More often than not, start-ups overlook the legal necessity of setting up their company correctly. This can be driven by the lack of capital or legal knowledge, but getting it right at the outset can diminish headaches as your company grows and seeks investment.
1. Why Incorporate?
Limited Liability: A corporation (or other corporate entities) has an independent legal existence from the owner. The personal finances and liabilities of the owner are separate from that of the corporate entity, and vice versa. Therefore, any debt or obligations against a corporate entity will not expose the owner’s personal assets to creditors.
Liquidity: Although the owners usually build up their business with the intent to remain committed to its success, there could likely be times where an owner decides to leave the business. Incorporation allows the free transferability of business interest from one person to another.
Credibility: Doing business by establishing a separate and professional identity (i.e. the corporate entity) creates credibility and trust in your customers.
2. Can I incorporate in my own state? Why is Delaware better?
You can incorporate in any state. However, Delaware is the best option and industry norm if your near term goal is to raise venture capital funding. In addition, the Delaware Court of Chancery has extensive expertise in corporate law and the number of precedent cases makes legal outcomes more predictable.
Most corporate attorneys are familiar with Delaware law.
Franchise tax can be low (as low as $125 plus reporting fees).
3. Corporation LLC. What do I need to know?
Taxation: Corporations are subject to double-taxation (at corporate level and shareholder individual level), whereas an LLC is usually a pass-through entity for tax purposes, but it can choose how it wants to be treated.
Ownership: Shareholders own a corporation, whereas members own an LLC. The key difference is that an LLC’s operating agreement can distribute profits regardless of the members’ contribution, whereas a corporation usually distributes its profits on a pro rata basis.
Operation: Corporations usually have Board of Directors and Officers, whereas an LLC can be member-managed or manager-managed.
4. Shareholder Board of Directors vs. Officers
Shareholders: owners (can be a person, a company, or other institution) of the shares of a corporation. Generally speaking, shareholders have the right to vote on major corporate affairs such as the election of directors on a pro rata basis.
Board of Directors: group of individuals elected as representatives of shareholders to establish management policies as well as make decisions on major corporate issues. Delaware requires a minimum of one director. Key characteristics of a Board of Directors is that it has a fiduciary duty to the shareholders of the corporation.
Officer: person who holds a specific office and has a position of authority in the company. Delaware requires a minimum of one officer. Examples of officers include CEO, CFO, Secretary, Treasurer. Officers can be directors, but aren’t required to be. It is ok for a person to hold more than one office. It is good practice to appoint a Secretary to keep track of all corporate minutes.
5. I’m incorporated in Delaware, but am headquartered in New York; do I need to qualify my company to do business in other states?
General principle is if part or all of your business is conducted intrastate (within the state borders), you must qualify to do business in that state. However, if all of your business is conducted interstate (across state lines) you do not.
The benefit of qualifying to do business is that you have the right to bring action in the state’s court. For example, New York Business Corporation Law Section 1312 requires that in order for a foreign corporation to bring an action in a New York court, it has to qualify to do business in New York, and it has paid to New York state all fees and taxes.
6. How much capital do I have to put into my company initially?
The key consideration is “adequate capitalization,” meaning the capital provided is sufficient for the initial operation of the corporation.
If thinly capitalized, a creditor might seek to “pierce the corporate veil,” arguing that the corporation is just an “alter ego” (shell) put in place to shield the shareholder from personal liability.
Some advisors think a debt to capital ratio of 10 to 1 is sufficient, but the actual amount of capital necessary to be considered adequate is highly case-specific. Avoid extremes.
Starting a company is usually straightforward, but like anything else, experience is critical to ensure a smooth start that thoughtfully considers all the variables. Rooney Nimmo has advised on numerous start-ups and companies expanding into the US, from simple to complex.
We’ve only just scratched the surface here; so if you have questions, want more detail or need guidance, please don’t hesitate to get in touch.
By Ziyan Gao, Associate, New York – firstname.lastname@example.org