Why you should incorporate your business from the get-go
“When should I incorporate my business?”
This is a common question first-time entrepreneurs ask. When first starting out, company incorporation can often feel very far off – when in fact it could be closer than you think.
There are many advantages to incorporating early, from taxation to liability and fundraising. We spoke to the experts at Zegal, a cloud-based legal software company. They helped shed some light on why it’s typically better to incorporate sooner rather than later.
Here’s what they had to say:
1. You will have protection from personal liability
One of the biggest reasons to incorporate your business soon is for the limited personal liability protection.
There is no legal distinction between you and your business before you incorporate your company. By incorporating your business, you’re creating a separate legal entity from yourself. This means that in most cases you’re not liable on your personal assets on matters that relate to your company.
For example, if the court finds your company owes $50,000 to a creditor, and your company is unable to pay it, the creditor can’t come after your own home. This is because it is the company that owes the debt, not you.
After registering your company and becoming a shareholder, you will only be liable up to the amount you invested in the company (which are represented by shares).
That being said, there are essential limits to this principle, including:
- If a shareholder or director of an incorporated company intentionally commits an illegal or fraudulent act, they are considered personally liable for any consequences
- In situations where you’re the sole shareholder and you need a loan from the bank to finance your company, you may be asked to provide guarantees on your personal assets
The above circumstances aside, incorporating right away your business ensures that your personal assets are protected from the start. This is the best practice and standard for most businesses.
2. You can formally define the rights and obligations of founders from the start
One often overlooked advantage of incorporating early is this: incorporating your company allows you to set up legal structures and binding agreements.
If you’re looking to run your business with other founders, shareholders, or directors (particularly if they’re family or friends), you’ll need to agree on what everyone’s rights or obligations are. That can be done through creating articles of association and a shareholders’ agreement – which can only be officially set up if you have an incorporated company.
Articles of association effectively act as your company’s “constitution”. They define things like the purpose of your business, organization of your company, and how many shares there are. This document is public. A Shareholders’ Agreement goes further to help you regulate the relationship among shareholders of a company, define their respective rights and obligations, and state how the decisions will be made. This document can also contain clauses about:
- proceedings of the board
- director nomination rights
- reserved matters at shareholders’ level
- pre-emptive rights on issue and transfer of shares
- transfer of shares in the event of death or default etc.
If you’re at a very early stage, or haven’t even started your business yet, having these legal documents defined might seem unnecessary. However, having these documents in place sets up clear expectations from the start. This will pave a smoother path for you as you grow.
3. You’ll be able to assign all intellectual property to the company
Most of the time, especially when it comes to software, startups like to have the minimum viable product established first before officially setting up and incorporating their business.
But here’s the issue: if you start working on a project with someone else (in the case of co-founders or friends, for example) the intellectual property belongs to everyone who works on it – not a company.
Incorporating as a company allows you to have formal contracts and agreements in place that assign intellectual property to your business.
So in the case where someone leaves the company, the intellectual property created under the employment contract or consultancy agreement will remain the property of the company. This is also really important for if and when you decide to fundraise, because investors want to know that the intellectual property belongs to the company they’re putting money into.
What’s more, if you register a trademark before you incorporate, later down the road if you want to assign that back to your company, you’ll have to go through additional fees and paperwork.
4. You can approach investors to fundraise
For most startups, the best way to get capital to fund your business is through venture capital and fundraising. However, if you don’t have a company, this becomes impossible. To put it simply, when fundraising, the investor invests in the company in exchange for current or future ownership over shares. Without a company, there are no shares to give in return to the investor.
When you incorporate a limited liability company, you now have shares and equity that you can offer investors.
5. You can file taxes under corporate taxation instead of personal income rates
Without an incorporated company, whatever profit you’re making will fall under your personal income. This means it’ll be taxed at the personal income tax rate.
For reference, personal income of over HKD$1,440,000 yearly is taxed at 17% (on a tiered system). Corporations, on the other hand, are taxed at 8.25% for the first HKD$2,000,000 and 16.5% for every dollar after that. You can find more on Hong Kong taxes here.
Incorporating does not automatically equate to a lower tax rate. However, the more you grow and scale your business, the more it will make sense to pay corporate taxes.
Incorporating early helps you set yourself up for success in the future. This is especially true if you’re aiming for rapid growth.
Don’t wait to incorporate!
If you do intend to incorporate your business, don’t put it off. If you intend to grow your business incorporating early will help you avoid unnecessary headache down the road.
And if you’re unsure about where to start, Zegal can help you set up all the legal documents you need to kickstart your business, such as a shareholders’ agreement, an employment contract, or a consultancy agreement. Check out Zegal’s special package designed to help startups.