Artificial intelligence (AI) is one of the most innovative and groundbreaking technologies in decades. The AI market is growing rapidly as more companies realize the value of using big data to make intelligent business decisions and improve customer experiences.
Furthermore, the rise of large-scale language models (LLMs) and generative AI platforms such as Open AI’s ChatGPT and DALL-E have brought AI into the mainstream as users look for machines to not only analyze data but also generate new content.
According to investment tracker PitchBook, AI valuations have far outpaced other industries, with investors pouring $330 billion into 26,000 AI and machine learning startups over the past three years.
If you’re interested in getting into this investment-rich and innovative industry, read on for tips and considerations for starting an AI company.
Is Starting an AI Company Right for You?
As AI grows in popularity and use, you should consider whether starting a business using the latest generative AI technologies is a wise choice. Many entrepreneurs are interested in this. Ask yourself if you have what it takes to compete with the basic models that are becoming more and more common, or if you should focus on building apps that leverage these models in a unique way.
AI companies come in many forms, including consulting, freelance AI design, AI education and training, AI agencies, and AI Software-as-a-Service (SaaS).
Once you’ve chosen your career path, put AI to good use when writing your business plan.
Choosing the Right Business Structure
Most startups form an LLC, S Corporation, or C Corporation. Each of these structures offers legal benefits that can protect personal assets from claims from creditors and others.
To determine the right corporate structure, it is important to compare each structure in terms of taxation, management structure, ownership, and compliance requirements.
Generally, LLCs are easier to set up and manage than S or C corporations. This flexible business structure also offers pass-through taxation, allowing company profits and losses to be transferred through the business and reported on the owners’ personal tax returns.
Managing a corporation can be complicated, and corporate law requires more formalities in corporate governance. For example, shareholder and board meetings must be held, properly announced, and minutes kept.
An S-Corporation (technically a corporation that has been elected to a special tax status by the IRS) is a popular choice because it is taxed more heavily than an LLC, but has the same pass-through tax benefits (not double taxation like a C-corporation). Although exempt from corporate taxes, S corporations must report profits on their federal income tax returns. Disadvantages of an S-Corporation include limitations on the number of shareholders (100) and the ability to issue only one type of stock.
So what business structure should you choose?
If you want to invest in venture capital, your legal advisor will likely recommend that you form a C Corporation. This is because most venture capitalists prefer to invest in C corporations and cannot invest in LLCs or S corporations or own stock in an S corporation. Choosing a structure other than a C corporation will not completely eliminate your chances of attracting venture capitalists; however, this is an issue you should discuss with your legal and tax advisors during the startup phase. Your advisor may also recommend that you incorporate your business in Delaware due to its favorable tax laws.
Another option is to change the structure of your AI company through a legal conversion at a later date. This is sometimes called a statutory merger or extrastatutory conversion, but the latter can be complicated and expensive depending on the state. There are also tax and legal considerations to take into account when transforming your business structure. Changing your corporation into an LLC can have significant tax implications. When your corporation’s assets are transferred to the new LLC, the corporation is taxed on the sale or transfer of its assets (called a “liquidation”), and shareholders are also taxed on any assets distributed to it.
Protecting Intellectual Property
As you start your AI company, consider what intellectual property (IP) is important to your company’s future growth. What technology and data will you use? What gives you a unique advantage, known in the industry as a “data moat,” and what intellectual property rights can enhance that advantage?
A data moat is the competitive advantage a company gains from access to high-quality, unique data. The more data your AI product has available to use, the more successful it will be. This involves aggregating differentiated, high-quality data that is unavailable to competitors and using it to train AI models.
Your intellectual property can be either the technology itself or the products and services enabled by your AI technology. However, even before you decide which assets you need to protect, you should consider internal ownership. Make sure all officers, directors, managers, employees, and independent contractors sign confidentiality agreements that include intellectual property clauses and transfer ownership of everything they create to the company itself.
Don’t forget third-party providers. Evaluate each provider to understand their technology, the quality of their training data, and their cybersecurity data protection measures.
Finally, be strategic about protecting your AI technology. Conduct a freedom of action analysis before going to market to avoid infringing on existing intellectual property rights. Adhere to open source licenses for all integrated components. Develop a comprehensive IP strategy that considers the entire lifecycle of your AI technology, aligned with your business objectives.
Data Security and Protection
As a technology startup, you handle sensitive information such as intellectual property, customer data and financial records. A data breach can result in financial loss, reputational damage and legal liability.
Data protection and privacy laws to consider include the EU’s General Data Protection Regulation (GDPR) and the California Consumer Privacy Act (CCPA), which govern the collection and use of personal data. There are also industry-specific data protection laws in sectors such as finance, healthcare, government, telecommunications, and education.
It is important to understand the privacy and data security regulations, standards, and frameworks that apply to your market. Adhering to these frameworks and standards is important for audits, attracting new customers, and potential mergers and acquisitions.
Other Compliance Responsibilities
You have other common legal responsibilities when running a business, such as:
- Obtain a State Tax ID Number and License: Apply for a state tax ID number and obtain the correct business licenses and permits from state, local, or federal authorities. You must also keep all licenses and permits up to date.
- File DBAs: If you want to do business under a name other than your legal name, you must file a “business name” or DBA registration and update it as necessary.
- LLC and Corporation Compliance: There are also state and federal compliance obligations that apply specifically to LLCs and corporations. These include:
- Filing state annual reports
- Paying state franchise taxes (privilege taxes)
- Having a registered agent in each state in which your company does business
- Filing FinCEN reports that include beneficial ownership information (BOI). New requirements in the Corporate Transparency Act (CTA) took effect in January 2024. They apply to LLCs, corporations, and other legal entities formed by filing documents with the state. For more information, see What Startups Need to Know About Beneficial Ownership Reporting.
- Labor Laws: Hiring employees creates additional responsibilities, including compliance with labor and employment laws. As an employer, you have obligations to ensure proper payroll, withhold payroll taxes, maintain records, provide unpaid vacation or medical leave for eligible employees, and more.
Requirements may vary depending on the type and location of your business. Research and ensure compliance with federal, state, and local zoning, licensing, employment, permitting, and tax laws.
BizFilings is here to help
Whether you’re starting a business or incorporating an existing business, it’s helpful to know and understand the formation and ongoing requirements each state imposes on corporations and limited liability companies (LLCs).
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