The Great Legal Structure Debate

Numerous websites, forums, blogs, books, and magazines offer to give advice on which legal structure is best for your new venture. Tax implications, protection from liability, ease of raising capital, and reporting requirements are all important issues that should be considered when making the decision. Major law firms have divisions dedicated to forming new ventures and there are numerous online ventures (http://www.legalzoom.com) that will incorporate your venture for a very reasonable rate (although the quality and level of diligence is minimal). However, I have rarely seen (if ever) people telling prospective entrepreneurs the benefits and strategies of not incorporating (at least in the short run).

I have run into countless prospective entrepreneurs who have nothing more than an idea and one of the first things they do is run to a law firm or online service and form their corporation. From my perspective this is a waste of both time and money and hurts the new venture in various ways.

From a bootstrapper’s point of view you should plan for the venture’s legal structure but do not implement it until necessary. Here are some reasons why:

1) As you begin networking and telling others about your venture you never know who will volunteer their legal services or consultation (it happens all the time).

2) The capital structure and external financing needs of your new venture may evolve in the short term as you’re planning your venture; as such there are numerous implications to your legal structure.

3) Even if you incorporate your venture online (depending on the state you live in) you are most likely looking at incorporation costs in the $300-$2000 range. These are sunk costs and as such you should preserve these precious start-up funds as long as possible.

4) As soon as you start your venture the law automatically (at least this is what a few lawyers have told me) considers your venture a sole proprietorship or general partnership (if you have a partner). As such if you are still in the research and development phase their really is no major rush to incorporate.

So when do you incorporate? As I said you should constantly be prepared for incorporation (choose a law firm and meet a lawyer to discuss the costs and services provided, or choose the online provider in advance and analyze the fees and requirements). Key events that hint you should be incorporating ASAP are: signing an agreement with the first major customer, receiving a large amount of outside investment, entering into a major contract (such as a lease, employee contract, loan, etc.), first major purchase of inventory, and so on. Basically, any major contract or cash flow that is foreshadowing the real start of your new venture is when you should incorporate.

So law firm or online? I have gone both routes with my own start ups and I have consulted clients on both routes. It really depends on the venture. If all you need is a pretty standard cut and dry legal structure then online may be the way to go. Make sure to do your own independent research first and possibly consider talking to a lawyer while still in the planning phase to gain some insight. A law firm is going to also point out critical risks and liabilities that impact your specific venture (something the online services will not). If they are experienced they may also know better than your research and know that you need a specific legal structure that was different than what you previously had thought.

Best of luck in your legal structure decisions, and remember that cash is the lifeblood of a new venture and should be carefully spent where it will bring the most value at the best time.