Updated on April 19th, 2023
Ever since she was a child, Dorothy has loved reading novels. Romance, adventure, fantasy, science fiction, you name it. Dorothy is an unapologetic bookworm. On Dorothy’s fortieth birthday, she decides to follow her lifelong dream and open a used bookshop with a café for fellow readers. After a few years of hard work, Dorothy succeeds in opening her store. Dorothy’s teenage daughter helps her with online marketing, and thanks to a viral TikTok, business skyrockets. Dorothy is even approached by an investor who is interested in her business and suggests that she expand it. Dorothy is certainly excited by the offer. However, she is made aware that in order to grow the business in the way she would like, she will have to turn her company into a corporation. Her husband Alistair urges her to pursue the idea. He tells her that by incorporating the business, she will protect their assets. In the event of a lawsuit, their home, car, and personal savings will be safe, which is important for their daughter’s future. Dorothy will also have more resources available to do the expansion she would like. But as a former English literature major, Dorothy does not know much about the incorporation process.
Incorporation is the process a business owner must follow to turn his or her company into a corporation or a limited liability company (LLC). Incorporating a business turns it into its own legal entity with similar rights and duties as a person.
The process of incorporation may be reduced to the following simple steps.
Benefits of Incorporation
One of the most well-known and significant advantages of a corporation is the liability protection that comes with incorporating a company. Because a corporation is a separate entity from its owner, the owner is not legally responsible for the debts or obligations of the business.
Another benefit is related to taxes. Corporations are actually taxed at a lower rate than individuals and can own shares in other corporations. Only 20% of dividends are taxable. Corporations can also pass on losses into future tax years to offset taxable income. Sole proprietorships, by contrast, can only pass on $3,000 in losses.
Other advantages include:
- Brand protection
- Deductibles for business expenses
- Easier to get financing
- Increased customer trust
- Unlimited growth
- Structural flexibility
- Investment opportunities
- Separate credit history
While most business owners will incorporate in the state in which they live and conduct their business, some owners have found it beneficial to incorporate elsewhere. Some states have more favorable incorporation laws. These states include Delaware, California, Nevada, Maryland, Pennsylvania, and Connecticut.
Corporations and LLCs can also own their own property, increasing assets and revenue. This property, however, could be affected if the business takes on debt. But the owner of the corporation will not be affected by this debt. His or her personal assets, such as their car or home, cannot be taken away.
1. Pick a company name
Believe it or not, there is a lot that goes into the naming of a business. It is important that a business owner conduct the necessary research before incorporating. Each state has requirements about naming that must be met. First, a business name that is available for use. This means if a another corporation in the state shares the same name, then an applicant cannot use that name. A corporation also cannot use certain restricted words, such as “bank” or “insurance.” A corporation’s name also cannot be confused with a government agency. It is also important that the name have the proper suffix. This means that the name should end with “inc.,” “corp.,” or “LLC,” to indicate that business is incorporated. Corporation names tend to share the following elements:
- A descriptive name that tells consumers what the business does.
Example: Dorothy’s bookshop could be named “Books Anonymous” because it is a name descriptive of the business. It wouldn’t be helpful to name the business “Custom Shelves,” because this may confuse customers. Customers may think the business sells shelving units and not books.
- A distinctive name that makes the business stand apart.
Example: Dorothy’s store “Books Anonymous” has a unique name that sets it apart. If she calls it simply “Books,” the name is not distinctive enough to set it apart from other used bookstores.
- A legal ending that is required by state law.
Example: Dorothy’s store would need to have an abbreviation added to it. So, she could have “Books Anonymous LLC,” or “Books Anonymous Inc.”
2. File Articles of Incorporation
Articles of Incorporation is a document that must be completed and filed with the Secretary of State in a business’ home state. This form will include all the important information about a company. The document must include, at minimum, the following information:
- The name of the corporation
- The purpose of the corporation
- The principal place of business
- If stock will be issued
- How many shares will be issued
- The value of the shares
Depending on the particular state in which a business files, the fee to file Articles of Incorporation ranges from $25 to $1000.
3. File the Operating Agreement
Even though some states do not require this document to be filed, it may still be a good idea to do so. This agreement details every aspect of one’s business. If a business owner wishes to assign managers to the company, this is the document on which they would be listed. A business owner may also include the future goals of the business. Now is also the time to consider the type of business one wishes to incorporate. Does an owner want his or her company to be an LLC or a corporation? If a corporation, then an S corporation or a C corporation? What about a general partnership or limited liability partnership? Each of these business structures has its own benefits and drawbacks, so an owner should do their research.
4. File Bylaws
Depending on the state, new corporations may need to file bylaws. Bylaws are a document that concerns the administrative governance of a company. It includes details on voting procedures and annual shareholder meetings, among other topics.
5. Appoint Directors
Appointing directors is not a mandatory step. That said, a lot of business owners will appoint directors or managers to operate the business, both on a grand scale and on a day-to-day basis. Often, having directors can help a business attain its goals. If there is only one or two owners, then it can be hard to handle all the responsibilities that come with operating a business. By having directors, it is easier to manage complications or difficulties that may arise. It can also help to have a different set of opinions to listen to. It is all too easy for an owner to make all his or her own decisions without any feedback or challenge.
When it comes to operations, directors are typically in charge of larger decisions, such as deciding when to sell stock and for how much. Owners can act in the role of directors, but it is not necessary that they do. Managers, on the other hand, will control business operations on a day-to-day basis and are not involved as much in the larger picture. Depending on the state, there may be rules about how many managers and directors a company can have.
6. Appoint a Registered Agent
In most states, it is required for a business to appoint a registered agent. The agent is a person put in charge of service of process. This means that the individual will be responsible for delivering legal materials to the business in the event of a lawsuit. He or she is essentially the contact person. In most states, a registered agent can be as young as 18 years of age. There are companies that offer the services of registered agents for a fee.
7. Get an FEIN
FEIN stands for Federal Employment Identification Number. It is a business’ unique identifying number and can be acquired for free. An FEIN is required to open and keep a bank account and business credit card.
8. Open a Bank Account
It is important that a business owner keep business expenses separate from his or her personal assets. To keep them together could lead to problems in the event of a liability issue. Opening a business bank account is a critical step in setting up a business’ account structure.
9. Set Up Accounting
Accurate and consistent bookkeeping is important for a new business. When a business is incorporated, it is essential that the owner complies with local, state, and federal laws. This means that he or she will need to pay fees, file reports, and get business licenses and permits as required. This is a lot of responsibility! To keep everything in order, it is important to have a reliable accounting method set up. This may mean hiring an accountant or buying an accounting system.
10. Hire Employees
A new corporation that wishes to hire employees has other requirements that must be met. An owner will need to purchase unemployment insurance and workers’ compensation. Because he or she will also be responsible for payroll, this means extra books and records that must be kept.
11. Create a Shareholder Agreement
A shareholder agreement is a necessary document for a business that intends to issue stock shares. This document goes over the procedures of selling and transferring stock, as well as other administrative procedures.
12. Hold a Board Meeting
At the first meeting of directors, the board will make certain decisions about the company’s administration and operation. They will discuss the fiscal year ahead, appoint officers, authorize and issue stock, and create and adopt bylaws. This is also the time that a vote should be held on whether to become an S corporation. An S corp, as it is called, has certain tax benefits, but will only work for certain types of companies.
13. Issue Stock
A corporation cannot start operations until shares have been issued among owners. If a corporation is large, it needs to register its stock with state securities agencies and the Securities Exchange Commission (SEC). Small corporations will usually only issue stock to 35 or fewer individuals. This means that they do not have to register with the SEC. Depending on the state, there may be specific SEC exemption rules. It is important that a business owner takes care to record the names and information of all stockholders. Also to be recorded are the shares that each person has bought, and how he or she paid for the purchase. In return, each shareholder will get a stock certificate.