A newbie’s guide to incorporating
If you’re anything like me, incorporating a company is as nebulous a process as they come. And there is surprisingly sparse coverage of how companies actually get incorporated; usually it sounds more like: “Some Great Person has created Some Great Startup. They raised a lot of money. The End.”
My goal with this post is to dig into how that actually happens. Specifically: how does one go about incorporating a company? I’ll answer that question by detailing the process my cofounder Alex and I went through to incorporate Penny.
Step 0: If at all possible, don’t
Incorporating will irrevocably complicate your life, so you better be 100% sure that you want — need — to incorporate before pulling the trigger. Put aside the messy, convoluted and arcane process of incorporating itself. Just think about the tax implications. Or don’t, especially if you don’t have any aspirin on hand. Just take my word for it that it is not pretty.
We waited for almost two months before incorporating Penny, but finally caved in when we started to expand beyond friends and family (and at the behest of our lawyer friend, h/t Neil Devani).
As I’ll detail in later posts, that was required (or at least strongly encouraged) before we could put into place a real Privacy Policy, sign deals with our third party services, switch out our app store developer names (previously listed using my real name), and protect ourselves from personal liability.
[T]he primary purpose for forming a separate legal entity is to protect yourselves from personal liability. — Carolynn Levy
Once you make the decision to incorporate, the goal should be to get through the process as quickly and correctly as possible. Which brings me to the first official step…
Step 1: Use Clerky
Since I knew absolutely nothing about starting a business leading up to my time at Penny, I’ve relied heavily on the excellent advice in How to Start a Startup, Sam Altman’s open source course taught at Stanford in the fall of 2014.
Lecture 18 of that course covered legal and accounting basics and mentioned that Y Combinator companies often use a service called Clerky to incorporate their company.
Clerky, as it turns out, is a godsend to people like me.
The best analogy I can give is this: remember in the old days when you actually had to use a real map to get driving directions? And then when you hit a traffic jam or found out a road was closed you were basically screwed unless you had an expert navigator in your car? That’s what incorporating felt like about 5 years ago. Unless you had a lawyer on hand, you were just praying that nothing out of the ordinary came up. And you still probably spent way too much time getting to your destination and or ended up in the wrong spot entirely.
And then along came the Google Maps app for your smartphone, and all of those endless hours screaming at your husband/dad/brother that he had no idea where he was going and should ask for directions finally came to an end. (Fun fact, it turns out MapQuest still exists. But don’t go to their website, because it just crashed my browser.)
Clerky, my dear friends, is the Google Maps for incorporating. It takes the manual effort, inefficiencies, and pain present in the usual incorporation process and distills it into a couple of quick, mostly painless forms to fill out. Turn left here. Watch out for the road closure ahead. That sort of thing. It’s not a one size fits all solution in the same way that you sometimes deviate from Google Maps directions, but for most startups, it’s exactly what you want.
All of that is to say, we used Clerky to incorporate Penny. And based on our experience, you should too.
Step 2: Execute
The actual process of incorporating through Clerky is hilariously easy and boils down to filling out four fields.
1. Business name
Choosing a business name is arguably the hardest part of this whole process. Since Clerky incorporates your company in Delaware, you need to use Delaware’s Name Availability Search tool to check that the name you want is available (don’t actually reserve it though!).
Our first stop was to check if Penny was available. It wasn’t.
Womp.
After some back and forth, we finally settled on Friendly Finances since that’s our tagline for Penny. It’s not the most glamorous name, but it serves its purpose (to fill in the input box I was staring at).
You also need to include a business suffix. Assuming you’re creating a corporation, that means appending any of the following: Association, Company, Co., Corporation, Corp., Club, Foundation, Fund, Incorporated, Inc., Institute, Limited, Ltd., Society, Syndicate, Union.
We chose Inc., making our official company name Friendly Finances, Inc.
2. Number of shares to authorize
The number of shares to authorize is subtly different than the number to actually issue, but more on that later. Clerky defaults to 10,000,000, so that’s what we went with.
3. Incorporator name
This is just the name of whomever is actually filling out the form; no need to list out everyone who is involved in your company just yet. For us: Mitchell Lee.
4. Business address
Finally (yes, we’re already at the end), you need a business address. The only gotcha here is to make sure you don’t list some place that explicitly forbids you from operating a business there. For example, some (many?) apartment complexes forbid you from using your apartment as the address for your business.
After you’ve filled out those four fields, just hit the submit button, electronically sign the resulting paperwork, and you’re all set!
Here’s an excerpt from my journal at the time: “Once we decided on the name, the rest was scarily easy. In about 5 minutes my application to incorporate under the name Friendly Finances, Inc. was off to the state of Delaware and my credit card was charged $381. Let’s hope I didn’t make any typos, because apparently there’s no going back now.”
Clerky files the relevant forms with Delaware for approval and you’re one step closer to having your very own business. According to them, it takes about 2–3 business days before you hear back on your application. In our case, it only took 1.
Step 3: Awkward Conversations Galore
While you’re waiting to hear back from Delaware, it’s a good idea to get two awkward post-incorporation conversations out of the way if you haven’t already.
Per the actual incorporation paperwork we filed, we were allowed to issue up to 10,000,000 shares. We issued 8,000,000 of those and set the remaining 2,000,000 aside for future use (for an employee pool or investor compensation, for example) at Clerky’s suggestion.
Then, we had to decide how to allocate those 8,000,000 shares. Enter awkward conversation #1.
1. Equity split
I’ll leave out the details of our conversation for the sake of privacy, but suffice to say that I am very lucky to have a cofounder that is not only incredibly talented, but also very pragmatic.
One thing I would recommend: heed the advice given multiple times throughout Sam’s startup class suggesting that equity splits should be nearly equal.
The take away on this point: in the top YC companies, which we call those with the highest valuations, there are zero instances where the founders have a significantly disproportionate equity split. — Lecture 18
Moreover, having similar but unequal equity splits is a huge mental burden; it implies the individual cofounders have unequal value to the company without making much of a difference in their respective outcomes practically speaking. Stated another way, there should be a very high gravity toward splitting the equity equally.
Once you decide on the equity split, some simple math (equity split * total number issued) will give you the number of options that should be assigned. Assuming a 50/50 split, that means assigning 4,000,000 options to each cofounder.
Then, prepare yourselves for awkward conversation #2.
2. Who should be CEO
There’s no right way to approach this conversation, but you need to have it before you can finish the necessary post-incorporation steps. If there’s a strong split between business and technical expertise, hopefully that makes the conversation a bit easier.
Alex summed up our collective opinion on this rather nicely.
We should just minimize any distinction or mention of official titles within and without the company, which I think is also better for culture. — Alex
Once you rip the bandaid off of those conversations and Delaware gets back to you with a thumbs up, you’re free to move on to the next step.
Step 4: Paperwork galore
Just because you’ve registered your new business with Delaware doesn’t mean you’re actually done incorporating. In fact, that was the easy part. The hard part is what comes next: the slew of post-incorporation documents that need to be generated.
Those include information and invention assignment agreements (your new company has claim to everything you’ve worked on relating to it), notices of stock issuance (you have millions of shares!), stock purchase agreements (the legalese related to your options), bylaws (yeah, those are a real thing), action of incorporator (heyo, you have a board!), and board consent (don’t shoot the incorporator, the board is now responsible for everything) to name a few.
Luckily, Clerky makes this pretty easy by auto-generating all of that paperwork for you after you fill in a very short form. That form looks something like this:
- Company name — same one you registered before
- Incorporator name — the name of whomever is filling this out
- CEO and President — from awkward conversation #2
- Secretary name — the CEO can also assume this role if you wish
- Stock purchase price — defaults to $0.00001
- Governing law of jurisdiction — the state you are currently operating in (e.g. California)
- Number of directors* — 2 (you’ll be asked to name both)
- Number of founders — 2 (you’ll be asked to name both)
- Number of shares issued — from awkward conversation #1
- Total purchase price — not sure why this isn’t auto-computed, but it’s just stock purchase price * number of shares issued (e.x. $40)
- Vesting provision — unless you have strong opinions about how to do better than the standard 4 year + 1 year cliff vesting schedule, leave this as is
- Description of excluded IP — related to the assigned agreement I mentioned earlier; you should probably leave this as None
*After some quick poking around we chose to assign ourselves to the board as inside directors (i.e. representing ourselves as majority stakeholders).
Once those fields are filled out, hit the submit button, have everyone involved sign the paperwork, and you’re all set! You’ll soon have more incorporation paperwork than you could possibly put to good use!
Step 5: Profit
Actually, more like taxes. Make sure to fill out the 83(b) election that Clerky includes in the paperwork. I have no idea what it is (I’m only sort of joking), but everywhere you look people are making a big deal out of it. Luckily, Clerky sends you reminders and very explicit instructions on how to do this. You have one month from the date of incorporation to mail the completed form to the IRS.
Technically, there are a few more things that still need to be done too. For example, you need to give the company a check for the options you were issued (e.g. $40). If you’re operating out of California, you’ll also need to register to do so with the California Secretary of State. Regardless, I’ll leave those to another post since they are only tangentially related and this post is long enough. You’re welcome.
Summary
And that’s it — you are now the proud owner of a fully incorporated and ratified company! It may seem like a lot of work, but that’s mostly because I’m long winded.
Here’s a quick recap:
Hope you found this at least somewhat interesting! Feedback and suggestions are always welcome: @dontmitch or mitch [at] pennyapp.io.
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