Incorporation is the legal process of restructuring your business into a corporation. When a business becomes a corporation, it becomes a legal entity completely separate from its owners and investors. Corporations can be created in nearly all countries in the world and are usually identified through the use of terms such as “Inc.” or “Limited (Ltd.)” within their names.
Corporations are a great business structure for startup founders looking to protect their assets, raise funding, and grow their company overall. For many, incorporating is considered to be one of the most foundational steps in bringing your startup to fruition, but it comes with risks. Before choosing to incorporate your own business, we’ve gathered everything you’ll need to know.
Should you incorporate your startup?
Creating a corporation can have great benefits for your startup, but also some major implications in terms of taxes or costs. Choosing whether or not to incorporate can be a difficult question, so we’ve gathered a pros and cons list to guide you through the decision making process.
Pros of incorporating
- Security: Corporations are granted limited liability, which protects your personal assets from corporate debts. The “limited” element refers to the maximum amount your personal assets can be implicated in corporate liabilities. Having these limitations can help to ensure that your personal bank accounts, homes, cars, etc. are unlikely to be seized for corporate purposes. Having this kind of security can be good for both your personal assets and the assets belonging to your corporation.
- Investing: Most startup investors are unable to legally invest in any business structures other than corporations. Additionally, many investors prefer to fund corporations due to ownership regulations and tax regulations that such businesses have to follow. Having these kinds of regulations makes for a more secure investing environment which is more appealing to large VC investors.
- Ownership: Incorporation allows for changes in ownership as your business progresses. If one of your founders were to move on, your business would be able to go on existing, whereas an LLC would face being shut down. For founders who wish to diversify their projects, incorporating allows for your business ideas to have a better longevity.
Cons of incorporating
- Double taxation: Corporations are first taxed on income and then taxed on dividends. You and your shareholders may get personally implicated in dividend taxation.
- Strict Rules: As a corporation, you would have to adhere to rules placed on almost every aspect of your business. Corporations face rules pertaining to corporate bylaws, governance, meetings, documentation, board of directors, and elected officers. Inability to comply with these rules could result in your business ceasing operations.
- Reports and fees: Corporations must file annual reports to the Secretary of State in the state where they incorporated. These reports can be rigorous and cost anywhere from $50 to $455 to file each year, with late fees potentially adding up to $10,000 or more.
When is the right time to incorporate?
If you do decide to incorporate, it’s important that you do so at the appropriate time. Knowing what timing is right can be challenging, but typically incorporation is best done at these stages:
- When your personal taxes have gotten too high. If you are paying your company’s taxes in your personal filings and the costs of paying business taxes have outweighed the business benefits, a structure change could be beneficial.
- When you have an annual revenue of over $100,000. While there’s no set revenue number that can apply to every company, if you’re earning at least $100,000 in revenue each year, then the cost-benefit ratio on aspects like formation fees, taxation, and dividends could be worth making the switch to a corporation.
Having these time frames in mind can be helpful in deciding when to incorporate. However, law and tax professionals should always be consulted before making the decision.
How do you incorporate your startup?
If you want the incorporation process to be done efficiently, these are the steps you should be taking:
- Name your business. Before anything else, your business is going to need a name. You may even want to consider trademarking the name for extra security, though you should note that trademark registration typically takes three to six months and can require a filing fee of anywhere from $250 to $750.
- Write bylaws. You need to rewrite your operation agreement to comply with state-required bylaws for a corporation. To find the exact specifications your company will need to follow, you can go to the website of the Secretary of State for the state you are incorporating in.
- File articles of incorporation. On your incorporating state’s Secretary of State website, you’ll either be able to file for incorporation online or download a PDF of the articles you’ll need to print, fill out, and fax/drop off. Enter all the necessary information into these forms.
- Collect your incorporation certificate or receipt. After you file your information, all that’s left to do is wait for your certificate or receipt. The amount of time this takes can vary depending on what state you’ve chosen to incorporate in. Once you receive such a certificate, your business will officially be a corporation!
Becoming a corporation is a major step in the life of any startup. Make sure you’re fully aware of any legal, professional, and personal impacts of incorporating your startup before making the decision for yourself.
By Michaela Lenahan in Startups