How do I incorporate a business?
The question of how to incorporate a business is a good one to ask if you’re an aspiring entrepreneur looking to start up your next venture, or if you’re someone just looking to make some extra money on the side by mowing lawns or selling homemade brownies. But to be honest, there is probably one question you need to be asking even prior to this, and that is the question of why you think it makes sense to incorporate your business. While incorporating a business can give you certain advantages, in particular in being able to scale up the business or take on new investors, it also brings along the potential for costs, administrative headaches, and headaches that don’t exist in a sole proprietorship.
But suppose you’ve moved beyond the point where simply running a sole proprietorship is the right move for you. And you’ve even gotten to the point where a limited liability company (LLC) no longer fits your needs as well. Maybe your business has grown over a period of years, maybe you have snazzy venture capitalists who want to invest and need the right structure to do so, or maybe you’re just looking to be able to sell your company and need a vehicle to do so. You’ve done your research and you know that setting up some type of more complex corporate structure is right for you.
How do you actually go about incorporating a business?
First, you’re going to need to make sure you lay out who actually runs the company. This means you’re going to have to consult with the shareholders who currently own the company, and formally appoint a board of directors. Now, if you have owned the entire company up to this point, this is typically pretty easy. You could choose to appoint yourself as the sole director, and because you own the entire company, there isn’t a single person in the world who will tell you that you can’t do this. But if you have other shareholders, or if you’re taking on new shareholders (like those clever venture capitalists), they’re going to want a say in who sits on the board of directors, and that’s something that you need to prepare for.
The next major choice you have to make it what type of corporation you want your company to become. You have two primary choices – an S-corp or a C-corp. There are a couple of key differences that you’re going to want to keep in mind. First, S-corps, much like LLCs, are pass-through entities. Pass-through entities are not subject to corporate taxation, and any income earned is passed through to the individual shareholders at their personal income tax rates. C-corps, on the other hand, are taxed at corporate tax rates, and then any dividends paid out are taxed again for individuals. The second major difference relates to the number and types of shareholders, as S-corps are limited to no more than 100 shareholders and only one class of stock, while C-corps can have an unlimited number of shareholders with different share classes as well. Consulting with an attorney specializing in incorporation can help you figure out which structure makes the most sense given your goals, and it’s worth doing to ensure that you don’t make a really costly mistake with the first decision you make about your business.
From there, you’ll have to follow guidance from your state regarding any forms and paperwork that are necessary for incorporating with the state. These forms often have fees attached to them, so don’t expect to be filing your articles of incorporation for free. Many states also require detailed filings that include information on corporate directors, board members, and operating status of the company. This information is typically required to be updated every year, along with, you guessed it, more fees. Once these forms are completed at the outset, the only item you have left to do is to register your newly-created corporation with the federal government, indicating the proper tax status for your company.
The actual incorporation process is actually pretty straightforward. In reality, as noted earlier, the area where you really need to spend your time is wrestling with the decision on whether incorporation is the right move for your company. My college football coach always had a cheesy but memorable phrase to help me remember what to do with these types of decisions. He’d say, “If I gave you eight hours to chop down a tree and an axe to cut it down with, how do you spend your time? Make sure you spend the first seven sharpening your axe and the last one cutting it down.” The actual process of filing and registering a corporation is not rocket science. But you need to figure out the how the pros and cons of incorporation work for your specific company. You need to consider tax burdens, regulatory costs (remember those fees from above), ability and necessity to add new shareholders, whether to use multiple share classes, and a whole bunch of other questions that may be unique to your business. Don’t make the decision to incorporate and then try to figure out if it’s right for you. Spend seven hours sharpening your axe, and then cut down the tree when you know you’re ready.