When you're in the early stages of a startup, there's a lot to consider — from revenue models to hiring early team members and developing your product. When it comes to legal matters, many founders want to wait to incorporate the business until they are further along, and know that their concept is viable or their company is fundable.
At a certain point, you will need to create a formal business structure (either by forming an LLC or a corporation). And in some cases, incorporating early will make more sense for your taxes and bottom line.
See also: 8 Common Tax Mistakes That Startups Make
Here are eight of the top situations when you'll want to take the step to incorporate your startup.
One of the key reasons to incorporate or form an LLC is to help protect the owner or owners from any personal liability. For example, if there's ever any kind of issue (like a customer or vendor sues the business or creditors seek action), the owners are going to be personally liable. But an official structure like an LLC or corporation basically puts a wall between the owner and business. As long as you comply with the required formalities and paperwork, creditors or court judgments typically won't be able to touch your personal assets.
This is why most people want to incorporate or form an LLC before their app, product or service launches to the public and there's more liability.
When you post a project on a crowdfunding site, it may feel like you're just starting out. The common misconception is that you don't need to incorporate until you actually have the finished product.
However, when you raise money on Kickstarter or other sites, you are dealing with tens, hundreds or thousands of investors. Any time you are making something, you can't always predict with 100% certainty how things will work out. For this reason, you'll want to form an LLC or corporation before setting up your Kickstarter campaign. That's because if your project doesn't go as planned, the business will be liable — and not you personally.

Image: Flickr, Simon Cunningham
When short on cash, it's common for entrepreneurs and startups to want to compensate early employees, contractors, vendors or others by granting stock options (or giving the opportunity to buy equity in the company at a low price). You'll need a formal company with shares in order to grant this.
While it is possible to create some kind of pre-incorporation agreement that says that a contractor will get equity upon incorporation, it's going to be a lot easier (and more enticing) to incorporate first, and then grant the stock options or equity.
When there's more than one founder in a business, there's always the risk of an argument over how equity should be split. That's true even if your founder is a close childhood friend or relative. Incorporating a company and issuing stock to the founders will prevent misunderstandings about how equity is split.
Even if you choose to form an LLC and not issue stock, you will still have formal paperwork that defines how the ownership is split. This will eliminate any misunderstandings or conflicts down the road.
In addition, if your startup involves any kind of IP and there's more than one founder, you will want to incorporate and then assign any IP to the company. Dealing with IP when a founder leaves a partnership or sole proprietorship can be very tricky.
Let's say you are developing a mobile app that you hope to eventually sell to Facebook or Zynga. In this case, you'd much rather be able to get long-term capital gain tax treatment on the sale proceeds, instead of having to pay the same tax rate as ordinary income. But in order to do this, the founder needs to hold stock for greater than one year.
The advisable strategy is to incorporate your company (and do this long before you have your app developed and ready for beta). Then assign any IP to the company. In this case, the buyer is going to purchase the stock of the company, and not the app itself. And as long as the shares of the company were held more than a year, you'll qualify for the long-term capital gain tax rate.
Are you looking for venture capital, angel or some other kind of third-party investment? If so, there needs to be some kind of formal structure set up in order to accept that investment. Most VCs and investors prefer to work with C Corporations, since it allows for two or more classes of stock (i.e. preferred and common).
It's also much easier to trade shares in a corporation than it is to trade membership interests in an LLC. So, if your exit strategy might include an IPO, you're going to need to be structured as a C Corporation.

Image: Flickr, Philip Taylor
As an owner of a sole proprietorship or partnership, you need to sign contracts in your own name, and you need to rely on your own personal credit in order to take out a loan or apply for credit. That's because with these business types, there's no separation between the business and the owner or owners.
If you ever want to apply for a business loan, you'll need to form an LLC or corporation, so the business can start building its own credit.
Let's say you've launched a startup, and instead of thinking about how much money you can put in your own wallet, you are more focused on growing the business. In this case, you will want to incorporate as a C Corporation. Then, if you don't take profits out of the business, it will be taxed at a lower corporate level and you can reinvest it in equipment, infrastructure, marketing, etc.
If you had any other business structure (a sole proprietorship, partnership or S Corporation), then you would need to pay taxes on your personal income tax statement (and at your personal tax rate) even if that money is staying in the business.
Incorporating or forming an LLC is a big step, and you'll need to keep in mind that once you create a formal business structure, you'll have to keep up with ongoing administrative obligations each year. And, if your plans change and you no longer work on the business, then make sure to formally dissolve the corporation/LLC.
In the eyes of the state, a business entity exists (and you'll be required to pay fees and file paperwork) until it's formally closed.
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Nellie Akalp is the CEO of CorpNet.com, an online legal document filing service, where she helps entrepreneurs incorporate or ...More