How to Start a Corporation
- March 14, 2021
What is a Corporation?
A corporation is a business started by a group of people that is a legally separate entity. This is an essential characteristic because it means the owners do not have personal liability for anything done by the business. If people have an issue, they will address the business, not the owners.
As a business entity separate from the owners, a corporation is a legal entity that can face lawsuits and pays its own taxes. The owners will take a salary from the business.
Also, corporations must have a board of directors and shareholders. The board of directors will run the business and make decisions for it. Shareholders invest in the company for partial ownership. Owners of the business will generally hold stock in their own company to maintain ownership proportions.
Types of Corporations
If you decide to start a corporation, you will need to determine what type of corporation you want to pursue. There are five options:
The most common of these are C corps and S corps, but you should be aware of each of type.
C Corporation
According to the National Law Review, one of the main features of a C corporation is that it offers personal liability protection to the owners. Another feature is double taxation, which is a negative aspect of this type of corporation. Double taxation occurs because the government taxes the corporation and then taxes shareholders on their income.
A standout feature of this corporation type is that it can issue preferred stock, which prioritizes those who own it. This feature can be attractive to investors. Another critical thing to note is that c corps have the most regulations put upon them by the government.
S Corporation
The main perk of an S corporation is the pass-through taxation. Instead of the double taxation of a C corp, with an S corp, the government will only tax the shareholders. It does not tax the business as well.
S corporations do have strict oversight to maintain the S corp status. It is possible to lose the status and become a C corp. The main requirement is a limitation of who can hold stock in the company, which will limit the types of investors you can seek. You also do not get to issue different classes of stock with this type of corporation.
Benefit Corporation
A B corporation is not available in all states, according to the U.S. Small Business Administration. The “B” stands for benefit. The main point of a B corp is that it must produce a profit and some type of public benefit. Its taxation is the same as a C corp.
Close Corporation
Close corporations are similar to a B corp in many ways, but they may not have public trading in some states. They also have a less formal structure and usually have no board of directors.
Nonprofit Corporation
A nonprofit corporation operates with the goal of charity, education, or some other public outreach. It does not operate to earn a profit. One of the biggest benefits of this type of corporation is that it is exempt from taxation. There are many rules for maintaining nonprofit status.
Pros and Cons of Corporations
Before you begin forming a corporation, you will want to consider the pros and cons. From this point, when talking about corporations, the focus is on C and S corps because they are most likely the types of corporations you will start as a business owner.
The following pros and cons apply to C and S corps only.
Pros
The top benefits of a corporation include creating a legal entity separate from yourself. This is incredibly important if there is any concern over legal issues with the business. Some industries are more litigious than others, and if you are in one of those industries where lawsuits happen a lot, you need the protection a corporation gives you and your personal assets.
Another main benefit is that you have more security as a business. Because it is its own entity, it will continue even if you or another owner is no longer involved or if you die. It also protects against divorce situations, which is something that can devastate a partnership or sole proprietorship.
With other business structures, anything that happens to you personally could spell the end of the business. It only takes one bad situation, such as bankruptcy or a divorce, to cause major issues and eventually lead to closure.
Finally, a corporation has a lot more opportunities to keep funds running through the business.
You have investors and can issue stock shares to help inject money into the business. A share of stock can become quite valuable, which means you have an easy option to make capital if you need it.
Cons
The disadvantages to a corporation include the potential for double taxation. This only exists with a C corp, but it is something you must consider. Even if you have an S corp, you may end up with a C corp at some point, especially if you desire changing your stockholder options.
The double taxation takes more money from the profits of a business. The only winner here is the government that can get twice the money out of you.
Another major disadvantage is the required formality. With a sole proprietorship, for example, there are few rules. You can do pretty much what you want. You may not even have to register a business name. Even with a partnership, the rules are more relaxed. You don’t have as many legal hoops you must jump through or government regulations with which you must concern yourself.
If you fail to file the right paperwork, you could find yourself and the business in trouble. It is essential that you understand every regulation that applies to your business, which is incredibly difficult to do on your own unless you have some prior training in the area of business.
You also have to keep everything transparent because you must answer to the shareholders. This may limit your ability to make instant decisions as well. The board of directors have to approve corporate decisions and can weigh in on what you wish to do in these matters.
With a corporation, you have legal requirements to have specific people in your company including Shareholders, a Board of Directors, and Officers. Note that you can be a shareholder, member of the board, and officer if you desire.
How to Form a Corporation
Now you can begin the actual formation of the corporation. There are multiple steps you need to take to ensure you meet all the legal requirements to form this type of business.
Step 1: Secure a Business Name
You will choose your business name and register it with your state. You must use a unique name not held by anyone else in your state. You should also avoid choosing a name that could easily confuse people or make them associate you with another existing business.
States will have specific requirements for business names. You need to research your state’s rules so that you can choose a valid name.
Step 2: File the Articles of Incorporation
The articles of incorporation or certificate of incorporation is a document that outlines important information about your business. You must register this with the Secretary of State in your state or the state in which the business will operate.
Each state may require different things for the articles of incorporation. Typically, you will need to provide information about the registered agent, also known as the agent for service is the person who acts on behalf of the corporation to receive legal documents or take the service of process. You will also need to provide information about your board of directors.
The articles of incorporation also serves as a type of guideline for your corporate structure. It can help you when organizing your business and ensure you are compliant with different legal requirements.
Step 3: Hold a Board of Directors Meeting
You will want to hold a meeting of the directors as soon as possible to set the groundwork for your corporation. During the meeting, the directors should discuss bylaws, shareholder agreements, and other important factors about starting the business. In addition, the board will appoint officers at this time.
Step 4: Complete Tax Registration
The next step is to register with the proper authorities for taxation. You need to do this at every level: local, state, and federal. You may need to file specific forms and complete different tax requirements. For example, you need an employer identification number from the state and federal governments to allow you to pay payroll taxes.
There may also be specific industry taxes you need to sign up for. You should consult with an accountant to ensure you complete all tax requirements.
Remember if you have a C corp, you will have special taxation requirements because the business is a separate entity. The IRS explains that you need to file income taxes on behalf of the corporation and pay estimated taxes.
Step 5: Secure Business Licenses
Your business may need to get multiple licenses. All businesses will need at least one license with the state to operate. Depending on your industry, you may need special licenses. For example, if you sell alcohol, you need a license for that.
Step 6: Open Your Business Bank Account
Because you are not operating a sole proprietorship, you need to manage all of your business funds through a bank account separate from your personal account. You will want to open a checking account for the business. This account should have all funds go through it. You will use it also to pay employees and make other payments on behalf of the business.
Having this separate account ensures there will be no questions about comingling of your personal funds and those of the business. It is essential when you have a corporation with multiple owners and people invested in the business.
Once you have completed these steps, you are ready to open your doors. The only thing left to do is maintain the corporation. Remember that with an S corp, you must meet specific requirements, so you will have to keep an eye on that to maintain S corp status. You also must adhere to all legal requirements, including paying corporate taxes and any filing fees or other maintenance fees associated with business documents and legal requirements.
There are many advantages to forming a corporation, but you also need to keep in mind the potential disadvantages of this type of business entity. When deciding on your business structure, it is essential to be as informed as possible.
