Ben Hron: Five signs it’s time to get your business organized

All entrepreneurs face the question: “when should I form a company?” Transitioning from partners in an informal collaboration to co-owners of an actual business may seem like a big step, but it is a necessary one that every successful startup eventually must take. Forming a corporation or limited liability company not only protects founders by limiting personal liability for activities related to the business, it also defines the rights of founders relative to each other and to the business, which is important in case there is ever a falling-out among the founders. So the short answer is: the sooner the better; but here are five telltale signs it’s definitely time to form a company.

1) You and your partners have developed IP critical to your business.

Intellectual property is the most valuable asset most startups possess, so it is crucial that the startup, not the founders, own IP developed for the business. As soon as valuable IP is developed, founders should assign their rights in the IP to a company in exchange for an ownership stake.

2) You’re hiring employees.

Many federal and state laws govern the employer-employee relationship and impose numerous obligations on the employer. Hiring employees through your company, rather than directly, helps limit your personal liability if something goes wrong in the employment relationship.

3) You’re signing contracts with other companies.

Business contracts impose legally enforceable obligations upon the parties to the contract, so if you sign an agreement on your own behalf, not as an agent of a company, you are personally responsible for performance. If your company signs the contract, it is much more difficult for your business partner to hold you personally responsible if the obligations under the contract 
are not met.

4) You’re ready to raise money.

It’s always tempting for entrepreneurs to accept seed funding from friends and family in exchange for a promise to repay the money or issue the lender equity in your company when it is formed. Doing so is very risky, however, because you are personally responsible for repayment of the loan until the obligation is properly transferred to your company. Rather than risk having your car repossessed, you should run the loan or investment through the company.  BE AWARE, however, that federal and state securities laws apply even to small investments in private companies, so you should talk to a lawyer before offering shares in your company to any potential investor.

5) You’re ready to launch your product.

Whether you’re making widgets or developing a new website, as soon as you’re ready to go public with your product you need a company in place to limit your personal liability in case someone or something is harmed while using it.

Two words of caution. First, it’s easy to find a website that will organize your new company for a few hundred dollars, but there’s a lot more to organizing a company than filing paperwork. Not all business entities are created equally; some will not afford you all the protection you may need for your business, and some may come with undesirable corporate structures or tax consequences. A good lawyer will help you determine the right type of entity for your business and make sure it is structured to meet your needs. Second, forming a company is only one of many things entrepreneurs and startups need to do to protect themselves from potential liability. You should talk to your lawyer about other ways you can make sure you and your business have adequate legal protection.

Benjamin Hron (bhron [at] vcreadylaw [dot] com) is co-founder of VC Ready Law Group, LLC, located in Cambridge, MA. VC Ready (blog) helps Boston-area entrepreneurs launch and grow their businesses by providing cost-effective legal and organizational guidance during the formative early stages of a company’s existence. 

 

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