Forming a legal entity is not always an immediate consideration for start-ups. In some cases, founders may choose to delay formalizing their relationship to ensure that other important business details are first put in place. At a certain point, the founders begin to think about when they must formalize their agreement and form a legal entity. Ask the following questions to assess whether the time has come to form a company for your start-up:
Moving past a solopreneur
Bringing on a co-founder can be the best time to form an entity if the original founder has not already. This enables the parties to think about important details and to make sure that they are on the same page before getting started. A few important details to think about when discussing the terms:
Ownership share. Ask who owns how much;
Vesting schedules. Establishing when rights to such ownership are fully vested;
Allocation of profits and losses. In some cases, this can be different than ownership;
Exit options. Set procedures in place to establish the rules for exiting while things are good;
Valuation. Establish procedures to routinely discuss and assign a value to the entity.
Take the time to write things down each time someone enters (or exits) the organization with ownership rights. Investors will look for these formalities and it will go a long way to minimize arguments between co-founders – even if the startup does not look to bring in outside investors.
Before seeking a patent
Intellectual property is frequently the most valuable asset of most startups. Protecting that asset is expensive, but not as expensive as failing to put the protections in place. Forming an entity before protecting the IP can make things easier by:
- Ensuring that all assets are owned by the entity rather than the individual creators/founders;
- Saves money associated with filing fees for assignments of the ownership of the IP;
- Minimized the chance of oversight in performing the assignments.
Forming a legal business immediately is the best practice for startups based largely on intellectual property. Doing it will save money, time, and frustration if things do not go exactly as planned.
Beginning to generate revenue
Money changes people and dynamics of every company – no matter how long the founders have known each other. Forming the entity and putting in writing how the parties will share the success is best done before the startup begins to make money. This will also help to address:
- Tax obligations and responsibilities;
- How the money will be shared:
- What debts will be paid; and
- Establish priorities for re-investment.
Nothing spoils a relationship between founders faster than a squabble over cash. Avoid this gigantic headache by putting in writing how the parties will deal with success, failure, and taxes – all of which are certain in a startup. Delaying this could result in hefty legal fees, tax penalties, and avoidable complications to your startup.
Founders looking to protect themselves in good times and bad should also be wary of doing just the minimum required. Forming an entity requires the founders to put into writing the important terms of their relationship and how it might end. Sooner is usually better than later to form an entity regardless of entity type selected.
Loop Legal offers services to entrepreneurs built on an innovative pricing model to help start-ups from launch through scaling. Contact us today to learn more.