My worst memory of the first startup I co-founded? Writing the final check to the lawyer to close the company.
It was in 2000, toward the end of the dot-com bubble. We had done everything by the book to start our company: each of the four co-founders wrote a $1,000 check and our lawyer created a Delaware C corporation. We looked for VC funding but it never materialized. So we eventually had to shut down the company before it never had any real activity.
To add insult to injury, there was a late charge on our lawyer’s bill that seemed bogus to us, so we called to enquire. The following month, we got charged 15 minutes of the lawyer’s time ($100) for the voice mail we had left. It was clear that any further discussion would result in more charges. So we did what we had to: we all wrote the final check to close down the company.
Writing that check is one of the most depressing moments in the life of a startup. It clearly is wasted money. When you get started, you have big dreams of success. The money you put down is an investment. But when you write the check to shutdown your business, there is nothing to look forward to. It’s a sunk cost, with no returns, and you know it.
Which brings me to the topic of this post: why incorporating is not necessarily the smart thing to do as the first step when you are just about to start a new business (caveat: I am not a lawyer so I can’t pretend to be giving any legal advice).
1. Doing incorporation right is expensive
A good corporation needs stock to motivate early contributors. Stock needs vesting or you’ll be very sorry some day. Do you need a stock option plan? How does it work with the independent contractor agreement you are using since you are not paying your early contributors?
Setting up a corporation properly is expensive, it costs thousands of dollars. Some law firms will offer you to defer payment for six months for instance. It sounds like a great deal on day one, but don’t take it. The six months go by very quickly, and then you have to pay a pretty substantial bill.
2. Doing incorporation on the cheap will be expensive
It’s tempting to go online and find a site that has templates for incorporating a company. It sort of works, until something goes wrong. A simple template for a partnership, LLC or even C corporation doesn’t cover the what-ifs. When something goes wrong, there is a disagreement between co-founders, you then realize that you are not protected.
To fix those problems later, it will cost you as much or more money than what you saved upfront. It’s a false savings.
3. Your revenue may not justify a corporation
Say you have a blog that makes $100/month in revenue. It’s a nice side income for you. Pocket the money and pay your taxes. But if you turn your blog into a business, expect to have fixed costs that will eat most of your earnings. Talk about a motivation killer!
4. Corporations are a pain to maintain
Incorporating is a one time cost, but entrepreneurs tend to ignore or minimize the recurring costs of keeping a corporation alive. When you start, one year feels like an eternity, but it eventually happens. Time to file annual taxes and get the accounting in order. Those all cost time and money. Again, and again. The IRS doesn’t care if your business is not really active. And then there is the dreadful final check that I mentioned in the opening story.
An entrepreneur, who approached us at a conference, told me that FairSoftware would be useful to him. In the past, he had started six startups — and spent more money on legal fees starting three of those than he ever made from them. If you can postpone all legal expenses until you know you have a viable business, you win.
5. Incorporating solves the wrong problem
Your problem when you start a business is to get a product ready that is good enough for consumer consumption. It means bringing together a small team of dedicated talent, working toward that goal. In that context, incorporating is a distraction that doesn’t bring you any closer to the goal. For online businesses at least, overhead is minimal.
A Fair business will take care of getting the team together and make sure all the intellectual property is in order. There’s not much else needed at that point.
To conclude, keep in mind that I am a little biased since FairSoftware is offering an alternative to incorporation. I’m not really claiming that incorporating is bad. It’s probably appropriate in 80% of all cases.
I was just trying to challenge conventional wisdom and make sure you pause for a second to analyze why you want to incorporate. Do it for the right reasons, not because your neighbor did.
