Artificial intelligence (AI) is one of the most innovative and disruptive technologies in recent decades. The AI market has expanded rapidly as more organizations recognize the value of leveraging big data to make intelligent business decisions and improve customer experiences.
Moreover, the rise of large language models (LLMs) and generative AI platforms, such as Open AI’s ChatGPT and DALL-E, has pushed AI into the mainstream as users seek machines to generate new content rather than just analyze data.
According to investment tracker, PitchBook, AI evaluations far outpace other verticals and investors have poured $330 billion into 26,000 AI and machine learning startups over the last three years.
If you’re interested in entering this investment-rich, innovative industry, read on for tips and considerations on how to start an AI company.
Is starting an AI business right for you?
As AI soars in popularity and use, consider if starting a business with the latest generative AI technology is a smart move. Many entrepreneurs are looking into this. Ask yourself if you have what it takes to compete with increasingly common foundational models or if you should focus on creating an app that uses these models in a unique way.
AI businesses can take many forms, including consulting, freelance AI design, AI education and training, AI agencies, and AI software-as-a-service (SaaS).
Once you have chosen your path, use AI to your advantage in writing a business plan.
Selecting the right business structure
Most startups form an LLC, S corporation, or C corporation. Each has legal advantages that can protect personal assets from liability, such as creditors.
To determine the right business structure, it’s important to understand how each compare in terms of taxation, management structure, ownership, and compliance requirements.
In general, it’s easier to form and manage an LLC than an S corporation or C corporation. This flexible business structure also offers pass-through taxation, where the business's profits and losses are passed through the business and reported on the owner’s personal tax returns.
Corporations can be complex to operate, and corporation laws require more formalities in how the entity is managed. For example, shareholder and director meetings must be held, proper notice given, and minutes taken.
S corporations (technically a corporation that has elected special tax status with the IRS) are a popular choice because they have preferable self-employment taxes compared to an LLC, but they retain the same pass-through taxation benefits (and aren’t subject to double taxation like C corporations). Although exempt from corporate taxes, S corporations must still report earnings on federal income tax returns. The disadvantages of an S corp include limits on the number of shareholders (100) and they can only issue one class of stock.
So which business structure should you choose?
If you plan to pursue venture capital, legal advisors are likely to recommend forming a C corporation. This is because most VC investors prefer to invest in C corporations and are not able to invest in LLCs or S corporations or own shares in S corporations. Choosing anything other than a C corporation does not completely eliminate the chance of attracting a venture capitalist. However, it is a topic to address with legal and tax advisors during the formation phase. An advisor may also recommend you incorporate in Delaware because of its favorable tax laws.
Another option is to change the structure of your AI company at a later date by using a statutory conversion. This may also be referred to as a statutory merger or non-statutory conversion, although the latter is complicated and expensive in some states. There are also tax and legal considerations when converting your business structure. When you change your corporation to an LLC, there could be significant tax implications. When the assets of your corporation are transferred to your new LLC, the corporation will be taxed for the sale or transfer of its assets (referred to as "liquidation"), and the shareholders will also be taxed on the assets distributed to them.
For more information, see Compare S corporation vs C corporation and LLC vs. Inc: Understanding the differences between an LLC and a corporation.
Protecting the IP
When starting an AI business, consider what intellectual property (IP) is important for the future growth of your business. What technology and data do you plan to utilize? What creates a unique advantage for you – known in the industry as your “data moat” – and what IP rights can enhance that advantage?
A data moat refers to the competitive advantage your company gains through its access to high-quality, unique data. The more data your AI product can learn from, the more successful it will be. This involves aggregating differentiated, high-value data that isn't available to your competitors and using it to train your AI models.
Your IP may be either technology itself or products and services that are enabled by AI technology. But even before you decide what assets must be protected, consider internal ownership. Ensure that each executive, director, manager, employee, and independent contractor sign a non-disclosure and confidentiality agreement that includes stipulations for IP and assigns ownership for anything that they create to the company itself.
Don’t forget third-party vendors. Assess each vendor to understand their technology, the quality of their training data, and their cybersecurity measures for data protection.
Last, be strategic in protecting your AI technology. Conduct a freedom to operate analysis before launch to avoid infringing on existing IP rights. Comply with open-source licenses for any incorporated components. Develop a comprehensive IP strategy aligned with business objectives and consider the entire lifecycle of AI technologies.
Data security and protection
As a tech startup, you handle sensitive information such as intellectual property, customer data, and financial records. A data breach can lead to financial loss, damage to your reputation, and legal liabilities.
Data protection and privacy laws to consider include the EU General Data Protection Regulation (GPDR) and the California Consumer Privacy Act (CCPA), which govern the collection and use of personal data. There are also industry-specific laws for data protection in sectors such as finance, healthcare, government, telecommunications, and education.
Understanding the data security and protection regulations, standards, and frameworks applicable to your market is essential. Compliance with these frameworks and standards is crucial for audits, attracting new clients, and potential mergers and acquisitions.
Other compliance responsibilities
There are other general legal obligations of running a business, including:
- Obtain a state tax ID and licenses: Register for a state tax ID and obtain the right business licenses and permits from the state, local, or federal government. You must also keep all licenses and permits current.
- File a DBA: If you choose to operate under a business name other than its legal name you must file a “doing business as” or DBA registration and renew it as required.
- LLC and corporation compliance: There are also state and federal compliance responsibilities that are specific to LLCs and corporations. These include:
- Filing state annual reports
- Paying state franchise tax (privilege tax)
- Having a registered agent in each state where the business operates
- Filing a FinCEN beneficial ownership information (BOI) report. A new requirement mandated by the Corporate Transparency Act (CTA) which went into effect in January 2024. It applies to LLCs, corporations, and other legal entities created by filing a document with the state. For more information, see What startups should know about beneficial ownership reporting.
- Employment laws: Hiring employees involves additional responsibilities, including compliance with labor and employment laws. As an employer, you must ensure proper payment, withhold employment taxes, maintain records, provide eligible workers with unpaid or medical leave, and more.
Requirements may vary based on the nature of your business and its location. Research federal, state, and local guidelines for zoning, licensing, employment, permits, and tax laws to ensure compliance.
BizFilings can help
Whether you are starting a business or incorporating an existing business, it is helpful to know and understand the formation and ongoing requirements each state places on corporations and limited liability companies (LLCs).
Check out our state guides for LLC and corporation. We provide key information on state-specific requirements for forming an LLC or corporation.
