One of the most important steps you’ll need to take as a business owner is choosing and forming a business entity. By doing so, you separate your personal assets and liabilities from your business, essentially protecting both. The two most commonly chosen business entities are LLCs and corporations, each with its own perks. Here we’ll focus on the latter, showing you how to start a corporation through a simple, straightforward step-by-step guide.
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What is a corporation?
Before we delve deeper into the actual steps to forming a corporation, let’s go over what a corporation is and the advantages of forming one.
A corporation is a separate legal entity, legally distinct from its owners. In other words, if your business incurs any debts, your assets won’t be in danger, and you won’t be personally responsible.
Your personal liability for your business’ debts is no more than what you invested into the corporation. Your personal assets, like your house or car, won’t be used to pay off the debts of your business if you file for bankruptcy or if you’re faced with a lawsuit. This type of asset and legal protection is referred to as limited liability or liability protection.
A corporation as a business entity is owned by its shareholders. Because the corporation is a separate legal entity, shareholders cannot take or use the corporation’s funds and assets at will. This means you can’t just take money out of it to buy a new TV – in most cases, you can only do this through dividends. To be precise, shareholders receive no money from the corporations unless the board of directors decides to distribute said dividends.
Corporations’ shareholders appoint a board of directors to run the company. The board determines and oversees the company’s strategy, gives consent to significant decisions, and appoints executives. Next down the corporate structure are executives, which are chosen by the board of directors.
The board of directors appoints executives in charge of the day-to-day operations at the corporations and usually have the most “hands-on” approach among the company’s upper echelons.
Following so far? Corporations are more complex than practically any other business entity, but this sort of management and ownership structure is essential in order to ensure it runs smoothly. Thanks to a clear chain of command, individual and legal responsibilities are clearly defined.
Don’t be taken aback by all these different levels of the corporate organization – they’ll become pretty straightforward as you dig deeper into it.
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Types of corporations
Another important thing to know before you get to the actual steps of how to start a corporation is the different types of corporations that exist.
The majority of small business owners decide to form a C corp. The term “C corporation” refers to any US corporation taxed separately from its owners. As you can see, it’s a pretty wide definition, which is why it represents the default choice for most businesses.
Alternatively, some owners might decide to form an S corporation. The S corp is a corporation that chooses to pass corporate income, losses, deductions, and credit through to its shareholders. This is done for federal taxation purposes, as income is taxed at the shareholder level instead of at the corporate level. This helps an S corporation to avoid double taxation, one of the main disadvantages of C corporations.
Lastly, some entrepreneurs decide to go with a Limited Liability Company, or LLC. The LLC is a sort of middle ground between a corporation and a sole proprietorship. With an LLC, you’re still treated as a separate legal entity and you benefit from personal asset protection.
On top of that, LLCs are taxed as “pass-through” entities, signifying that the company’s profits are passed through to the owners. With pass-through taxation, both profits and losses are reported on individual tax returns of the owners, resulting in tax savings and significantly simpler paperwork.
Besides these three types of corporations, you can also decide to form a nonprofit organization, but these are reserved for businesses that focus on charity, religious work, science and the like.
Pros and cons of forming a corporation
Corporations come with some pretty substantial benefits, allowing you to finance and manage your business properly. Here are the main advantages of forming a corporation:
- Limited liability
- Transferability of shares ensures business continuity
- Management delegated to the board of directors
- Can raise capital through stock sales
- Investor ownership
- Tax benefits (for S corporations)
However, corporations also have some less-than-ideal characteristics when compared to other business entities:
- Double taxation: both for profits earned and when dividends are paid
- Fees: initial charter fee, annual reports and annual renewal fees
- Expensive and time-consuming to open
- Rigid structure and rules
- Immense amount of paperwork
After going through how corporations are structured and their pros and cons, you should have a pretty clear understanding of how these types of businesses work.
Carefully weigh the advantages and disadvantages of each business entity covered before committing to an application process. If you’re sure you want to form a C corp or an S corp, and not an LLC, read on.
Forming a corporation
1. Choose a location for your business
The first step you’ll need to take is to choose a business location for your corporation. Many factors play into this decision: your existing infrastructure, location of your target audience, business interests, state-specific rules, local government regulations, and fees.
Taxation often also varies from state to state. Choosing a tax-friendly state can help you save considerable amounts of money. However, you shouldn’t trade other important factors for a small tax break. Consider everything that might be important for helping your business grow.
Make sure to check out whether the state you’re looking to form a business in has local or state incentives. Besides certain corporate tax benefits, a state government might incentivize companies that create jobs, utilize green energy, or contribute significantly to the economy in one way or another.
2. Check state requirements for forming a corporation
Before you get started with carefully following each step to form a corporation, there’s one thing you need to know. The steps required to form a corporation differ from state to state. Here, we’ll try to be as thorough as possible, covering all possible steps you might need to go through. However, while some states require you to go through all of them, other states might not. Check this list of state business offices for a list of requirements specific to your state.
3. Choose a business name
Choosing a business name is, on paper, the easiest part of creating a C corporation or an S corp. In reality, you should carefully think through all business name ideas going around your head before committing to one.
Your corporation’s business name should correspond with the brand you’re trying to build, reflect your business’ qualities and goals, as well as act as a good representation of what your company offers. Also, you need to check whether your state has specific naming conventions and whether the name you’re trying to take isn’t already in use.
While there are different state requirements when it comes to naming your business, these general guidelines usually apply:
- As mentioned, the name cannot be the same as another corporation registered in the corporation’s office.
- Your business name must end with one of the following corporate designators or their abbreviations: “Corporation,” “Incorporated,” or “Limited”.
- The use of words like “bank”, “trustee”, “credit union”, or “trust” in your corporate name is forbidden without approval.
- The corporate name cannot contain words or abbreviations that might indicate a connection with a federal or government agency, such as “FBI”, “US”, “State Department”, and so forth.
Another thing you should keep an eye on is whether your business name violates another business’ trademark. If it does, it could lead to lawsuits and costly legal processes down the line. In case you want to prevent others from infringing on your corporate name, consider trademarking it. This will protect your name – and hence your brand – at a national level.
In case you’d like to operate under a name that is different from the actual entity name of your business, consider registering a DBA (Doing Business As). The DBA name has to be registered with state or local agencies, with laws surrounding DBAs differing between states. Do note that while this does not translate into legal protections for your DBA name, you still might be required to register it if you plan on using one.
4. Hire a registered agent
To register your corporation with the state you plan to operate in, you’ll need to hire a registered agent first. Registered agents are practically your liaison officers for communicating with state authorities. Corporations appoint them to receive government correspondence (like tax and legal documents), service of process (lawsuit notice), and compliance documents on behalf of the business.
In some states, a registered agent is referred to as statutory agents, resident agents, or agents for service of process. Whatever their name, you’ll need a registered agent before you go ahead with registering your corporation with the state.
There are only a few requirements as to who you can appoint to be your registered agent. To be appointed as a registered agent, a person has to:
- be at least 18 years old
- have a physical address in the state you operate in
- be available at the given address during normal business hours
While some states have unique rules concerning who can be a registered agent for a business, these are requirements that usually apply. While a corporation cannot be its own registered agent, one of its employees or owners can be the agent for the company. Alternatively, you can hire a professional registered agent.
5. Appoint directors
For the next step, you’ll need to appoint a board of directors. Again, some states might have a pre-determined minimum and a maximum number of directors you can appoint. Owners are the ones that appoint directors, and they can choose to appoint themselves. However, it is not required of directors to also be the owners of the corporation.
6. Register your corporation
Now that you have your business name chosen, it’s time to register your corporation. Before you register, you should consult state laws concerning corporate registration, which will often depend on your business structure. States might require you to register your business or DBA name before you can go ahead with corporate formation.
When it comes to federal agencies, you’re usually not required to register with them. Instead, the only thing you need to do is file a Federal Tax ID, which will automatically make your corporation registered. To do so, you’ll need to get a federal tax identification number from the IRS, also referred to as the EIN (Employer Identification Number). The steps to do so are outlined on the IRS website.
However, if you’re looking to trademark your name, registration with the federal government is required. This is done by filing a request with the United States Patent and Trademark Office.
On the other hand, registration with state agencies is required before you can conduct business operations. Besides hiring a registered agent, which we already covered, you need to fulfill the following requirements for state registration:
- Your business must have a physical presence in the state, such as an office or headquarters.
- You must have frequent face-to-face meetings with customers in your state of operation.
- The bulk of your corporation’s revenue must come from the state in question.
- At least one of your employees works in the state you’re registering in.
Depending on the state, you also can be required to register with the Secretary of State’s Office, Business Bureau, or Business Agency.
You’ll need to file certain critical corporate documents and pay a registration fee to go ahead with state registration. The filing fee ranges anywhere from $50 to $450, depending on the state. The documents you’ll need to present for registration are:
- The name of your business
- Corporate structure, ownership, or board members
- Registered agent information
- Number and value of shares
As you probably know, shares represent units of ownership for the corporation, with each stock representing 1% of ownership. There are, of course, rules as to how many shares you’re allowed to issue and in which class. Before you reach a decision concerning the share structure, you should consult both your corporate lawyer and state regulations. In general, having a corporate lawyer is practically a must-have, both for crucial legal advice and for handling the truly immense amount of paperwork involved.
Business licenses and permits
If you thought this was everything, you were wrong. The registration process also requires you to file for state and federal business licenses and permits. As for federal licenses, they’re only required if your business takes part in activities regulated by federal agencies. You can visit SBA’s website to see which activities are regulated by said agencies and check how to apply for them.
You also need to make sure you have the correct business licenses that are issued by state agencies. The required licenses and permits largely depend on the state you operate in and the type of business you conduct.
1. File articles of incorporation
Now comes one of the most crucial steps in our “How to start a corporation” guide: filing articles of incorporation. The articles of incorporation (also called certificates of incorporation or corporate charters) are legal documents that contain pertinent information about your business. The articles of incorporation are a mandatory step in forming your corporation, regardless of state.
This is what the articles of incorporation need to contain:
- Business name
- Registered agent’s name and address
- Type of corporate structure (in this case C corp or S corp)
- Names and addresses of board members
- Number and type of authorized shares
- Name, address, and signature of the incorporator
Typically, articles of incorporation are filed with the Secretary of State’s Office. For single-owner corporations, the owner is the person that fills in and signs the articles of incorporation. In case there are multiple owners, they may all sign the document or appoint one owner to do so.
Additionally, some states may require you to state the company’s purpose in the document. More often than not, these definitions are fairly broad to allow for greater flexibility in operations.
2. Write corporate bylaws
Corporate bylaws are detailed rules that determine how the corporation will be governed. Unlike articles of incorporation, corporate bylaws are not a public document. Instead, they’re an internal (but legal) document that specifies the management structure and how the corporation will be run. This includes defining the powers and responsibilities of corporate officers and directors and meeting requirements and other important definitions regarding corporate governance.
While corporate bylaws are not filed with any government or federal institution, they are still required to start a corporation and be regarded as a legal entity separate from its owners.
3. Prepare a shareholders’ agreement
One of the main advantages of corporations is the ability to transfer ownership, letting the business continue operations even if the original owner dies. The shareholders’ agreement defines what happens in case the owner dies or retires. Such an agreement will protect the interests of the remaining shareholders and allow for the uninterrupted continuation of operations.
A shareholders’ agreement is not legally required, but it’s strongly recommended that you draft one.
4. Hold the first board of directors meeting
After you’ve appointed the board of directors, filed articles of incorporation, and created corporate bylaws, it’s time to hold the first board of directors meeting. The rules concerning the first board meeting are often also defined by the state you’re operating in. However, the most common rule is that it has to be held within the first 30 days after incorporation.
This meeting is more than just a formality, as the directors have to make important business decisions as well as handle a few formalities. Here’s what the initial board of directors meeting should entail:
- Setting the corporation’s fiscal and accounting year
- Appointing corporate officers
- Sign and adopt corporate bylaws
- Adopt an official stock certificate form
- Adopt an official corporate seal
- Opet corporate bank accounts
Many states also define how often you have to hold board meetings per year and the maximum time that can pass between two meetings.
5. Issue stocks
Before you go about conducting any business as a C corporation, you need to issue stocks. The issuing of stocks divides ownership interests and is mandatory for your business to be considered a corporation.
Here comes the tricky part – SEC regulations. The SEC (Securities and Exchange Commission) has stringent regulations concerning the issuing of stock. Luckily, a small business will often be exempt from these regulations. As you might expect, different states often have varying rules on SEC exemption. If you’re issuing shares to a small number of people (10 or less), you’ll most likely be able to get an exemption and issue stock certificates immediately.
In case you’re not exempt, you should register your stock offering with the SEC and prepare to pay up for more legal and accounting fees.
6. Open a corporate bank account
The last step you’ll need to take is to open a business bank account. A corporate bank account is there to separate the funds of the corporation from that of its owners. As such, it both legitimizes your corporation and offers liability protection for your assets.
Additionally, having a business bank account allows you to build up a credit profile for your small business and make your accountant’s life easier. Otherwise, come tax season, the accountants would have to comb through potentially thousands of transactions to identify those relating to your business.
Lastly, having a dedicated corporate account lets your business appear truly professional and serves to protect your identity.
You’ll need these types of corporate bank accounts: checking account, merchant account, savings account, and credit card account.
The majority of banks will require you to have an EIN number and present corporation formation documents before opening an account. When choosing a bank for a business account, the most important metrics to keep in mind are transaction fees, savings/checking interest rates, the minimum deposit required, and interest rates for lines of credit.
To help you make this difficult choice, we’ve gathered a selection of the best business accounts to consider as a small business corporation.
The Final Word
After you’ve opened a business account, you’re actually ready to start conducting business and earning corporate income. After you went through this lengthy guide on how to start a corporation, you hopefully found out all there is to know about corporations, including their ins and outs.
Corporations are complex entities with complicated, drawn-out formation processes. Still, they make room for nearly infinite growth and come with valuable perks like personal liability protection and management delegation. While we have done our best to make this guide detailed and thorough, you always should consult professionals before embarking on the paperwork-heavy road towards incorporation.