Process of Forming a Company: Key Legal Steps

Key Takeaways

• The process of forming a company generally includes four stages: promotion, incorporation, capital subscription, and commencement of business.
• Key early decisions include choosing the business structure (LLC, corporation, partnership, etc.), naming the company, and defining ownership and management roles.
• Promoters play a central role in organizing resources, drafting foundational documents, and preparing agreements.
• Legal documents such as the memorandum of association and articles of association define the company’s objectives, ownership, and governance.
• Incorporation requires filing formation documents with the state, appointing directors, and paying applicable fees before receiving a certificate of incorporation.
• Companies with share capital must complete additional steps before starting business operations, such as issuing shares and meeting subscription requirements.
• Professional advice helps ensure compliance with state requirements and protects owners from personal liability.

The process of forming a company depends on the type of company being formed. Forming a new company can be broken down into four stages:

• Promotion
• Incorporation
• Capital Subscription
• Commencement of Business

What Decisions Have to Be Made to Form a Business?

Before you can establish a company, you will need to make several decisions. For example, you will need to determine:

• The name of the company
• How you want it to be incorporated (LLC, s-corp, c-corp, partnership, sole proprietorship, etc.)

A business can change its legal form at any time. The formation of each business type provides a different legal framework, including how it conducts its activities and its tax liability. When a private company or a public company with no share capital is formed, promotion and incorporation are the only steps that must be taken before starting its operations.

While all new companies have various steps to take during the formation process, a private company is able to commence business immediately after they have received a certificate of incorporation. A company with share capital will go through additional steps before commencing business. Let's take a look at the process of forming a new company.

Choosing the Right Business Structure

An essential part of the process of forming a company is selecting the appropriate legal structure. Options include sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. Each choice affects taxation, liability, management control, and capital-raising ability. For example:

• LLCs provide flexibility in management and limit owners’ liability.
• Corporations offer strong liability protection and easier access to outside investment but come with more regulatory requirements.
• S corporations avoid double taxation but have restrictions on the number and type of shareholders.

The right choice depends on factors such as the number of owners, desired tax treatment, industry regulations, and long-term growth goals.

Promotion

All companies start with promoters. This is the individual or individuals who take the initial steps necessary to begin the formation process. When an individual or individuals discover a business opportunity and then invest with funds, property, and managerial skills for the purpose of earning income, this would be a promotion.

Another example of promotion would be participating in the startup of an enterprise. It involves all activities that are a part of the startup process. Promotion begins as early as when an individual seriously starts considering the formation of the company, according to H.E. Heagland. In addition, once the business is up and running, promotion comes to an end, Heagland adds. Likewise, Guthmann and Dougall agree that promotion begins at the conception of the idea and carries on until the business is operating.

Of course, an enterprise can't just establish itself; an individual or individuals must bring the enterprise into existence. Therefore, it has to be promoted to exist. If something is to be promoted, it must have a promoter as well. The promoter is the individual who conceives the idea of formation and then takes action to establish the enterprise into existence.

Legal Responsibilities of Promoters

Promoters act as fiduciaries for the future company and its initial investors. Their responsibilities include disclosing material facts, avoiding conflicts of interest, and ensuring that any contracts they enter into on behalf of the yet-to-be-formed company are properly adopted after incorporation. Failure to uphold these duties can result in personal liability for promoters.

Who Can the Promoters Be?

Promoters can be professional, occasional financial contributors, entrepreneurs, or a variety of other types. When a company incorporates, it becomes its own legal business structure. It is separate from its owner or owners and is an entity to transact business as a separate legal unit. In addition, a corporation has liability protection and can raise capital through sales of shares of the company. Retirement funds and qualified retirement plans are established more easily, as well. States will vary in the requirements for forming a corporation.

After a name has been verified for availability, the promoter would prepare the following documents.

Memorandum of Association

Forming a company places a lot of obligations on a lot of people. All initial shareholders who agree to form the company will sign the memorandum. The memorandum is basically a legal document that sets up the company, including the objectives of the corporation, its name, its address, and the names and addresses of all members.

Articles of Incorporation or Certificate of Formation

In many jurisdictions, instead of or in addition to a memorandum, businesses file articles of incorporation (sometimes called a certificate of formation). These documents are filed with the secretary of state and contain essential information such as:

• The company’s name and registered office.
• The purpose or scope of business.
• Authorized share structure (if applicable).
• Names and addresses of incorporators and initial directors.

Once accepted, the state issues a certificate of incorporation, officially recognizing the company as a legal entity.

Articles of Association

The articles of association set out how the company is to be managed, governed and owned.

Corporate Bylaws and Operating Agreements

After incorporation, companies typically draft bylaws (for corporations) or operating agreements (for LLCs). These documents:

• Outline voting rights, shareholder or member meetings, and decision-making processes.
• Specify how profits and losses will be allocated.
• Provide procedures for resolving disputes or handling the departure of an owner.

Though often kept internally rather than filed with the state, these documents are critical for smooth governance and reducing future legal conflicts.

Copy of Proposed Agreement

If a company chooses to hire a full-time director or manager, an agreement should be entered and then be filed with the Registrar of companies.

Basic Steps to Form a Company

To register your company, you will need to file several important documents. These documents must be filed with the appropriate entities or you will not have a legit business to operate. Instead, you will be operating illegally and this could land you in hot water with the IRS. Once you have filed the proper paperwork with the appropriate entities, you will likely have to pay a fee to become an official business. After you have met all requirements, you will then receive a Certificate of Incorporation.

Post-Incorporation Requirements

After receiving a certificate of incorporation, a company must take additional steps before commencing operations:

• Obtain an Employer Identification Number (EIN) from the IRS.
• Register for state and local taxes, including sales and payroll taxes where applicable.
• Apply for licenses and permits required for the industry and jurisdiction.
• Open a business bank account to separate personal and business finances.
• Comply with ongoing obligations, such as annual reports, shareholder meetings, and recordkeeping.

Neglecting these requirements can result in penalties, loss of good standing, or even administrative dissolution of the company.

Frequently Asked Questions

1. What are the four stages in the process of forming a company?
   The stages are promotion, incorporation, capital subscription, and commencement of business.
2. What is the difference between articles of incorporation and bylaws?
   Articles of incorporation create the company legally with the state, while bylaws set the internal rules for governance and operations.
3. Can a company start operating immediately after incorporation?
   Private companies often can, but corporations with share capital may need to complete capital subscription before beginning operations.
4. Do all companies need an Employer Identification Number (EIN)?
   Yes, most businesses need an EIN for tax reporting, hiring employees, and opening a business bank account.
5. Why is choosing the right business structure important?
   It impacts taxation, liability, control, and the ability to raise capital, making it a crucial decision in company formation.

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