Starting a small business is not just about having enough capital, choosing your business location or hiring people. As a business owner in the making, you need to decide how to structure your business. This structure largely depends on your specific needs, business location and the nature of the business itself.
If you have decided that the best structure for your business is an incorporation, you need to learn the ropes of this business structure, including its pros and cons. Of course, the disadvantages are always there, but in most cases, the advantages outweigh these disadvantages. That explains why many business owners choose to incorporate their businesses.
Before you incorporate your business, you need to understand what incorporation really means.
What is Incorporation?
The term “incorporation” comes from the word “corporate,” which comes from the Latin word “corpus,” which means “body.” In the eyes of the law, a corporation is a body. Just like any legal person, this body has the right to acquire and sell properties, bring lawsuits, contract and be taxed. And yes, it can also commit crimes.
Considering that the law treats corporations as legal bodies, a corporation serves to protect the owner of the business from any personal liability in case of corporate obligations and debts. The fact that it is created as a legal entity that is separate from the individual who established it and operates it only suggests the business owner is not held liable and accountable for any tax burden that may arise in the duration of the business.
Why Incorporate Your Business?
As a business owner, you have more than enough reasons to incorporate your business. Incorporating involves myriads of benefits to businesses, and that includes even small businesses. Since incorporation allows your business to become its own legal entity, this move represents a crucial shift in your company’s development.
While incorporating offers several benefits, we cannot totally say that it is the only best option that business owners like you have. There is no single right entity form for your company, so you still need the weigh its advantages and the advantages to see if it is the perfect fit for you. Incorporating is a major decision to make, not only because it does overhaul the structure of your business, but even more so, because incorporating your company and eventually undoing it may be very costly on your end.
Here are some of the reasons why many business owners find incorporating an effective means of carrying on a business:
- Less Liability. This is one of the most significant advantages of incorporating. When you operate as a sole proprietor, no one and nothing else is liable for the debts of the entity—in this case, your company—except you. If your company does not have sufficient funds to pay its debts, you will eventually see your personal bank account seized or your home foreclosed on.
The advantage of incorporating is that since your company becomes a legal entity in this structure, you, being the business owner, are no longer liable for the debts of your corporation. That means that if your corporation gets sued, it gets sued but you and your personal assets remain protected. The only thing that’s put at risk here is the amount of investments in the company.
- Unlimited Lifespan. When you incorporate, your business gives birth to a separate legal entity, making it different from a general partnership or sole proprietorship where the owners are intertwined with their business. Since it is a legal entity on its own, the corporation has its own bank accounts so it does not get your business finances mixed up with your personal finances.
Also, unlike in sole proprietorships and general partnerships, a corporation has an unlimited life because its existence does not depend on the life of its owners or investors. Even if you or any of the principals in your corporation dies, your corporation goes on indefinitely until it finally meets its objectives, merges with or is acquired by another business, or declares bankruptcy. The corporation lives on unless the new owners state otherwise.
- Easy Ownership Transfer. When it comes to ownership, one of the advantages of incorporation lies in the transferability of shares. This structure issues shares of ownership which can be easily transferred from one individual to another. Isn’t it good when you can easily sell, transfer or give away to a family member the ownership interest that you have in an incorporated business?
Unlike in sole proprietorships or general partnerships where you are required to cumbersomely retitle the property, come up with new deeds for all the assets that need change in ownership, and burn a hole in your pocket, in corporations, the shares of stock that you hold represent all of your rights and privileges as a business owner. So, if you want to achieve efficient transfer of ownership, you just need to see the back of each stock certificate where you need to endorse and sign over whatever shares that you want to sell or dispose of. Since each share in a corporation is entitled to a portion of the total assets of the company, and since the assets are all under the name of the company, you do not necessarily have to retitle the property to be sold.
- Ease in Raising Investment Capital. Compared with sole proprietorships and general partnerships, corporations find it so much easier to draw new investors due to its nature. Since corporations are characterized by limited liability and ease in transferring shares, they are more attractive to investors who want shares of stock to be transferred directly to them.
In a nutshell, the advantages of incorporation are:
- Business owners are free from any liability when it comes to company debts and obligations
- Transfer of ownership can be easily done by simply transferring securities
- It is easy to raise capital through the sale of securities
- Corporations continue to exist even after the death of its owner
- Corporations can create tax benefits in certain circumstances
On the other hand, the disadvantages of incorporation include the following:
- The need to attend annual meetings where all directors and owners are required to observe certain formalities
- Costlier to set up compared with sole proprietorships and partnerships
- The need for periodic filings with the state
Before you finally decide to incorporate your business, weigh the pros and cons and make sure that the business structure is worth it for your company. It may be ideal in certain situations, but just like in any other business structure, it also has its own share of drawbacks.
You should also consider the fact that once you incorporate, your profits become automatically subject to double taxation—first on the corporate level, and second, when they are paid out to the owners of the corporation. Operating as a corporation involves tax burden, and that is indispensable. As a business owner, being burdened with tax issues is probably the last thing you will ever wish to deal with, especially when you are just starting out.
How to Incorporate Your Business
Now, if after careful consideration of the pros and cons of incorporation you still find the business structure suitable for your business, the next thing you need to know is how to get started.
As mentioned, a corporation is treated as a legal entity on its own, existing separately from the individuals who created it and take charge of its operations. If there is one good thing about incorporating a business, it’s that even with just one incorporator, a corporation can already be formed. You can do this by simply filing an application for a charter in your state.
As you file the application as the incorporator, you need to prepare to disclose the following details:
- The purpose of the corporation
- The incorporators, including their addresses
- The types and amount of capital stock that the Corporation will be authorized to issue, and
- The rights and privileges of each stockholder in the corporation
Creating a corporation is not an easy task. You have to familiarize yourself with the ins and outs of incorporation before you get to achieve your goal. While the process of incorporation is a tedious one, it all boils down to these steps:
Step 1. Decide on Your Business Name. Perhaps this is the same for every business, no matter the business structure. The first and most fundamental step in forming a corporation is choosing a name for your business. How do you do it? As you think of a name for your business, you probably find myriads of ideas popping in your head. While you have the freedom to choose the name of your corporation, it is still best if you choose one that something that will make it easier for people to remember your business.
As you come up with an effective business name, you should also avoid duplicates. You can check with the corporate filing of your state or the federal and state trademark registrars to see if the business name that you plan to have is already taken or is still available. Since it is always possible to have a duplicate, it’s better if you come up with an alternate name also in case your first choice is no longer available.
Step 2. Identify Your Business Location. Once you have already chosen a name for your business and have verified that no other business has used it yet, the next thing you need to do is choose a state that will serve as the official location of your business. Sticking with your home state will make it easier for you to process everything, but remember that your state of residence does not necessarily have to be your place of business.
There are certain factors that you might want to consider in choosing your state for incorporation. These factors include the cost required in the state where you will incorporate, as well as the taxation and corporate laws in a particular state.
Step 3. Choose Your Preferred Type of Corporation. After choosing your business location, the next thing you need to decide on is the type of corporation that you will create. You have the option of incorporating your business as a C corporation, and S corporation or an LLC. It is best if you have a deep understanding of each type so you may know which of them fits your business best. It is also advisable that you seek the professional advice of a reliable tax accountant so you will know the tax implications of each.
Step 4. Identify the Names of the Company Directors. Every corporation has a set of directors. These directors are the ones responsible in running the corporation and overseeing its operations. Choosing the directors to lead your business is crucial since their management skills will determine the course and future of the corporation.
Step 5. Select the Type of Shares. Choosing the type of shares that your corporation will sell to stockholders is another important step in incorporation. Since corporations are mostly private, the availability of these shares are usually limited to just a handful of individuals, which in this case are the directors.
Step 6. Get a Certificate of Incorporation. You obtain this certificate from the corporate filing office of your state. This document, which you need to fill out, includes the name of your corporation, its purpose, location and all the other information included in the previous steps.
Submit the Articles of Incorporation. The final step in incorporating a business is the submission of the articles of incorporation, which you prepared in your chosen state of business. You submit the articles of incorporation with the required amount for the registration fee, which usually varies from state to state. If you have a corporate lawyer, he or she can file the paperwork on your behalf. You can also use a third-party service provider as long as you can afford their services.
Once you have already incorporated your business, you have to make it a point that it stays on the right side of the law. Remember that a corporation is a legal entity, so it is liable for any rule or law it may break. Make sure that you follow the rules of incorporation and keep accurate financial records for the corporation, clearly separating its income from that of the owners.