When contractors are constructing a large building, they can spend months establishing layers of sand, gravel, and cement to create a sure foundation to build on. Then, once the foundation is secure, they can construct a beautiful edifice. If they don’t get the foundation right, months or even years later, the building can sink into the ground, crumble and fall, and ultimately fail.
Startups are like buildings — you need to get the foundation right; otherwise, they fail. And that’s why founders are called “founders”, because it’s their job to get the foundation right.
Lots of things go into the foundation of a startup: your technology, your go-to-market strategy, your culture, and your team, to name just a few. But there is one critical component of every startup’s foundation that often gets overlooked: your company’s legal documents. Just like if the technology your company is built on is buggy, inadequate or incomplete, legal documentation can have company-ruining effects.
In this article, we’ll take a look at the first step to establishing a solid legal foundation for your startup: your entity formation. Although forming your entity properly is a multi-step process, in this article we’ll be exclusively focusing on the legal formation of an entity and not what comes after (equity issuances, option plans, board governance, etc.).
Requirements for Formation
Formation requirements are governed by state law, which means they vary state to state. They can also vary depending on whether you are forming your company in the same state where you plan to have your office and operations, or in a different state.
In this article, we’ll assume you are planning on forming a Delaware corporation for a business that has its operations in a different state, since most startups fall into that category. (Go to our FAQ below for a discussion on why most companies incorporate in Delaware.)
The typical requirements for forming a Delaware corporation are as follows:
- File a Certificate of Incorporation
- Establish a registered agent
- Execute a document called the Action by Incorporator
- File a Form SS-4 with the IRS to obtain your EIN
- File to do business as a “foreign” entity in whatever state you’ll be operating
Now that you know what steps are required to form your entity, let’s do a deeper dive into each step.
Certificate of Incorporation
The legal inception of your business occurs when a Certificate of Incorporation is filed with the Delaware secretary of state. If you are filing in other states, sometimes they call this document something else, like “Articles of Organization.” Here, we’ll call it your “Charter.”
You can file your Charter with Delaware by mailing it in with the required filing fees, or by paying a filing agent with electronic access to Delaware’s filing portal. If you mail it in, the turn around can take weeks. If you go with a filing agent, it’s typically less than five business days (and you can pay extra to have it expedited).
Delaware requires that your Charter have the following key elements:
- Company Name — The name of your company must include one of the legally required suffixes, like “Inc.,” “Corp.” or “Co.”
- Registered Agent — Your company must list a Delaware registered agent and its address. We’ll dive into this more in the next section.
- Company Purpose — Don’t be fooled into listing your “mission statement” or some other actual statement of your startup’s goals here. Rather, you’ll want to keep it as broad as possible. For example: “The purpose of the corporation is to engage in any lawful activity for which corporations may be organized under Delaware law.” This keeps your options completely open without cornering you into any specific type of business.
- Classes of Stock — You’ll need to list the classes of stock your startup will be issuing. Standard startups only issue “common stock.”
- Authorized Shares — Along with the classes of stock your startup can issue, you have to list how many shares are authorized for issuance. This number will be a hard cap on how many shares you can initially issue, so it is important to calculate how many shares you’ll be issuing out the gate, and then provide for a reasonable cushion on top of that. Startups typically use a pretty high number like 10-15 million shares. (Read more about Authorized Shares in our FAQ below.)
- Par value — Par value usually doesn’t have much of an impact on your company, but it does affect your franchise tax calculation as well as the minimum amount that founders must pay for their shares. Typically, par value for startup stock is really low, like $0.0001 per share or even less.
- Incorporator Information — The “Incorporator” is just the person who signs the Charter filed with Delaware, and the Charter needs to list the Incorporator’s name and address. The Incorporator can be a founder, but is often a lawyer or the filing agent hired by the company. (Go to “Action by Incorporator” below to read what other actions the Incorporator is responsible for.)
(Here’s Delaware officially telling you it is a good idea to form there.)
As a business operating outside of Delaware but incorporating in Delaware, you’ll need to hire a “Registered Agent” with a physical address in Delaware (no PO Boxes, for example). This address will serve as your “Registered Office” for Delaware’s purposes, so that they can send mail and deliver service of process to your company. The name and address of your Registered Agent must be listed in your Charter.
In most cases, companies interface very little with their Registered Agent. In fact, typically companies only hear from their Registered Agents when they get annual reminders to file their Delaware Annual Reports and pay their Delaware Franchise Tax.
Companies can find lists of Registered Agents online, or they may be automatically signed up for one by their attorneys or filing agents. All Registered Agents charge annually in advance, and you will need to continue paying them every year. However, prices and “add-on” services vary significantly between Registered Agents, so investigate closely for the best option. If you fail to pay your Registered Agent, they can withdraw as your Registered Agent, which will result in your company falling out of good standing with Delaware, unless you designate another Registered Agent.
When you use Savvi to incorporate, you receive a Delaware Registered Agent for your entity.
IRS Form SS-4, EIN Application
Once your company is incorporated, you must get an Employer Identification Number (EIN). An EIN is like a Social Security Number for businesses. It is necessary for many things, including the following:
- Filing both state and federal income and employment taxes
- Reporting to the IRS
- Identifying the corporation to many non-IRS organizations
- Opening a bank account
- Getting hired as a third-party contractor to other entities
- Hiring employees
Put simply, all corporations need an EIN. To get an EIN, a founder must file a Form SS-4 with the IRS. Again, this is a simple but tricky process. You can file this manually by downloading and filling out the form, then mailing or faxing the form to the correct IRS office, or you can do it much more simply by requesting an EIN online at IRS.gov. This EIN must be requested by an officer of the company or someone with the power of attorney to request the EIN for the company.
If you go the online route, the IRS website will immediately generate a PDF containing your EIN confirmation for you to download. If you file Form SS-4 manually, the IRS will mail you a copy of your EIN confirmation in approximately 4 weeks.
(Take a look at the official instructions from the IRS.)
Action by Incorporator
The “Incorporator” of a company is the party that signed the company’s initial Charter. In Delaware, Incorporators have very limited authority and can’t actually operate the companies that they form. Because of this, Incorporators should sign a document called the “Action by Incorporator” immediately after filing the Charter. This document is where they take the “Action” of appointing the company’s initial directors, who under Delaware law DO have the authority to operate the company.
The “Action by Incorporator” is usually no more than one or two paragraphs. Because it is so short and simple, and often needs to be signed by someone other than the founders, it often gets overlooked. However, failing to get a signed “Action by Incorporator” can have major consequences. Without the Action by Incorporator, there is no documentation appointing the initial directors, and therefore any action taken after the incorporation could be potentially deemed unauthorized and possibly invalidated. This could include any equity issuances, contracts, investments, etc. In other words, founders should ALWAYS verify that this document is completed and stored promptly after their entity is formed.
(Here’s the official Delaware code requiring Action by Incorporator.)
Qualification as a Foreign Entity
Filing your Certificate of Incorporation, obtaining an EIN, and signing the Action by Incorporator are the most basic requirements for getting any startup off the ground. However, if you are operating in any state other than Delaware, you may be required to submit a filing in that state to be allowed to operate there. Every state calls this filing something different, some call it a “registration to do business,” others an “authorization to exist,” but for our purposes, we’ll use the generic term “Qualification as a Foreign Entity.”
A company typically needs a Qualification as a Foreign Entity in each state where it owns or leases real property or pays employees. It is also typically required to make state filings for employee or sales tax. Some banks may require you to have your Qualification as a Foreign Entity before opening a bank account in that state.
To file for a Qualification as a Foreign Entity, you typically need to fill out a form with basic information about your company, like the names and contact information of the directors and officers and the EIN. Some states may also require a Certificate of Good Standing from Delaware. The exact requirements differ state to state. Most states provide electronic filing portals, though some still use fillable PDFs and fax numbers or snail mail. All states require a filing fee to submit a Qualification as a Foreign Entity; these can range from $30 to $750, depending on the state.
(Go here for California’s official instructions on foreign qualifications.)
Options for Incorporating
Online with Savvi.Legal
Everything you need to start accepting money
Private Data Room
Startup Attorney Review
Print & amp Fill Out Paper Forms
Print the PDF template, fill out by hand, and snail mail to Delaware.
Hire A Startup Attorney
Pay a Lawyer to Fill Out the Forms
In conclusion, the first steps to establishing a strong legal foundation for your startup is to make sure you do your entity formation correctly. This will typically require the following actions:
- File a Certificate of Incorporation with Delaware
- Hire a registered agent
- Obtain an EIN from the IRS
- Have the Incorporator sign an Action by Incorporator, and
- File a Qualification to do Business in whatever state(s) you plan to operate in.
What Can Savvi Do For You
This list of tasks to complete the first step in creating your legal foundation can be overwhelming. It doesn’t have to be. There are lots of ways to get legal work done, but in our view Savvi is best. At Savvi, we combine technology with actual experienced attorneys to provide expert legal services efficiently. Savvi helps founders get legal work done quickly and properly so they can sleep well at night and get on to doing what they do best: building their business.
For your entity formation, Savvi can actually complete this whole process for you. We will
- File your Certificate of Incorporation
- Hire a Registered Agent and obtain a Registered Office
- Apply for and obtain your EIN
- Generate and sign your Action by Incorporator, and
- File Qualifications as a Foreign Entity where requested.
We’ll also save all of these important documents directly in an online file cabinet.
Required Forms to Incorporate
Certificate of Incorporation, Delaware
SS-4 – for EIN application
Qualification as a Foreign Entity, California
Why should I incorporate in Delaware?
Every state has laws that allow for incorporation, but most high-growth startups choose to file in Delaware. They do this for several reasons.
- Business expertise of Delaware courts – Delaware has long been the standard and go-to state for incorporation. As a result, Delaware has courts that only hear corporate cases, and their judges are the most knowledgeable in the country regarding corporate law.
- Breadth of Delaware case law – Law should be predictable. Because so many companies are formed in Delaware, more corporate cases are tried under Delaware law than anywhere else. This means that every potential loophole has been explored and litigated, and founders or investors are better able to predict outcomes.
- Flexibility of Delaware statutes – The laws in Delaware are designed to attract businesses by being as flexible as possible. For example, in Delaware, one single person can be the director, shareholder, and officer of the same corporation, which is not the case in some states.
- Familiarity of Delaware corporate law – Investors don’t like uncertainty. That’s one reason why investors prefer to work with companies incorporated in Delaware–they know what they’re getting into.
Why should I incorporate?
Incorporation is essential, especially for these reasons:
- Protection – Incorporation protects the founders and directors from being personally liable for the dealings of the business.
- Investment – Incorporation is essential for being able to take on capital investments. It also allows investors to get equity in the entity.
- Continuance – Corporations help a business go on continuously. Many corporations even outlive their founders. Wouldn’t that be cool.
- Familiarity – Corporations are familiar. There are 1.7 million C-corporations in operations today. Other business structures like B-corps and partnerships are less familiar.
- Growth – Corporations give the framework for big growth.
The founders we work with are most frequently motivated by protection and investment. They don’t want to lose their house if their business goes south. They also don’t want to lose their chance at a venture capital investment because their legal work isn’t done right.
(Trying to decide between an LLC and C-Corp? Read this.)
Why don’t I just do the legal work myself?
Most founders understand the importance of a good legal foundation for their business, but from time to time a founder might try to do all of the legal work themselves. Honestly, sometimes this do-it-yourself approach works out fine. But more frequently, the result of DIY legal work ranges from bad to worse. Bad scenario: You pay a lawyer a lot of money down the road to clean-up whatever didn’t get done right in the first place. Worse scenario: You lose your company to sophisticated investors or competitors who realize you didn’t cover your bases.
(If you do, don’t forget these 4 documents.)
What suffix should I use for my company?
Although which suffix you pick has no impact whatsoever as long as it falls within the “legally authorized” list, most tech companies use the “Inc.” suffix. We recommend that companies stick with this standard, simply because it signals to investors that you are trying to do your legal work “by the book.”
What number should I list for Authorized Shares?
We recommend you plan on issuing 10,000,000 shares to the founders and then authorize 1.5x that amount. Our standard formation issues 10,000,000 shares to founders and authorizes 15,000,000 in the Certificate of Incorporation.
What Par Value should I assign my stock?
We recommend something relatively low, such as $0.0001 or $0.00001 per share. This will allow you to easily transfer stocks, qualify for a lower franchise tax, and give more shares at the same percent.
How to choose a Registered Agent?
You can choose a registered agent online from a long list of registered agents in Delaware. They vary by price and services offered. Savvi will find an agent for you.
Certificate of Incorporation
A Certificate of Incorporation is the founding legal document of a corporation. This is the name given the document by Delaware, other states may use other names.
This is the number of shares the incorporator has authorized to be granted by the corporation. Typically, good legal work will indicate a very large number of authorized shares, like 15 million.
Par value is the lowest amount a share can be sold for — the face value. Good legal work typically makes this a very low number, like $0.00001.
Your “incorporator” is just the person who signs the Charter filed with Delaware. They have no authority other than to file the Charter and assign the initial directors of the company. They need not be a founder, though it can be. Often it is someone from your law firm or the filing agency you use to file your Charter.
Action by Incorporator
The Action by Incorporator is a document that records the first action taken by the corporation.
Registered agents act as the company’s liaison within the state of incorporation. They receive and forward service of process correspondence, notices of state fees or taxes, and information about annual filings.
The registered office is the office address a business uses to qualify for incorporation in Delaware. A registered agent will provide a registered office address which the founder then lists on the Certificate of Incorporation.
Delaware Annual Report
Businesses must file a Delaware annual report with their Delaware franchise tax. It includes some specific business information:
- The company’s address
- One officer’s name and address
- Corporate directors’ names and addresses
Delaware Franchise Tax
The Delaware Franchise Tax is the fee charged by the state of Delaware for owning a Delaware company. It doesn’t only apply to franchises. Paying it is necessary to maintain the good standing status of your company.
Qualification as a Foreign Entity
Foreign Qualification is the process of registering your corporation as a foreign entity in the state it is operating in.
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