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Time of Start-up Company Formation

Post about incorporation issues

Time of Start-up Company Formation

Postby Pinskylaw.ca » 03 Jan 2014, 13:23

There are several good reasons to form the company as early as possible.

Holding Periods

The earlier the company is formed, the sooner the shares can be issued and the capital gains holding period begins to run. Upon a liquidity event, shares that have been held for one year or more will be taxed at the long-term capital gains rate. Gains on shares held for less than one year are taxable at an individual's ordinary income tax rate which can be significantly higher than the long-term capital gains tax rate.

Cheap Shares Issues

Founders of companies often make the mistake of waiting until they have received a strong indication of interest from an investor before they decide that it is time to incorporate. Forming a company so close in time to raising capital can create a significant tax issue.

Ability To Contract

The founders may want to establish certain relationships with third parties that require contracts. As an example, there may be an independent contractor that is going to be developing some software code. For the company to own this code, it needs to enter into a work for hire agreement with the contractor. This obviously cannot be done until the company is formed. Non-disclosure agreements, or NDAs, raise a similar issue. Founders are often in contact with potential strategic partners, advisors, employees, and others at the very earliest stages.

Limited Liability

Perhaps the most fundamental benefit of incorporating is the protection of the corporate shield. Individual shareholders are generally not liable for the liabilities of the company in which they hold shares. Until a company is formed, the individuals are acting in their personal capacity, and may be personally liable. To enjoy the benefit of the corporate shield, certain corporate formalities must be adhered to, including the maintenance of separate corporate records and accounts, the holding of annual meetings of the shareholders and directors, and the execution of documents in the name of the company.
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