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Incorporation Decisions: A Guide for Tech Startups

Updated: Aug 9, 2023

Incorporation decisions of a tech startup can feel like navigating an intricate maze, but worry not. Armed with the right knowledge, this labyrinth transforms into a straightforward path.

The overwhelming consensus among startup experts is to incorporate as a Delaware C Corporation, often known as a "Delaware C Corp." But why is this the case? Several factors contribute to this recommendation, chief among them the legal infrastructure, the familiarity to investors, and the Qualified Small Business Stock (QSBS) tax benefit.

Delaware's legal framework is incredibly favorable to businesses. The state boasts an extensive body of case law, which offers clear guidance on various corporate issues that may arise. Moreover, investors - particularly venture capitalists - are well-acquainted with Delaware C Corps, which allows for a smooth investment process.

Then there's the QSBS tax benefit. Under Section 1202 of the IRS code, shareholders in C Corporations can exclude up to 100% of their capital gains from federal tax, subject to certain limits and qualifications. This tax advantage can represent significant savings, enhancing the appeal of Delaware C Corps.

However, before embarking on this journey, be prepared for some necessary obligations. Among these are the annual franchise taxes and the necessity to file an 83(b) election. The 83(b) election, in particular, is a vital document that allows startup founders to pay taxes on their shares when granted, rather than when vested. This step can yield significant tax savings, given the potentially vast difference in valuation between these two points in time.

When incorporating your startup, consider setting aside a 10-20% employee option pool. This pool provides a way to incentivize and retain top talent in your company, aligning their interests with the company's long-term success. The exact percentage can vary, but keeping it within this range ensures a balance between rewarding employees and preserving equity for future investment rounds.

To navigate this legal landscape, engaging a knowledgeable law firm is often a prudent move. Firms like Orrick, Cooley, Wilson Sonsini, and Fenwick & West have carved a niche in the startup and venture capital space, offering tailored services to new businesses.

Incorporation is just one piece of the puzzle in the startup journey. At Redbud VC, we're dedicated to helping founders maneuver through these challenges, offering the benefit of our network of legal experts and deep understanding of the startup legal space. We understand that your time is better spent on building your product and team, so let us help you with the rest.

Lastly, don't forget about the Orrick Startup Forms Library, an excellent resource that provides a range of documents, from incorporation paperwork to equity incentive plans. It's a treasure trove for startups, and we strongly recommend using it.

Incorporating your startup is one of those things that should occupy your thoughts. With the right approach and the right partners, it can set the stage for your startup's success.


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