United States: When Should I Incorporate My FinTech Startup Company?

Last Updated: February 11 2013
Article by Kate H. Pharr

The WilmerHale FinTech Group is a multi-disciplinary team of lawyers that leverages the expertise of our Corporate, Financial Institutions, Technology and Intellectual Property practices and others to offer integrated, full service legal solutions to clients within the FinTech sector and to a whole host of other clients who do business or invest in the FinTech sector. The group is uniquely positioned to represent FinTech clients throughout their lifecycles and to advise on a vast range of transactions and other legal matters. In this blog, our attorneys offer insight on the latest developments in the FinTech sector.

The FinTech industry is booming, and there is no time like today to enter into this exciting field. If you're reading this post, you're likely thinking about founding your own FinTech company, or maybe you have done so already. As founders of FinTech companies, you should consider incorporating as soon as possible to get your businesses off the ground and running.

One of the threshold questions that founders need to discuss with their lawyers is what type of entity—typically either a limited liability company (LLC) or a corporation—is best suited for their venture. This post broadly discusses incorporation, which implies a corporation.

1. Why should I incorporate my FinTech startup company?

The most important reason to incorporate your FinTech company is to protect yourself against personal liability. If you comply with corporate laws and maintain the separateness of your own assets from those of your corporation, creditors of the company generally cannot reach your personal assets, or those of the other company stockholders, to satisfy the company's liabilities. Although you could lose any amounts that you have invested to launch the company, you cannot be held personally liable for the corporation's obligations. You should think about incorporating well before launching your products or services. Keep in mind that the risk of liability begins when you start to take actions in the name of or on behalf of the business, and it only increases as you increase the number of your customers, service providers and users.

Showing that you have incorporated can help you attract investors. If third-party investors want to invest in your company, there should be an entity in place that can accept their cash. Corporations are more attractive to new investors because of the limited liability and the ability to more easily transfer equity ownership of the business. And as you know, investors are important to getting your business off the ground.

An additional consideration for you if there is more than one founder in your FinTech company: arguments can arise over how to divide the equity. Incorporating your company and issuing stock to the founders helps prevent those arguments and can help keep your business running smoothly.

Many FinTech founders discover they are low on cash when starting out. One option is that a corporation can issue stock in return for funds, and this means that you can get much-needed cash to develop your products or services. You will find that a corporation offers you flexibility in shifting control and varying the nature of shareholder investments as your FinTech business grows. Also, corporations allow founders to partially compensate employees or contractors by granting stock options or giving them the opportunity to purchase equity at low prices. This can help you bring talent on board even before your company begins to prosper.

IP has become increasingly vital in the FinTech space, which additionally makes incorporation important. If your company has multiple founders, it is a good idea to have each founder assign his or her IP to an entity earlier rather than later. Otherwise, if a founder leaves without the IP being assigned to another founder or entity, the use of IP may become difficult.

Finally, FinTech founders need to incorporate a company if they want to hire employees to develop their products and services. It makes the most sense to have an employee or contractor enter into an agreement with the company instead of a founder. Again, any IP created by the contractor or employee can be assigned to the company, which means that the company can protect and develop the IP even after the contractor or employee leaves.

2. What are the downsides to incorporating my FinTech startup?

Although we have explained why you should incorporate your FinTech company, we also will share some of the downsides of doing so. First on the minds of all founders is the upfront cost of setting up a corporation. Filing fees and costs for incorporating your business could total as much as $2,000.

Furthermore, founders must do administrative tasks when they incorporate, like adopting written articles of incorporation and bylaws, electing a board of directors and officers and holding an organizational meeting of the shareholders and directors. Because corporations are formed under the laws of a state with its own set of rules and regulations, you will likely find that you need the assistance of an attorney or accounting professional to help you incorporate and again as your business grows. Corporations are required to make periodic filings and pay annual fees with the states where they are incorporated and qualified to do business. In order to take advantage of the limited liability, you have to act like a corporation, and that takes time and money.

Once your FinTech company starts making money, there is the problem of double taxation. Corporations as entities are subject to corporate income tax at both the federal and state levels. Any earnings that are distributed to shareholders are taxed again. Some of the money you worked hard to earn will end up in Uncle Sam's hands rather than in your pocket (as it would have done as a partner in a partnership or a sole proprietor). It is important to weigh the trade-offs of keeping that money or enjoying the benefits of the corporate form.

3. Should I talk to my employer before incorporating?

Founders of FinTech companies are often employed by other companies in the industry when they decide to branch out and make a go of their ideas. Leaving your employer and making sure that you will not find yourself embroiled in an IP battle is important.

First, you need to determine whether you signed a non-disclosure or confidentiality agreement. Your employer may have required you to sign such an agreement so that you would have to maintain the confidentiality of their unpatented ideas or trade secrets during and after your employment. Protected information can include customer lists, manufacturing processes or formulas, invention designs or materials in a copyrighted software program. If you have signed such an agreement, you should have an attorney review the agreement before you head out to start your FinTech company. You want to make sure that you understand what information is protected by the agreement and how long that information must remain confidential.

Second, you need to determine whether you signed a non-competition agreement. If so, you may have agreed not to pursue a profession that is similar to or in competition with your employer. Again, it is a good idea to have an attorney review your agreement to determine its scope. Are you prohibited from starting your own company within the FinTech field? Is this restriction limited by geography? How long does the non-competition provision run after you leave your job? While courts can be reluctant to enforce non-competition agreements, you are almost certainly better off following the letter of your non-competition agreement when you head off to start your FinTech company.

You should also be aware that non-disclosure and non-competition agreements are often coupled with non-solicitation provisions. These provisions may prohibit you from reaching out to customers of your former employer in order to attract their business. They may also prohibit you from asking former colleagues to quit their jobs and join your company. You want to make sure that you are aware of the scope of any non-solicitation provisions that you agreed to—this may change your mind about how you plan to conduct your new FinTech business.

Ultimately, before you leave your employer, you want to know the ins and outs of your employment records and the laws of the state in which you plan to incorporate. Not all employees have to sign these agreements, not all of these agreements look the same and not all states will uphold them. Still, what you signed with your employer can have a huge impact on when and how you start your own FinTech company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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