Founders Guide: where to incorporate your startup.

Early-stage founders are always busy talking to prospective customers and building their MVPs. They want to spend as little time dealing with other tasks as possible. We have seen such focus with numerous founders who have built amazing companies.

But two legal tasks have to be taken care of at early beginnings. First, ensure your co-founder relations and IP rights are handled. Read more about this here. Second, cost-effectively incorporate a legal entity suitable for further business growth and development.

This untypically long post aims to help European founders choose the most optimal corporate structure. Bare with us. We hope it will help you make the right call.

tl;dr

If you have already shaken hands with a (pre)seed investor, it's best to ask for their recommendation. However, if you're bootstrapping and running on your own steam, incorporate at home first and tackle this issue later on.

Identify relevant features of your business.

We recommend that you figure out how your business will evolve. There are no guarantees, but as an early-stage founder, you should be able to assume certain operational elements. It would be best if you answered the following questions to yourself.

1. Am I a solo founder, or will there be co-founders?
2. Where are most of the co-founders physically based? Where do we intend to run the company from?
3. Do I intend to raise capital from VC investors, and if yes, where will they most likely come from?
4. Where are my customers located? What are the most important markets?
5. Do I wish to join an accelerator?
6. Is our business regulated and requires approvals and licences to operate?
7. Answer these questions to yourself, and the rest of this blog post will explain their relevance when choosing the jurisdiction to incorporate.

C-Corp in Delaware remains the golden standard.

C-Corp in Delaware has been the last decade's golden standard for incorporation for startup founders. There are several reasons it might also be a good option for you.

1. It is excellent for raising capital. Most US VCs prefer to invest in DL C-Corp, and some make it a requirement to invest. Y Combinator has also hailed it as the best way to raise capital. Raising funds via SAFEs became the standard for pre-seed rounds.
2. You can incorporate it easily online—no minimum capital is required. Nlaw also provides this service. Click here for details!
3. This is an excellent choice if your customers are online or in the USA, as you can use this entity for all your trading needs.
4. If you intend to grant shares to employees, Delaware regulation provides for quick and efficient issuing of shares under option agreements and establishing ESOPs.
5. Delaware enjoys a good reputation in Europe and the US. The majority of the best-known technology companies are incorporated in Delaware.

As with all things in life, Delaware is not necessarily a perfect choice. Here is the list of potential issues.

1. If you intend to raise capital from European VCs, be mindful that many of them are not allowed to invest out of the EU, and some can only invest in particular EU countries.
2. Incorporating a C-Corp in Delaware is relatively cheap. Operating it is not necessarily affordable. European founders are often surprised by some basic costs, such as accounting, which can easily be 3-4x what they are used to from CEE. If you are about to raise VC funds, that’s fine; otherwise, you should be mindful of the increased costs.
3. Operating a Delaware entity could cause some challenges related to tax residency. Suppose the seat of effective management of your company, or its substance, is one of the EU Countries. In that case, chances are that the tax authority of that EU country will claim tax residency over your Delaware corporation. But, if you, as founders and managers, work, build, sell, operate and make all decisions from the EU, you are exposed to this risk. Because you will not be profitable from the beginning, you might not worry about this issue much; however, filing corporate profit taxes for a Delaware company in Europe could be an annoying and pricy administrative exercise. 

The UK is the strongest European venture hub.

Until Brexit, England was the most popular startup jurisdiction in the EU. However, European founders looking for a suitable jurisdiction instead look to the US today, as England has lost some of its appeal, such as tax-free share swaps for the EU founders. Nevertheless, London remains one of the leading global VC hubs, and England and Wales is one of the most reputable legal systems in the world.

You should consider incorporating in the UK for the following benefits it provides.

1. It is excellent for raising capital. Issuing new shares as a limited liability company is fast and flexible. Most European VC funds are based in London, and most US VCs are open to investing in English entities. England also enables raising funds using the Advance Subscription Agreement, similar to the American SAFE. The SEIS scheme is exciting, incentivising business angels to invest due to tax benefits. British business angels, therefore, only invest in eligible UK entities.
2. You can incorporate it easily online. No minimum capital is required. The incorporation and operations costs of a company in England are reasonable. Nlaw can assist with incorporating as well! Get in touch for details!
3. This is an excellent choice if your customers are online, in the UK, or Europe, as you can use this entity for all your trading needs. The only restriction is the sale of goods to the EU.
4. If you intend to grant shares to employees, English regulation provides for quick and efficient issuing of shares under option agreements and establishing ESOPs.
5. England enjoys a good reputation in Europe and the US. Many reputable technology companies are incorporated in England. London boasts the largest founder and VC community in Europe.

Incorporating in England also has some drawbacks.

1. If you intend to raise capital from European VCs, be mindful that many of them are not allowed to invest out of the EU, and some can only invest in particular EU countries.
2. Operating an English entity could cause some challenges related to tax residency. Suppose the seat of effective management of your company, or its substance, is one of the EU Countries. In that case, chances are that the tax authority of that EU country will claim tax residency over your English corporation. But, if you, as founders and managers, work, build, sell, operate and make all decisions from the EU, you are exposed to this risk. However, due to the excellent connectivity of all major EU cities with London, it is possible to establish legitimate business substance in London.
3. Since Brexit, England has lost a lot of its appeal. For instance, share swaps in English corporates for European founders are no longer neutral. Employment and residence permits can be an issue. Trading goods is an issue due to customs. Consequently, from the perspective of the European founder, England is less competitive against Delaware than it used to be.

Incorporating at home, in the EU, has its advantages.

If you felt compelled as a European founder to incorporate in the US or UK, take a step back. It is true that Delaware is the standard and sometimes feels that the only way to build a successful startup is the USA way, but the truth is far from that. VC space has grown immensely in Europe in the last five years. The regulatory framework for incorporations and fundraising could be better, but it still offers many advantages. In the EU, Nlaw operates offices in Slovenia and Croatia, but the following benefits most likely apply also to many other EU countries.

1. Perfect to raise from EU VC investors. European VC investor space has been booming for the last five years, and raising pre-seed and seed rounds at home from regional investors was lucrative. You should note that the EIF is an investor in many European VC funds, and often, they require these funds to deploy capital in the EU or certain EU countries. Also, larger funds such as Seedcamp, Atomico, and Sequoia are comfortable investing across the EU in various European countries.
2. No tax residency risks. Since you will be incorporating in the same country where you have an effective place of management, you will avoid any risks related to the tax residency.
3. Home court benefit. Many things will be easier for you compared to incorporating overseas. You are probably familiar with the system, know people you can ask for advice, and quite likely, a lawyer and accountant are in your network of friends. Any operational challenges will be easier for you to deal with.
4. Easier access to banking. Due to complex banking regulations, opening bank accounts has become increasingly difficult. It is always the easiest to open an account with a bank that you are in business with already. You have at least your personal bank account at one of the local banks, and it will be the easiest and the fastest to open an account for your startup there as well.
5. Low costs of operations. Central Europe is known to have lower costs of operating business than Western Countries. Registered address, post services, accounting and other vital functions in the company typically cost less. That could be very beneficial if you are starting without VC backing.
6. Large domestic market. The EU is the largest single market in the World (yes, it is larger than the USA). There are no restrictions in trade, offering of goods or services, etc. It is easy to offer services across the EU.

Of course, Central European countries, like Slovenia and Croatia, also suffer from several problems.

1. It is not great to raise capital. Issuing new shares typically requires notarisation, which requires in-person attendance (or via video call) and delivery of numerous translated and apostilled documents from foreign investors. The cost and time needed to execute a transaction is abnormally longer than in the US or the UK. In principle, SAFE/ASA Agreements are not recognised, but you can use convertible notes.
2. Online incorporation has its limitations. There are numerous restrictions, such as how many founders and directors can be named at the beginning. In most countries, it is required to have a qualified digital certificate for online incorporation. A deposit of minimal share capital is needed beforehand (7.500 EUR in Slovenia, 2.500 EUR/1,00 EUR in Croatia, 1 CZK in Czechia, 35.000 EUR/17.500 EUR in Austria).
3. Consents and documents. You need to open a bank account before incorporating. And then, you need to deposit the initial share capital. And then, the bank has to issue a confirmation, which you need to incorporate. You often need the written consent of the building owner to register your business address. If you are a foreign investor, you must provide all sorts of documents from abroad.
4. Granting shares to employees is painful. It again requires the cooperation of a notary. It is rigid and slow.
5. Fair or not, Central European legal systems do not enjoy the tradition and reputation of England and Wales or the US.

A dual corporate structure could bring you the best of both worlds.

Why not have both? UK/US plus your home jurisdiction? It works very well. There are two possible structures: the UK/US as a parent or the EU as a parent. Each of them addresses completely different problems.

You can structure your corporate set-up with a UK/US parent and a wholly-owned EU company. The UK/US parent is typically used for fundraising; the EU company is where all the operations happen. The EU company hires the team where R&D, marketing and other functions are performed. The parent entity sometimes also acts as the trading company. This structure is excellent if you wish to have a look and feel of a US/UK company and if your investors prefer investing in the UK/US.

Alternatively, you can keep your EU company as the parent and incorporate a wholly-owned US/UK company. This is typically done when the US or UK are your important markets and where most of your customers come from. They often prefer buying products or services from another US/UK company instead of an EU one.

The dual corporate structure is, in principle, outstanding and is widely used. Setting them up and managing them can sometimes be tricky.

If you started with an EU company and wish to transition to a parent US/UK company structure, you must transfer your shares in the EU company to the US/UK company. This will likely trigger a taxable event as share swaps are not tax-neutral if done outside the EU. Keeping an EU company as a parent and incorporating a wholly owned US/UK company comes with no tax challenges at that stage.

Once you have your dual structure in place, you should be mindful of how both entities conduct business with each other. Suppose the parent entity raises capital from investors. In that case, there are various methods to transfer that money to a wholly owned subsidiary entity, namely by capitalisation, intra-group loan or payment of services. If companies provide each other services, transfer pricing rules must be implemented.

These challenges are manageable, but only if you can afford in-house or outsourced experts to help you with the compliance.

It's a very long blog for a simple conclusion.

The founder’s job is to follow the money. And there are essentially two potential money sources to pursue: investors’ and customers’ money. When considering which corporate structure to choose, we recommend you choose one that will increase your chances of winning investors and customers. It is perfectly acceptable to talk to your investors and customers about how your corporate structure matters to them.

Nlaw remains here to provide advice, share experience and help you execute.