You don't need an LLC... yet. How and when to form a business entity

Indie hackers have ideas all the time, which is why validation is so important. But once it's validated, how do you know when (and how) to form a legal entity for that idea? I know what I did, but if I'm being honest, I was just flying by the seat of my pants. So I did some digging.

The usual advice from experts on Google is to do it right away. But I'm not so sure that applies to indie hackers. We do things differently. So I looked into what other indie hackers are doing — here's what I've found. 👇

** Perfunctory disclaimers: I'm not a lawyer. I'm not an accountant. Neither are the indie hackers who I'm learning from. And what follows is written about U.S. businesses.

Why to do it

A lot of people will tell you it's necessary in order to make money since a business bank account requires an EIN, but that's not the case. You can also set one up with a DBA (doing business as). And products like Stripe allow you to charge as an individual.

So here's why people do it:

• Protect yourself from lawsuits: Liability is the biggest reason. When sued as an individual, they can come after your personal assets. Incorporating makes this tougher to do, though there are exceptions.
• Protect yourself from creditors: Yep, if you get a business loan and the company hits hard times, they can't come after your personal assets. Though as always, there are exceptions.
• Team up: If you're splitting equity with co-founders, you'll need to set up a business entity first. And co-founders can be a godsend, so that's well worth it IMO.
• Hire and expand: When it's time to hire, you'll need a business entity to protect your assets.
• Get bigger customers/clients: There are lots of examples of big businesses who refuse to work with you unless you've got an LLC or corporation. This is primarily the case with B2B products and service companies.
• Look more credible: This is connected to the above, but you look much more credible with an official business entity, and this can easily impact your bottom line.
• Tax advantages: Depending on how you do it, there can be tax advantages.
• Raise capital more easily: If you're wanting to raise capital one day, you'll have a hard time doing it as a sole proprietor.
• Protect the business name, recognition, and trademark.
• Transfer the company more easily: If you want to sell the company one day, or pass the torch to a loved one, it's way easier to do that if you've got a legal business entity..
• It goes on if something happens to you: A little bit of a downer, but the entity can outlive you, which is good for your loved ones.

And though I haven't seen this mentioned anywhere, @ShivaPunathambekar mentioned one more reason:

I was only going to build an email list, but was still advised by the entrepreneur law assistance clinic in my university to file for an LLC before I collected any user data…

I assume this is, once again, due to liabilities.

When to do it

As I mentioned above, the general advice on Google is to form a legal entity as early as possible, and that's generally good advice, but for indie hackers who have lots of ideas and less cash to throw around, it might not be the way to go.

Here on IH, most agree that it's best to wait until the business is validated and profitable. And given the option, the beginning of the year is the best time to do it. Here are some words from people in that camp.

@chillyorange: personally take a very pragmatic approach when it comes to incorporating. I choose to stay away from it as long as I possibly can. I only start considering incorporating when my day-to-day business operations are hurting by not being incorporated. For example; my business is in the b2b space and when we started attracting larger corporate clients who were starting to ask for proper invoices, this became a push to start considering incorporating. Hiring staff is another push to start considering pulling the trigger. There are tons more examples, depending on what business you're in.

I would advise anyone against incorporating simply due to some imaginary scenario (like someone might sue me). Do it when you absolutely have to and when not doing is hurting your bottom line.

… The truth is, the chances of your business failing are way bigger than the chances of you benefiting from having a legal entity to get you out of trouble.

@stevenkkim: In California, the annual LLC tax is $800; also, if you hire a lawyer or use a service to incorporate, obviously there are those fees too. So I generally don't incorporate until I have at least $1000 in annual revenue because it doesn't make sense to spend time and money to incorporate early on when there's a high chance that the idea won't work in the first place.

Another consideration is that having an LLC (at least in the U.S.) requires additional tax filings for that tax, so I generally would avoid incorporating near the end of the year because then you have additional filings for both this year and next.

While you are unincorporated, you are a sole proprietor and still responsible for taxes on your personal return. As a sole proprietor, you don't have the same legal protections as a corporation, but the legal risk of early-stage SaaS is basically non-existent. If you think your saas is going to get you sued, then maybe incorporate at the beginning. But I would argue that if your saas is going to get you sued, maybe you shouldn't do it in the first place.

@stpe In general - go build something. Then worry about the admin.

@financeguy: I've done this before for a consulting business, a real estate investing vehicle and to incorporate ideas. The first two generated costs and revenues from day one while the last one went nowhere. My recommendation is that until you have some decent revenue that's imminent ($1,000+), don't waste time, energy and costs going through the process. The set-up fees alone can run into the hundreds of dollars and the annual tax filing fees (if doing it through an accountant) also cost much more than personal tax filings.

@the0posthuma: A simple answer is when you have 500 USD to burn (I did stripe atlas, it was the best!) and at the end of tax season.

And @felixg pointed out that this is the best way to go unless

…you plan to try out many projects over time and it doesn't matter if this one fails (company shouldn't be specific to that project)...

But some indie hackers were in the other camp. Here's what they had to say:

@vanjeff: Contrarian take here - incorporate now. This is Canadian-specific, but we started as a partnership and didn't incorporate until our MRR was $5k or so and we had built up assets (mainly cash).

Transferring the partnership to the corp was a nightmare. So much accounting and legal crap..."deemed dispositions", rollover clauses, etc, etc.

You can use your corporation for another business if your first one fails. When I start a new company, I'll just bite the bullet and pay the $500 to incorporate. Yes, there are additional compliance issues you'll have to deal with, but I think the benefits far outweigh the costs.

@armgitaar: Separate out personal from business no matter what. Doesn't matter if you don't make anything, someone can sue you and will go after your personal holdings if you don't have an LLC or something for separation and protection. State of Idaho, LLC is $100 and takes 10 mins to register for.

@ManoRanaweera: I would suggest incorporation before the first customer. Or if you are still uncertain about your business, after you hit a certain customer milestone.

Incorporation brings credibility to your organization. It provides a legal framework for all your stakeholders, from customers to suppliers and the talent you deploy. It also demonstrates that you are serious about your venture. These are all positive signals to the market.

And here's what I think it really comes down to:

@thwiw: You need to weigh the risk of being sued or otherwise held monetarily accountable to an entity over the cost and complexity of incorporation.

But there's another option.

Umbrellas

Here's what I do. Like I said before, I was really just making it up as I went along, but it turns out other indie hackers made the same call. Set up an "umbrella" type company for your projects.

To be clear, I'm not talking about having a "holding company" with LLCs under it. That'd be excessive for most indie hackers, not only cost-wise, but because of the tax and legal complexity. I'm talking about one LLC with multiple products.

From what I've seen, it's perfectly legal to do this. And if you create a DBA for the LLC with each new product (possible but not entirely necessary), then you can operate under a different name and accept payments under that name. The only downside that I can find is that the liabilities of one business will affect all the businesses.

Here's what indie hackers had to say:

@krazier: I set up one parent company as an S-corp, this gives you an EIN, can get bank accounts, offers some protection and it's the "official" company.

Under my parent company I have set up 2 "Doing Business As (DBA)" companies. These too can have their own bank accounts based on your sCorp information, but you don't have to create separate EIN numbers for them. So at Tax time (assuming you are in the U.S. anyway) you file all income, expenses under the sCorp EIN.

Starting/Stopping DBAs are quite easy, so you could start a side project, see that it's gaining some traction, set it up as a DBA for banking purposes and remain protected by your sCorp.

Then lets say a year later, you have a partner and he wants ownership, you can easily pull that DBA out and form it into its own real entity and carry on. Or the opposite could happen, the project fails, you decide to kill it, you can easily close the DBA and you are done.

By the way, here's how to set up a DBA.

@Isaac: Coming from a background of having a main business I operate under, I just work on side projects under that. I don't know that I'd bother otherwise. If I spent $500 in accounting costs for everything I've dreamt up and started working on, I'd be in a hole!

@pupeno: I would recommend having an LLC, LTD or some other form of company depending where you are based and do all your projects under it. That limits your liability should something go bad and if you have some dealings with a potential customer, potential investor, etc, you actually have a legal entity which looks professional. You can push this scheme into revenue, get some money, experiment, even hire people to work on it.

When the time comes for it to be its own entity, your lawyer (at that point you'll get a lawyer), will create a corp in Delaware or whatever makes the most sense tax-wise (your accountant will tell you that) and then you sell all the IP and so on from your LLC to the corp for a dollar or whatever makes sense.

How to do it

So when it's time to incorporate, here's how to do it.

I'll start by saying that Stripe Atlas makes all of this super easy, so if you don't mind dropping a few bucks, start there.

Personally, I've always registered companies through the secretary of state. If you're in the US and you're going the LLC route, LLC University is a free, step-by-step resource on how to do this in each state. I've found it to be hugely helpful.

But in a general sense,

1. Choose your business structure — probably an LLC.
2. Choose a state to do it in (more on that below).
3. Get a registered agent — if you're incorporating outside of your state, then you'll need to appoint someone with a physical address in that state to hold this role for you. There are services that will do this — just search "registered agent in [state]".
4. Create your Articles of Incorporation and Operating Agreement, and file them with the Secretary of State. The process varies according to the state, but it's easier than it sounds. You just need the company name, founder names, place of business, legal purpose, addresses of founders, name and address of the registered agent, and signatures.
5. Get a tax ID number through the IRS.
6. This isn't technically a step in setting up your business entity, but at this point, you should set up a bank account for the business entity.

Where to do it

Here's a list of the best and worst states to set up your business in. Interestingly, Delaware isn't listed as one of the best states to incorporate in, so I'll just mention that it's a popular choice for indie hackers thanks to its privacy protection, tax benefits, business-friendly laws, cheaper filing fees, and so on. I believe that's where Stripe Atlas sets new businesses up.

I personally am a big proponent of local commerce, so I prefer to give my money to the state where I live. Your home state tends to be less complicated. And despite other states being cheaper, it can actually end up costing less as you can avoid paying taxes and filing reports in more than one state.

@peterfbell: Again, not a lawyer, but if you have "nexus" in a state, you're typically required to register as a foreign corporation/LLC which requires typically an annual fee plus state income tax prep. Speak with a lawyer about it, but most of the benefits of a Wyoming/Nevada corp/LLC tend not to accrue unless you're resident in those states or unless you're trying to justify shifting a percentage of your profits to that state, but as a small business, that's non-trivial to justify at audit time. Now of course, you may not have been caught by your home state if you previously only had a Wyoming LLC, but that's like not paying your taxes - it may be OK - until it catches up with you.

What to form

Here's the short story:

Sole proprietorships don't offer any protection, but they're the simplest and cheapest. And there are some specific tax deductions for sole proprietors, such as health insurance deductions. Plus dissolving doesn't require any paperwork.

LLCs are the go-to for indie hackers, thanks to their flexibility, simplicity, and tax advantages (no double taxation). Though S-corps also get pass-through taxation. The filing fee can be as low as $40 or as high as $1000.

C-corps are best if you think you'll want to take outside investment at some point. But they come with double taxation (taxation of the corp + your income). However, you can elect to be an S-corp to avoid that.

There are, of course, other options, but these are the main ones that most of us will be looking into. Here's what indie hackers have to say about it:

@spiritt: The LLC is the easiest way to protect yourself and the taxes are still done through yourself (separately, though you take income from the business). The LLC is the go-to. It can house nearly everything you're doing (John's Ventures) and easily turn into a C-corp if your side project gets bigger.

@stevenkkim: …if you're looking for outside investors, generally c-corp is the way to go. If you're going to bootstrap/stay private, then I'm a big fan of LLC (less paperwork/bureaucracy, single level of taxes instead of double).

And quite a few indie hackers shared another option — a DBA with liability insurance.

@tscionti You don't have to wait to make the decision on whether/how to incorporate to legally have a business that makes money. A DBA ($35-$65 depending on your state) allows you to open a bank account for your business and collect revenue. This makes you a sole proprietorship which means your business income is your income and can be declared in your taxes.

An LLC ($50-$500 depending on your state) limits your personal liability and can effectively function as a sole proprietorship depending on how you structure it/if you have a partner.

@twalling: Business liability insurance is really the only thing that can protect you. I've used The Hartford in the past. It's very affordable as well… Looks like I paid about $500 for the year. It all depends on your coverage too. I was contracting through an agency and they had requirements for coverage.

So just assuming it would be roughly the same for you, you're looking at the same cost as the LLC BUT you'd be getting much more protection plus you get to pay it monthly/quarterly, etc vs one large payment.

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What did I miss?

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