When to Form a Business

I have been asked by many entrepreneurs about the timing to incorporate their businesses. Some are hesitant to do so at an earlier time for a number of reasons, primarily, the cost associated with the formation, uncertainties about the market prospect and how equity and profit can be split among co-founders, and conflict of interest with existing or former employers. There are many good reasons that a company shall be formed sooner than later. I encourage entrepreneurs to balance the advantages and disadvantages.

Advantages to form a company are:

Ability to contract/Limited liability – Founders may want to establish relationships with third parties in order to plan the business. These third parties could be strategic partners, advisors, employees and etc. Some founders enter into these contracts before the company is formed, this arrangement is not ideal, because any potential liabilities arising from the contract may be founders’ personal liabilities. Once a company is formed, a corporate shield is established, and founders could not be held personally liable in conducting the normal business in most circumstances.

Tax advantage – The earlier the company is formed the sooner stock can be issued and sooner the capital period begins to run. For income tax purposes, when stocks that have been held for more than one year are sold, they will be taxed at a preferential rate than those have been held for less than one year.

Cheap stock issues – If you wait until receiving strong indications from potential investors to form a business, there may be bigger tax liabilities for founders. The difference between what founders pay for their stocks and fair market value of stock at the time of purchase (as determined by reference to what investors are willing to pay) may be characterized as income, possibly resulting in significant tax liabilities to founders.