Why you Shouldn't Wait and Form a Business Now

A common question I get from entrepreneurs is whether they should create a company and if so, when. My answer to this question is invariably the same: you should formally establish your company and do it as soon as possible.

I know that when you are starting a business creating a company is not in the list of tasks that will enable you to move towards your business goals. Making decisions about the legal structure of your company and doing some paperwork may seem like a distraction that has nothing to do with your primary goal of making money.

Actually, I also think it's a distraction, but a necessary one. Here you have 6 reasons that support this statement, with examples and in plain English.

1. The Lost Founder

One of the main advantages of having a business is that you can move all assets to the company. For instance, consider the following example, which is also a true story:

You start working on an idea with a group of friends, one of them quits because he finds a job. You continue and after a lot of hard work you finally succeed and investors are lining up to take you to the next level. This is when your "friend" remembers you and decides to quit his job and go back to the startup asking for 50% of the shares. You took all the risk and turned the idea into a successful business while your friend was watching you from his safe job. And yet, your lawyers tell you that you are forced to accept this extremely unfair deal. Why? Because he registered the domain of your business under his name since there was no company to assign it to. Your domain is your brand, and your brand is very important to your business, so if you want to keep it you have to give him 50% of it.

The same applies to that other "friend" who wrote some lines of code for your startup and then left. Watching your succeed 3 years later, he decides to get x% of your shares claiming that he owns part of the product. As unfair as it may seem, a court will probably acknowledge him (or her) ownership of that code since it was never transferred to a company.

In general, not having a company makes that every person involved in the development of the idea may claim ownership of her/his contributions. The moment you properly create your business you can:

Assign ownership of all past contributions (e.g., domains, code, patents) to the company.
Future contributions of the members of that company can be assigned to it, preventing potentially unfair situations like the ones described above.

2. The Legal Mistake

If you don't create a company, you respond with your personal assets to every problem that may arise connected to your idea or business. Here you have two examples:

• You ask for some money to develop your idea. It turns out that your idea doesn't work but your creditor still wants the money back. 
• A competitor sues you because he claims you are infringing his copyright and wants to take you to court. 

In both cases, since you didn't operate as a company but as an individual, your personal assets are at risk. You can lose your house, car or money since a court may decide to repay your creditor with your money, or that you have to pay an expensive penalty for infringing your competitor's copyrights.

The moment you form your business as a corporation or an LLC (Limited Liability Company), you are granted limited liability. This means that your personal financial liability is limited to a fixed sum. More specifically, you respond with your personal assets in case the company runs into financial trouble only up to the value of your investment in the company.

3. The Smart Competitor

Imagine that you build a business around website ww.yourbusinessname.com, but that you have not registered a company yet. A smart competitor may make the move of registering a company with exactly your domain's name: Yourbusinessname. This may confuse some of your customers which may fall on your competitor's side. It also gives your competitor power over you. Once more, your domain is your brand, and your brand may be closely tied up with your business. If your company name is taken by someone else you can't just change your domain name and pretend there'll be no consequences.

4. The Money-Making Idea

When you start making money you start worrying about taxes. But by then it will be too late to enjoy many tax benefits that you would have had, had you created a company from the start. More specifically, corporations and LLCs may deduct normal business expenses before they allocate income to the owners. This means that the money you put towards growing your business can be deducted from your taxable income, allowing you to pay less taxes. Let me put you an example.

Scenario 1: you create a LLC, then pay a programmer to code a mobile app for you.
Scenario 2: you pay a programmer to code a mobile app for you.

In Scenario 1 your personal income tax is lower than in Scenario 2 because you can deduct the salary of the programmer as a business expense of your LLC.

5. The Awkward Conversation

Legally establishing a business forces you to have perhaps the most difficult conversation among the founders of the business to decide how to divide the equity ownership (e.g., shares). This will obviously have a direct impact on how much each founder will participate in the financial success of the business. This is an awkward conversation nobody wants to have. It can create division among founders when there are apparently more important things at stake to discuss, like for instance how to make money. So, founders may be tempted to delay this conversation and reach a superficial agreement, like:

Let's all put effort into the idea to make it work. When we're successful we'll split the pie according to each individual contribution.

Creating the company right at the beginning forces founders to reach a formal agreement (i.e., an agreement with legal implications). This has several advantages:

• It is much easier to reach an agreement when there is no money on the table than when there is. 
• It is much easier to split equity according to what each founder potentially brings to the business, than doing the accountability exercise of agreeing on the degree to which each founder's contribution was important for success. 
• If there is no agreement among founders the loss is minimum, whereas if this conversation is delayed a lot of time and money may have been invested by founders. 
• If there is no agreement among founders, maybe they have trust issues, or it's not clear what each one brings to the business, in which case it may be a good idea not to start a business together at all.

Variations of the Problem

• The problem gets even worse when the founders don't talk about splitting the pie, even at a superficial level until it's too late. 
• A verbal agreement is obviously not enough either. 
• Even a written agreement outside the scope of a company will not provide founders all the necessary guarantees.

The Greedy Founder:
It is also a problem when a founder registers the company under her name and promises the other founders a certain percentage of shares once the company achieves a certain milestone. Leaving aside the fact that this founder may not honor her word, this way of doing things also brings many problems. By the time when the owner wants to give the other founders the shares, their market value may be too high for the founders to buy their way into the company.

6. The Game of Credibility

A major benefit of incorporating your business is the stamp of approval adding an "Inc." or "LLC" after your business name. This distinction affords your business with instant credibility and authority associated with owning an incorporated company. Potential consumers, vendors and partners tend to prefer to do business with an legally established company and will look overlook those who are not.

Conclusion

For all the reasons above, I strongly encourage entrepreneurs to formally establish their business right when they start working on the idea at an early stage. If done properly, it will only take you a few hours and less than $500.

The Online Course

Due to the large number of people interested about this subject, I have created an online course that teaches you how to easily create (and dissolve) a US business from the comfort of your home, be it in the US or elsewhere, avoiding expensive legal fees.

The course contains 37 lectures with videos, instructions, quizzes and checklists to help you navigate through the process of setting up your US company, avoiding common pitfalls inexperienced entrepreneurs usually fall into. You will also find templates for all the necessary legal documents, which you can freely download and use right away.

As a special thank to my blog readers, I've created 100 coupons to access this course with a 50% discount. Click on the link below to redeem your discount code before I run out of invitations!

For an in-depth understanding of how to form your business in the US I recommend you this book by Constance E. Bagley.

Enjoy creating your US company!