When do I need to form a company?

TLDR: It is generally best to form a company sooner rather than later and there are many benefits to forming a company, including limiting your liability.

In general, it’s usually time to consider forming a company when you have a great business idea and are committed to seeing it through. For the vast majority of Silicon Valley venture capital-backed start-ups, this means incorporating as a Delaware corporation (see FAQ: “Why should I incorporate a Delaware corporation?”).

There are many reasons why entrepreneurs choose to form a company, including the following:

1. Limit Personal Liability: A company is typically considered to be a separate legal entity from its founders, with its own assets and liabilities. When your business is conducted through the company, agreements are made between third parties and the company only, and the activities of the company and its founders are clearly separated by following the appropriate corporate formalities, you as a founder are generally protected from personal liability for the obligations of the company. Thus, you should seriously consider forming a company before launching a product in the market, entering into any agreements with third parties, or taking other actions for which you would not want to be held personally liable.
2. Formalize Co-Founder Relationships: Forming a company and entering into contracts between the company and each co-founder (e.g., stock purchase agreements and employment agreements) help to formalize the relative ownership percentages and responsibilities of multiple co-founders in a start-up. These agreements are usually a must before you can seek funding from investors for your start-up.
3. Consolidate Ownership of Intellectual Property: When you have multiple people developing portions of your business’s product or technology, it is important to consolidate the ownership of the potentially disparate intellectual property rights of each contributor. This consolidation can be accomplished by forming a company and having each person who works on the product or technology assign their intellectual property rights to the company. Once such rights are assigned to the company, any intellectual property developed related to your business will stay with your company. This process helps to ensure that your business has all of the rights that it needs to produce and market its product or technology, and will avoid confusion about intellectual property ownership if and when certain contributors move on to new projects or companies. These conversations can be difficult and are therefore important to have them upfront so that everyone has clarity before moving forward with starting the business.
4. Incentivize Your Workers: Companies are able to offer benefits, including stock options and other equity incentives, to attract, compensate, and retain workers. This is especially important for start-up companies, as cash is typically not a large component of compensation in the early stages of a start-up.
5. Easier to Take Investment: Forming a company creates a separate legal entity that can accept investment. Investors are accustomed to investing in companies and owning equity in the entity. Most Silicon Valley investors will not provide funding until after you have formed the separate legal entity.

Founding a company is not easy. There will be out-of-pocket costs and ongoing legal and tax obligations to maintain your company. If you are not 100 percent committed to your idea and running your own business, it may be a good idea to postpone forming a company.

You should also keep in mind that if you have a great idea but are currently employed, you likely should wait until you leave your current job before forming your new company (see  FAQ: “I’m currently employed. Can I work on my start-up?”).

Finally, if applicable, consider your immigration status. If your current immigration status does not allow you to work for a start-up, you should resolve any issues with an immigration attorney before forming your company.

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