What is the best way to incorporate a tech startup?
- Where should you form your startup?
- What is the best type of business for a small tech startup?
- Is an LLC or corporation more common?
What is the best way to incorporate a tech startup? The considerations in forming a startup are the same as considerations in forming any other small business. For most, it comes down to liability protection for owners from business creditors. More important, however, is 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.
What Kind of Company Is Best for Tech Startups?
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. Most of those lawsuits could have been avoided entirely. Facebook should have used a well-written Delaware LLC Operating Agreement from the beginning. 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.
Delaware Courts will enforce the LLC Operating Agreement governing the company as written, even if unfair to your business partners. That is the main advantage of forming an LLC in Delaware for your tech business. Judges will enforce as written even harsh provisions, 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 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. The protections built into their internal organizational structure are highly valued by investors.
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. 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
Why Incorporate a Startup
We have heard a few leaders of startups say they will incorporate or form an LLC when their business gets “off the ground”. The problem with operating a business before it takes off and without the protection of an LLC is that the owners may expose themselves to what is known as promoter liability. The promoter is the person who is entering into contracts on behalf of the business. If a business is found to be liable for a contract it entered into before forming an LLC, the owner may be held personally liable.
Startups may also be hesitant to form an LLC at the outset of operations because the owners do not want to pay the fees to file the LLC. It is important to note that the liabilities the owners may expose themselves to personally often exceed the cost of formation by leaps and bounds. Setting that aside, a serial entrepreneur may benefit from forming a Delaware Series LLC and using it as an “incubator,” designating a protected series for each new startup. The members of the protected series have the option to make a filing to “spin off” the series and operate the business as a separate traditional LLC if the idea turns into a viable business.
What Should My Startup Do After Incorporation?
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, you can accomplish that 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 you can convert it to Delaware to take advantage of the Delaware LLC Act.