What is Incorporation?
The incorporation is um legal procedure by which a legal entity or company is established. The resulting legal entity, called a corporation, is distinct in terms of the assets and income of its owners and investors.
Corporations can be established in most countries and are often recognized by the use of suffixes such as “Inc.” or “Corp.” at the end of their names. The process involves officially declaring a corporate entity independent of its owners.
How does Incorporation work?
The term “incorporation” refers to the action of registering a business in a state so that it becomes a legally separate entity. This business form is usually owned by shareholders and may be managed by a board of directors.
It is not mandatory for a company to be incorporated to begin operations. Business owners can opt for formats such as sole proprietorship, partnership, or limited liability company (LLC). These structures manage debt and taxes differently compared to a corporation.
One of the main benefits of incorporation is the ability to issue shares. This allows ownership of the company to be shared through the issuance of shares, unlike a sole proprietorship or partnership which is typically owned only by the operators of the business. If there is no need to sell shares, an LLC may be a viable option, offering legal protection with pass-through taxation, where profits are taxed only once.
The Creation and Organization of Corporations
The incorporation process includes the preparation of an “article of incorporation” that details the primary purpose of the business, its location, and the number and type of shares issued, if applicable. A closely held company is generally owned by a restricted number of shareholders and does not have its shares publicly traded. A corporation's shareholders are owners of the corporation and can range from a single individual in small businesses to thousands in large, publicly traded corporations.
Shareholders are generally only responsible for paying for their own shares. As owners, they are entitled to the company's profits, which are often distributed in the form of dividends. They are also responsible for electing the company's directors.
Directors, in turn, are in charge of the company's day-to-day operations. They have a duty to zealously manage the corporation and act in its best interests. Typically, directors are elected annually, with smaller companies may have a single director, while larger companies may have a board of several members. Except in cases of fraud or specific tax legislation, directors have no personal responsibility for the company's debts.
How to Incorporate a Business
Setting up a company involves several crucial steps. Below, we detail the decisions and procedures an owner must follow to incorporate their business.
Decide where to operate and comply with local laws
Before incorporating, it is essential that the company ensures compliance with local business licensing and zoning laws. This includes obtaining the necessary licenses or permits, which vary depending on the type of business.
Additionally, the location of operation may influence where the company will be incorporated. It is often advantageous to incorporate the company in the same state where it operates, due to the specifics of local legal requirements. Incorporating in a state other than the state of operation may require registration as a foreign corporation. However, such a decision can also lead to benefits such as reduced fees and simplified corporate maintenance requirements.
Decide if a company is the best option for you
Choosing the legal structure of the business is one of the most important the owner will make. The most common structures include sole proprietorship, partnership, corporation, and S corporation, as well as an LLC (limited liability company), which is a widely accepted option under state law. While this article primarily deals with forming a corporation, it is crucial to consider other legal forms that may better meet the needs of the business.
It is essential that the owner chooses a structure that offers long-term strategic and operational advantages. Corporations have the ability to issue shares of stock, which can be an effective way to raise capital. Furthermore, the choice of structure directly impacts tax and liability issues.
If you are unsure which structure to choose, it is recommended that you consult with a lawyer specializing in commercial law to explore the options available.
Select a unique name
When incorporating, the company's name must be distinct from others already registered in the region to avoid legal problems, such as trademark violations and confusion in the market. Incorporated companies often adopt suffixes such as “Inc.” to indicate your legal status.
There are online directories that make it easy to search for existing names and check their availability. Some states also offer the possibility of reserving a business name for a period of 60 to 120 days, facilitating the incorporation process.
Select a Registered Agent
A registered agent is a legal representative authorized to receive official documents on behalf of the company. State law requires the appointment of a local registered agent, providing a reliable point of contact for handling correspondence and legal matters.
This agent does not need to be the owner of the company. For example, a lawyer specializing in business law can fill this role as long as he or she has a physical office in the company's state of registration. If the registered agent moves out of state, the company must appoint a new agent. There are also online services that offer representation as a registered agent for a fee.
Prepare and File the Social Contract
As mentioned previously, the articles of incorporation must detail essential elements of the company, such as business name, location, share details and registered agent information. Each state has specific requirements for filing this document, usually accompanied by a fee that can vary but often amounts to a few hundred dollars.
Draft the Bylaws
In parallel with the drafting of the articles of incorporation, companies must draft a bylaws that stipulate the structure of remuneration, issuance of shares, voting rights and functioning of the administrative board.
The bylaws provide a detailed guide for the company's operation, serving as a reference for clarification on internal procedures. Although some states do not require this document to be filed, it may be requested by financial institutions during procedures such as opening bank accounts. The bylaws can also be updated to reflect the company's changing needs.
Hold Board Meetings
During the first board meeting, members must take a series of critical actions. These include the formal adoption of the articles of incorporation and bylaws, the authorization and issuance of shares, the election of directors and other important operational decisions. It is essential that the minutes of these meetings are meticulously documented, as they may be requested by certain regulatory or financial entities.
Complete Additional Requirements
There are several operational obligations that business owners must meet throughout the incorporation process. Although they are not directly part of the incorporation process, they are essential to the legal operation of the company. These tasks include applying for an employer identification number, opening a business bank account, filing federal tax returns, publishing notices of company formation if necessary, and submitting annual reports as required by local authorities.
Pros and Cons of Incorporation
Pros
- Liability Protection: Owners have protection from personal liability as the corporation is responsible for its own debts.
- Capital Raising: Facilitates obtaining capital through the sale of shares, which can be carried out more easily than in other business structures.
- Tax Benefits: Possibility of receiving favorable tax treatments compared to other business structures.
- Personal Profits: Allows owners to profit from the sale of partial shares without the need to sell the entire company.
Cons
- Cost and Complexity: Requires more investment of time and resources to comply with regulations, reporting obligations and filing procedures.
- Double Taxation: Profits distributed to shareholders can be taxed twice – once at the corporate level and once at the individual level.
- High Costs: Generally involves more expenses due to fees and associated legal costs.
- Reduced Flexibility: Less operational flexibility, as the company must adhere to its bylaws and board decisions.
Conclusion
The decision to incorporate a business is significant and requires careful evaluation of several considerations. While incorporation offers liability protection, facilitates capital raising and can provide tax benefits, it also brings with it a number of challenges, including increased regulatory complexity, additional costs and potential restrictions on operational flexibility. It is crucial for business owners to weigh the pros and cons against their specific needs and long-term goals.
Choosing between different business structures, such as LLCs and different types of corporations, should be made based on company size, number of owners, capital needs, and tax preferences. Furthermore, considerations regarding the ideal time to start or transform a business entity are essential to align operations with administrative and tax benefits.
It is recommended that owners seek advice from qualified professionals, such as lawyers and accountants, to ensure that the choice of business structure and incorporation process are aligned with best practices and legal compliance. By doing so, business owners can maximize their companies' potential while successfully navigating the complexities of the corporate environment.
FAQ
Is an LLC better than a corporation?
The choice between LLC and corporation depends on the specific needs of the business and its owners. LLCs offer advantages such as avoiding double taxation through pass-through taxation, and do not require a board of directors, and are also cheaper and easier to maintain. Corporations are more suitable for larger companies or those with multiple owners, offering ease in raising capital through the sale of shares.
When should you start a business?
From an administrative point of view, starting a legal transformation at the beginning of the year, on January 1st, is advantageous for tax reasons. Operationally, it may be more strategic to convert a company into a corporation when it is ready to raise more capital, making it easier for investors to invest.
Do I need to pay myself after incorporating?
When incorporating, it is not mandatory to pay a salary. However, it is important to consider the tax implications of receiving a salary versus taking withdrawals or distributions. Corporation income is taxed both upon receipt and distribution to owners, which may encourage delaying personal withdrawals to minimize taxation.
Can an individual be a corporation?
Yes, it is possible for a corporation to be formed by just one person. S Corps and C Corps options are popular among small businesses or sole proprietorships. Although a single person can form a corporation, an LLC generally offers a more flexible structure for individuals, even allowing the option of taxation as an S Corp if that is more advantageous.
