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What is the best way to incorporate a tech startup?

By IncNow | Published February 19, 2016
  • Where should you form your business?
  • What is the best type of business for a small tech startup?
  • Is an LLC or corporation more common?

app launchDear IncNow,

What is the best way to incorporate a tech startup? What steps should I follow?

Dear Customer,

 

The considerations in forming a tech business are the same as considerations in forming any other small business. It usually comes down to liability protection for owners from business creditors, but more importantly, protection from your own business partners. As a practical matter, the greatest threat to your business is internal, your partners. They are much more likely to cause the destruction of your business than outside creditors.

Three quarters of new businesses formed are LLCs and only about one quarter are corporations. There is a reason for this: the LLC is better.

You may have seen the movie The Social Network or read about Facebook’s origin. If Facebook had used a well-written Delaware LLC Operating Agreement from the beginning, most of those lawsuits could have been avoided entirely. That movie is really a parable of the problems that can result from the “Do-It-Yourself” mentality when it comes to creating reliable business agreements.

The main advantage in forming an LLC in Delaware for your tech business would be that the LLC Operating Agreement governing the company will be enforced by the courts as written, even if unfair to your business partners. So even harsh remedies, such as loss of business interest for failing to make subsequent capital contributions or the requirement that your business partners who leave your business to go work for Google get whipsawed in the buyout, only getting book value, those provisions will be enforced as written. Those are examples of provisions you can put into your Operating Agreement that will be honored by a business court in Delaware.

Statistically, companies that incorporate in Delaware can expect about 10% additional market cap because of protections built into their internal organizational structure.

This is one reason 80% of the new IPOs are Delaware companies and 66% percent of the Fortune 500 are Delaware companies. Smart business owners want this desirable protection if you are going to be creating the next “unicorn” tech startup.

Small startups should generally avoid the corporation because that form of business is much more complicated to operate properly, plus most do not have built-in shareholder agreements.

We have a comparison infographic to summarize the benefits:
Why Incorporate in Delaware? | IncNow

After you incorporate, you are also well-advised to establish Assignment of Intellectual Property Agreements with your business partners and Non Disclosure Agreements to help keep company trade secrets and ideas owned by the company.

Even if you add partners or want to provide incentives for key staff, that can be accomplished through amending and restating your LLC operating agreement in the future. The Delaware LLC is great protection and very flexible when drafting.

Good luck with your new tech business venture. You should consider the alternatives and choose to form a Delaware LLC. Even if you have not formed your LLC in Delaware, at a later date it can be converted to Delaware to take advantage of the Delaware LLC Act.

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When deciding where to form your company, consider that Delaware has advantages over your home state that may benefit you. Go