Starting a Startup: Where to Start - Part 1: Making it Official: Incorporation

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This series was written for you: the entrepreneur with a dream. We want to help you turn your dream into a thriving reality by sharing our expertise with you.

What follows is a series of articles outlining the basics you need in order to start a startup in Israel; it contains terms you need to know, steps you will have to take, and considerations to ponder when making choices about how to run and grow your company. We'll add a new chapter each week – so keep coming back for more! As always, we welcome your comments below.

So - welcome to Part 1 of this series: Making it Official: Incorporation

You've been thinking about starting your startup for a while, right? You've got an idea and you think you know how it's going to work. But before you make it official, you want to test out your idea. So you start developing your product. You ask people for their opinions. Maybe you even try to get a buzz going. You figure you'll do the technical step of creating a company when you're about to see the dollars roll in.

Hang on a minute.

You might want to incorporate a bit sooner than that. First of all, one of the legal advantages to incorporating is that if you have a company doing the work, you can "hide" behind it. Your company creates the product. Your company signs the contracts. And if your company messes up and someone wants to sue it – you're not on the hook, the company is (unless you intentionally do something particularly malicious). Secondly, there are serious tax advantages to creating a company before it has any value. If you establish a legal entity and it has nothing (no intellectual property, no revenues, no product), and you get shares in that empty, nothing-in-it company, then your shares are worth nothing. So if you pay nothing for nothing, you don't owe taxes. But – if your company has value right from the start and you pay nothing to get shares that are worth something – well, you've made a profit and the government will want a piece.

Even more important: If you've been working on your product before you set up your company, and it's been out in the world and has value – transferring it to your company (in exchange for shares) can have negative tax ramifications. Sometimes, you can get an exemption from the tax ramifications, but there will be a catch or two. You'll have to apply for that tax exemption from the authorities. And if you get it, it will impose limitations on your company. For instance, you won't be able to go ahead and sell that valuable intellectual property for at least two years from the "transfer". This includes selling off pieces of your company and diluting your holdings below a certain percentage. In turn, this will get in the way of accepting equity investments and prevent the growth of your company (we'll have a whole installment with more about getting investments).

The actual process of incorporating a company is pretty painless. If you decide to incorporate in Israel, you choose a name and who will hold shares, sign a few forms, pay a fee of approximately NIS 2,500, and a few days later – you have an official company. If you decide to incorporate in a different country, the process tends to be similar, with the fee being the main variable. Reasons you might want to incorporate outside Israel can range from having an investor on the line who will only put his money in a US company, to tax incentives (you've heard of offshore companies, right?), to proximity to a certain industry, to regulatory constraints (some businesses are illegal in one place and legal in another). Your legal advisor can help you decide on the right jurisdiction for your company, and can introduce you to local counsel in the jurisdiction of your choice in order to get the company up and running.

The content of this article does not constitute legal advice.

Shira Teger is an associate in Yigal Arnon & Co.’s high-tech practice. In her previous incarnation (before choosing a life of law), Shira was a journalist.