When to Incorporate? Benefits of Using a Term Sheet for Incorporation

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When to Incorporate? Benefits of Using a Term Sheet for Incorporation

Lawyers will tell you it’s important to incorporate your company as soon as you possibly can to avoid personal liability and to settle all outstanding matters among the founders.  That’s good advice, but the place to start is with a Term Sheet for the incorporation.  The reality is that the incorporation process is time consuming and creates hassle for you in the form of payroll tax reporting and minimum franchise taxes, etc. so you want to be sure there is a real business in your idea before you pull the trigger on the incorporation.

Certainly, you need to incorporate before you 1) hire employees, 2) sell products or 3) raise money.  Prior to that, however, there may be a limbo period when you are talking to other potential co-founders and trying to decide if your idea is worth pursuing.  It is important to surface all the issues that arise among the founding team before anyone has spent significant time working on what might be false assumptions about “the deal” among the founding team.  It’s much easier to discuss these issues early on when it’s all still very hypothetical and no one has become emotionally vested in their role.  The best way to do this is to use a Term Sheet.

Here are a couple of tools to use to help socialize and discuss the deal among the founders:

Form of Term Sheet for Incorporation
Incorporation Data Sheet

The Term Sheet is non-binding, but it does help you actually discuss and at least conceptually agree on things at a level of detail that helps to avoid disputes later.  Nothing kills a startup as quickly as “fighting founders” which happens all too often.  Startups are already a very risky venture and the deck is stacked against you, so if you give off signals to others that the founders are having trouble agreeing with each other, you will find no one wants to deal with you.  The reality is that you are probably operating as a verbal partnership with your co-founders prior to incorporation and that can be extremely murky to untangle.  No one has the time to deal with that headache.  It can make a great idea truly un-fundable if the IP doesn’t have clear title that can be traced back to its origins and has been properly assigned to the corporation by all of the initial owners of the IP.  So, it’s critical to air the issues early on and come to at least a spiritual agreement among the founders before the IP gets developed by anyone.