When and Where to Incorporate Your Startup
Deciding where and when to incorporate a new startup are the two key administrative decisions an entrepreneur will make. Failing to incorporate at the right time and in the right place can hobble the business with unfriendly startup eco-system, lack of talent, high taxes, and inability to protect its intellectual property. This guide will help you guidelines for choosing the right time and right place for incorporating your startup company.
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You should incorporate as early as possible after you have validated your business idea and concluded that it’s commercially viable and that you are ready to invest your time and money into it.
Although there are a number of different business structures for incorporation your business, a private limited liability company is the most advantageous and the de-facto standard for startups. It brings a host of benefits that include limited liability, easier access to capital, an image of professionalism, and more.
When to Incorporate?
There are several factors that can influence the timing for incorporation.
As a general rule of thumb, as soon as you have validated your business idea and you plan to pursue it seriously, you should incorporate a company as the first order of business. Failing to incorporate early enough can lead to personal financial risk, loss of intellectual property rights and missed opportunities in attracting people and capital.
Below are some common business scenarios when an entrepreneur certainly should incorporate.
Multiple Founders Involved
If your business involves more than one owner, a sound argument can be made for incorporating before they start working on the business idea. Adopting bylaws and distributing ownership can go a long way toward preventing misunderstandings and disagreements down the road. This is important if one or more founders decide that the enterprise is not for them and end up leaving. It is also important if the founders are contributing to the startup in unequal ways, such as one providing financing while the other providing sweat equity or intellectual assets.
In other words, the earlier you incorporate the sooner you can address these tricky issues and avoid a potential disaster later.
Need to attract top talent
Many entrepreneurs find the best way to attract top talent at an affordable rate is to offer stock options as an incentive. This is not possible without incorporating. Employee stock option plans enable employees to buy a specific number of shares in the company at a fixed price, which is usually less than their actual value. This is the model that many Silicon Valley startups use.
Intellectual Property Protection
A business that involves any intellectual property should incorporate immediately. Intellectual property developed before incorporation is the property of the person who developed it. Intellectual property developed after the startup is incorporated belongs to the company. Failing to incorporate before unique products, processes, applications and other creative components are developed can leave ownership open to question. This ownership question leads to disputes if the person who created the intellectual property decides to leave the startup and wants to take the intellectual property with him or her. Incorporating before the intellectual property is developed obviates the need to clear up ownership issues, which can be expensive and time-consuming.
Need to Hire staff
If your business is ready to start bringing on staff or hiring third-party contractors, you should incorporate right away. Not only you will have easier time to hire them under a company, it will protect your personal assets from any liability issues involving staff, workplace, contracts, etc. Incorporation also enables the business to assume ownership of any intellectual property created by employees or contractors while working for the startup.
Other operational activities
The startup should be incorporated before you enter into any contracts, such as office, equipment and vehicle leases or agreements for services with clients. If you are not incorporated, you will be entering into those contracts personally and will face personal liability if you cannot make good on them. Moreover, others will perceive an unincorporated startup as less established and will likely offer your worse terms in the contract to compensate for the added risk of dealing with an unsophisticated business. Finally, corporate taxes often allow deductions on expenses that are not permissible under tax schemes for individuals or unincorporated businesses.
Before you business takes in any revenue from sales, you must set up an appropriate business structure by law.
If you’re looking for investment, angel investors, venture capitalists and other investors generally will refuse to work with a business that has not been incorporated. Sole proprietors and partnerships look unattractive to investors, do not offer them the ability to own and transfer shares and do not provide them with limited personal liability.
Unincorporated businesses cannot get a business loan from a bank. Any loan would be a personal loan to the founders and would be based on the founders’ personal creditworthiness. To obtain the loan, the founders may have to stake their houses or personal vehicles as a form of loan security.
When not to incorporate yet
Situations in which you should not incorporate immediately, include the following:
- You are uncertain about your business idea and feel unsure that you will proceed forward with the startup business.
- A prior agreement (such as a non-compete agreement) will expose you to litigation if you form a competing business. By incorporating in a business jurisdiction such as Singapore that does not look kindly on anti-competitive agreements such as non-competes, you can significantly mitigate this issue.
Where to Incorporate?
The jurisdiction where you incorporate your business will have very important and long-lasting consequences.
If your startup’s business model is highly local (for example, a local restaurant), the choice of incorporation place is limited to the local city-state. However, if your start up’s business model serves global clients, then you must take the time to choose the right location that makes it easy to do business, maximize the potential of your business, minimizes the tax burden, and offers good infrastructure to work and live.
Dealing with a complicated bureaucracy (such as for onerous licensing procedures) is a drain on resources that entrepreneurs could otherwise use to grow their business. There are a number of governments who understand this and have gone to great lengths to create a business-friendly regulatory environment as a way of enticing entrepreneurs to relocate. In these countries, business creation is straightforward and on-going compliance regulations are minimal.
Intellectual Property Protection
Seek out a location that provides good protection for your company’s intellectual property rights. Intellectual property rights protections vary greatly around the globe, which means choosing the wrong country for your corporation base can leave you vulnerable to losing control of your IP assets.
The tax advantages to a startup of incorporating in a tax-friendly yet reputable jurisdiction typically outweigh the additional administrative costs in the long run for many successful businesses. Startup friendly countries such as Singapore offer low corporate tax rate, no capital gains tax, no tax on distribution of profits to shareholders (dividends), and extensive tax treaties with other countries to avoid double taxation.
Tax is a significant cost of doing business, and tax rate differential has proven to be a significant competitive burden for companies operating in high-tax countries such as U.S., India, Australia, etc. Whether incorporating a startup in low-tax country is worth the cost and effort depends upon the characteristics of the business and the founders’ objectives. If the founders’ vision is, in the long run, to operate globally, then incorporating in a tax-efficient country should be seriously considered.
Rather than pestering entrepreneurs with taxes and regulations, the ideal government spends its time investing in modern infrastructure. If your business sells a product that needs to be transported, you will need to choose a developed country with high-quality roads, railways, and ports. And, all 21st-century businesses require uninterrupted Internet access, reliable telephone lines, and quality electricity supply. According to a report by the World Economic Forum, the top three countries with the best infrastructure are Switzerland, Singapore, and Finland. India and Ukraine are examples of countries with poor infrastructure.
Perception of Customers
It is important to take into account the perception that your customers will have of your corporate location. The more reputable the jurisdiction, the better the perception. For example, a startup based in British Virgin Islands might come across as fishy, whereas a Silicon Valley or Singapore based startup will have a much better perception.
Access to Human Talent
Look for a location that has a population of sufficient size, education, and skills to meet your business’ human resource needs. As English has become the international language of business, you might also consider the chances of a local employee or contractor speaking the standard of English required by your business.
Quality of life
If you’re looking to run your business for the long-term, it’s important that you feel comfortable in your chosen country. Your choice will depend on your personality and lifestyle requirements. For example, Hispanic and Southern European cultures typically have a slower pace of life, which might be seen as anything from edifying to boring. Japan is renowned for being one of the safest places in the world to live and raise a family, but some people find its culture stultifying.
Some of the factors that you should consider when evaluating quality of life include:
- Overall public infrastructure
- Rule of law
- Healthcare facilities
Singapore ranks among the top countries for most of the above factors.
In general, it is a good idea to incorporate your business as soon as possible since incorporation brings many benefits. However, it is also important to carefully chose the location where you will perform the incorporation as jurisdictions differ significantly among themselves. When and where to incorporate is an important decision as it will have long-term implications for the business and for the entrepreneur. Therefore, the decision should be made with care and forethought.