Famous Last Words Sept09

When is time to incorporate or form your LLC? (September 2009)

Dear Jim:

Four of us are starting a studio. Should we incorporate or form an LLC right away? We want to appear "professional" when we pitch, or show our work.

High Hopes

Dear High Hopes:

Congratulations on starting on the road to your own company! Working on your own projects with friends and colleagues can be hugely rewarding on many levels!

I believe one error that many new studios or developers make is incorporating, or forming an LLC, too early.

My practice is largely in California. In the Golden State, there is a minimum annual tax on corporations and LLCs. Whether or not the company does any business, has any employees, or sees even a dollar in cash flow, returns must be filed and minimum payments made. If you are working in California, establishing the entity in Delaware, or Nevada (often hyped in radio ads), does not escape California taxation. Other states have their own rules on this.

I have seen clients set up entities because they are sure they will have their deal "in a week or so." But we all know the unpredictability of these things. The tax obligation endures; even if the dev deal slips away.

Unless there is some compelling reason to do so, I urge clients not to take steps to set up their organization until they literally are holding the pen above the line where they have to sign for that first deal.

So what are compelling reasons to incorporate or set up an LLC?

Two that I recognize are related to liability, and ownership/control of work product and other IP.

1. The primary benefit of operating through a properly formed and maintained corporation or LLC is that the entity exists as a separate "person" in the eyes of the law. If there were to be a claim that your game was infringing, or, for example, that you were using unlicensed copies of tools, or that your company name infringed on someone else's trademark (no, you probably can't name your company "Actovision"), the claim, and resulting liability, could be against the company, not you and your partners personally. If the entity is set up and managed properly (that is a subject of another discussion), you may sleep better knowing your home, kid's college funds, and your retirement savings are not at risk in a potential claim!

2. A second benefit is the new entity can be structured to be the owner of all IP created by the participants. If there is no entity, under copyright law, copyright will subsist in the creators of work product from the time it is first fixed in tangible form. Without an entity, and as the creators, ownership of elements of the code may be fragmented among each of you, and trademark rights for the business name may be equally shared by all. This could make it difficult, or at least more complicated, to move forward.

One way to avoid this without forming an entity is to reach agreement, and sign, a collaboration agreement among all participants. Such an agreement can lay out ownership of code, other IP, patent rights, and confidential information, and how decisions are to be made regarding opportunities or exploitation of any of this.

The collaboration agreement does not have to be complicated, but should reflect the consensus of the participants. It should provide that in the event an entity is established to continue the business, all rights of the group will be transferred to the entity.

Forming a new company can be an exciting process, and a source of pride for the founders. But like everything in business, careful planning, and a disciplined execution of that plan, can go a long way to helping make the venture a success.

©2009 Jim Charne. All rights reserved.