do not need to incorporate before they finish the product, the truth is you are really dealing with hundreds or thousands of investors if you choose to raise money on Kickstarter or a similar crowdfunding website. When you are making a product, you cannot be 100% sure how it will turn out, or if it will turn out at all. Forming an LLC or incorporating before you start a crowdfunding campaign is a good idea to protect you from liability if everything does not go as planned.
2. You plan to issue stock
Many startups decide to give compensation to early vendors, employees and contractors in the form of stock options, or the chance to buy equity in the company at a lower price. To do this, you will need to incorporate. While it is technically possible to give employees an agreement stating they will get equity when you incorporate, it's much easier to do so beforehand.
3. You have 2 or more founders
Even if you are forming a business with your best friend, you need to accept the possibility that arguments or issues will come up later. Incorporating and issuing stock to founders prevents any problems down the road about how business profits and losses are split. You can also choose to form an LLC and complete your operating agreement that spells out ownership and eliminates the risk of conflicts later.
4. You want to build credit for your business
When you have a sole proprietorship or partnership, you will need to sign all business and vendor contracts in your own name and use personal credit for loans and credit for your business. This is because you do not yet have a separate legal entity. If you want a real business loan or you want to establish credit for your business that does not leave you liable for business debts, it's essential to incorporate or form an LLC.
5. You want to grow your business
If you are interested in growing your new startup by putting money into it, you will want to form a C corporation. If you incorporate and do not take profit out of the business, your business income is taxed at a much more favorable corporate tax rate and you can use the money to reinvest in business marketing, equipment and more. With a sole proprietorship or partnership, you would be required to pay taxes on your personal income tax statement, even if the money stays in the business.
If you are planning a startup, it's important to discuss your incorporation options with a business services company and/or attorney as soon as possible to protect yourself against risk.