By Farrah Rahman
Serial entrepreneurs are constantly coming up with the ‘next big idea’. During the excitement of starting the process of building a business, incorporating might not be the first thing on an entrepreneur’s mind. Employees might be promised shares in a corporation that doesn’t even exist. Can the employees enforce this promise?
An oral or written agreement promising to provide equity in a company that has not yet been incorporated can be considered a valid agreement.
In Fedel v Tan, Tan entered into an oral agreement to provide 40% equity to Fedel in their new seaweed derivative company that had yet to be incorporated. The company was incorporated one year later, with Fedel and Tan as directors of the company. 100% of the shares were issued to Tan, however, Tan had promised that Fedel would still receive 40% of the equity. Fedel continued to work as vice-president of the parties’ company. 10 years later Fedel argued that he was entitled to the 40% ownership interest promised by Tan. The court held that the oral agreement made pre-incorporation was a valid agreement, as the parties’ actions proved that the parties intended to be partners in their company, each holding equity in the company.
Although parties can create binding vesting contracts prior to incorporation, there are a number of benefits to incorporating a business immediately:
Investors: When searching for investors to invest in your next big idea, they will be looking to invest in a legal entity, rather than financing individual founders. It is a good idea to have the company incorporated before looking for investors and funding.
Employees: Founders may decide to pay new employees out of their pocket prior to incorporation. However, hiring employees by a legal entity can result in tax benefits, and IP assignment from the employee to the company. Furthermore, it eliminates the additional step of entering into a second employment agreement after incorporation.
Intellectual Property: If you are coming up with the ‘next big idea’, it is likely that you will have some IP to protect. It is also likely that you will want the IP to be the property of the company, and not individual founders. Incorporating the business will protect the IP of the company and will ensure that IP is assigned to the legal entity. Incorporating early is also a good idea where founders want to protect their unique company name.
Check out Clausehound’s Small Business Law Library for standard incorporation documents, such as Articles of Incorporation!
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