Generally speaking, you should incorporate right before your first customer pays you. That is assuming you cannot operate your business as a sole proprietorship or partnership. There are plenty of resources explaining the advantages and disadvantages of doing so versus incorporating, so there is not much I can add to that conversation. Assuming you need to incorporate, the question becomes when, and what are the drawbacks of doing it too soon.
When to Incorporate:
A good rule of thumb is to incorporate right before you get paid. That was the advice that was given to me. I heeded it, and it is the advice I give to others. The actual incorporation process is normally straight forward. Of course, you and the founders should have all the necessary conversations ahead of time (e.g. splitting equity, shareholder agreements, etc.), which will inform the Articles of Incorporation and Bylaws. However, those conversations are not worth having if you do not have the prospect of customers willing to pay you. That is why paying customers is a good benchmark: It shows you have some traction.
There still might be a question of how much traction you have, or how big the market is. Reacting to that, I know of startups that signed their first customers free of charge. The examples I can think of are startups operating in foreign markets and they gave their products away for free to avoid paying local taxes. When their ideas showed more promise, then they started charging. If you cannot afford to give your product away for free, this is a moot point.
You timeline for incorporation may be altered if the following apply to your business. You will have to incorporate before your first customer.
- There are regulatory requirements for you to operate in the market.
- You need liability protection to operate in the market.
- You are accepting funding, either from the founders or someone else.
Reasons not to incorporate too soon:
- It takes time, energy, and money. Barring the three “Other Considerations” listed above, your time, energy, and money should go towards finding traction, not incorporating a business that does not have paying customers.
- The moment you incorporate, you start paying taxes, and unless you do your own taxes, you are paying an accountant. Suddenly you are spending money and time on maintaining a business, not on progressing the business.
- It is a giant hassle to wind up a business, even if you never showed revenue. It will consume your time, and costs more money. There is no reason to go through the hassle for a business that never got off the ground. It is a giant hassle.
*Important Note: Incorporating should not be confused with genuine progress. One’s business model or idea is not suddenly more viable because the business is incorporated. I prefer to think of incorporation as a requirement which is only required when the right conditions are met. Otherwise it is not worth the time and money.
If you have questions or want to share your experiences, do so in the comments and I will be sure to respond.