If there is more than one founder, the likelihood of an argument about how the equity should be split in the new company increases dramatically. Incorporating a company and issuing stock to the founders will help prevent misunderstandings among the founders about equity splits. Trying to clean up pre-incorporation promises to grant equity in a startup company is hard, especially when founders part ways before there are formal documents in place.. Even if a company is incorporated, founder stock purchase agreements with repurchase rights over unvested stock is not included
Creating intellectual property
If there is any IP created and there is more than one founder, then incorporating an entity and assigning IP to the entity is important. Otherwise, if a founder leaves before incorporation and IP has not been assigned to the other founder or an entity, then use of IP created by the former founder may be difficult. The documents from typical online incorporation services do not contain IP assignment provisions in connection with the purchase of founders stock or separate IP assignment documents.
Hiring employees and contractors
Unless you can personally pay an employee out of your own pocket for a year prior to incorporation while incubating an idea, you will need to incorporate a company if you need employees. If you need contractors, it generally makes sense to incorporate a company so that the third party enters into an agreement with a company instead of an individual. In addition, any IP created by the contractor can be assigned to the company instead of an individual founder.
Issuing stock options
Stock options can stretch your cash by letting you partially compensate third parties by granting stock options or giving them the opportunity to purchase equity at nominal prices. You can have pre-incorporation agreements granting equity upon incorporation, but, its simply easier to incorporate and grant stock options or equity.
Incorporating a company protects the stockholders against personal liability. When you launch services and products to the public even small damage claims can add up if lots of people are affected. When your company complies with corporate formalities, creditors of the company generally cannot touch the stockholders to satisfy the company's debts. Launching a product or a service is a huge trigger point for formalizing your business organization.
Obtaining foreign talent or resources
Incorporating a company and demonstrating that it is a "real" business with sufficient capital is typically a prerequisite to a visa application. If you will have non-U.S. citizen non-permanent resident founders or employees working in the U.S. on your startup project, a formal business entity helps get the requisite visas.
Favorable tax treatment
When you sell stock in a taxable transaction and it is held for greater than one year, then the capital gains tax rate is 15% for founders. These days, it is fairly easy to develop a hit iPhone app or Facebook app and sell a company fairly quickly. Some apps are developed and sold in less than a year. Those that are packaged in a organization that has issued the stock a year ago can be sold for the low capital gains rate if you can sell the app in a stock transaction. Otherwise you are stuck selling the business and paying ordinary income tax
Third party investors won't invest without the formal legal entity protections of bylaws and operating agreements. The sooner you create the entity the longer duration you have to justify the intellectual capital difference that the third parties will pay for their shares.
Additional resources provided by the author
You can view incorporating as increasing your investment in your business or you can simply view it as an added costs, and complexity. If you still have a day job as an employee of another company, then the founder may need to review the founder’s employment documents carefully and address the issues raised. You should talk with a business attorney about when to create your company or LLC.