Forming A Corporation: Step by Step Guide
To create a corporation, you'll need to go through a number of important steps and it's recommended to hire a lawyer to assist you in the process.7 min read
To create a corporation, you'll need to go through a number of important steps. It's recommended to hire a lawyer to assist you in the process, as it can be rather difficult to do on your own.
What Is a Corporation?
A corporation is a specific kind of business structure that is a legally distinct entity separate from the finances of its shareholders and owners. Just like an individual sole proprietor, corporations can own assets, enter into a contract, loan money to other parties, and hire employees. Unlike an individual sole proprietor, no single person will be held liable for any of the corporation's legal obligations or debts.
However, that benefit does not come without a price. Corporations have extremely complicated administrative and legal requirements, meaning the corporation designation is typically only used by bigger companies, such as Microsoft or Coca-Cola.
Because each state sets their own rules regarding corporations, this also makes it tricky to learn how to open a corporation, as well as to operate as one. Most states do require corporations to file an Articles Of Incorporation, which defines the company's policies and guidelines and acts as a document of creation for the corporation. After filing this document and paying a fee, the corporation can then receive an official certificate of incorporation from the state.
Types of Corporations
Below are the five different types of corporations that you may want to consider when you create a corporation for the first time.
A C corporation is a corporation taxed separately from those who own it.
S corporations choose to pass corporate income, losses, and credits to their shareholders for federal tax purposes.
B corporations exist to provide benefits to society. Typically, they are not solely profit-driven but focus on social and environmental good.
A closed corporation is not publicly traded but owned by limited shareholders.
A nonprofit corporation operates for other purposes other than to make a profit. These corporations are still incorporated under state and federal law.
Benefits of Creating a Corporation
When you first learn how to start a corporation, you’ll want to consider the advantages and disadvantages. Below are the benefits of creating a corporation.
One of the most important advantages of forming a corporation is being able to offer personal protection to stakeholders. Essentially, shareholders will only be responsible for what they have contributed to the company. Their personal assets will not be affected.
Being a registered corporation can help present your business as more established in the eyes of potential clients, employees, partners, and vendors.
Furthermore, it may be difficult to attract investors without the promise of limited liability. Thus, registering your business as a corporation will also be advantageous to attracting investors.
Unlimited Life and Transferable Ownership
Corporations do not expire. If an owner passes away or wishes to transfer their business to another individual, this option is available.
Many tax benefits are afforded to corporations, such as tax-deductible owner-paid health insurance premiums. Business owners may also save on the following expenses: social security, medicare, and workers’ compensation taxes.
Access to Capital
Many corporations sell ownership through publicly traded stock options. They are able to raise capital by selling stock. This can be advantageous for growing the business or protecting a business from bankruptcy.
Disadvantages of Creating a Corporation
Below are the disadvantages of creating a corporation.
While the fee differs from state to state, there is always an associated cost with registering a corporation. The general cost that you can expect when setting up a corporation is between $600 to $1400.
The application may be a deterrent because it can be timely. Different states will be able to provide a general timeline. Not only can learning how to set up a corporation be lengthy but once you understand how to start a corporation, it will often be accompanied by extensive paperwork.
Registering a corporation often involves a lot of paperwork. For example, you will be responsible for filing a certificate of incorporation, corporate bylaws, a certificate of good standing (if you are operating in a different state than you are registered), and corporate minutes.
There also may be additional state-specific administrative requirements. It is best to consult with your Secretary of State to determine the requirements.
Steps to Creating a Corporation
There are several steps to take when you decide to form a corporation, whether it’s a family corporation or a personal corporation.
Choose and Register a Name for Your Corporation
Choose your name. This will help define your company and set it apart from other businesses. Depending on your state, you may need to include the word "limited," "incorporated," or "corporation" in your name.
Check to make sure your name is available. If another company is using an exact or similar name, you may not be allowed to register it with your state.
Register the name of your corporation. Follow your state's policies for name registration. In addition, consider registering any fictitious business names you might use during the course of business.
Choose Where to Create Your Corporation
Choose where to incorporate. Deciding on which state to incorporate in can be tricky. Sometimes, incorporating in a state where you don't conduct business can be advantageous. For example, many companies incorporate in Delaware because the state has favorable laws for corporations.
Pick the Board of Directors
Pick the board of directors. When choosing your board of directors, you want to select capable leaders, as they'll be in charge of protecting the interests of the shareholders and managing the operation of the company. In many cases, directors can be investors, officers, or someone with no relation to the company whatsoever.
Start Working on the Articles of Incorporation
Start working on the articles of incorporation. It will act as the official charter for your new company. You'll also need to get signatures from the directors of the company.
Compose bylaws. Bylaws can help define the responsibilities of each shareholder, director, and officer involved with the company. They also state who will manage certain aspects of the business and the overall purpose of the company.
Write a Shareholder Agreement
Write a shareholder agreement. To give your shareholders a better idea of their responsibilities and rights, create a shareholder agreement. It should cover share valuation as well as ownership terms.
File and Pay the Fee for the Articles of Corporation
File and pay the fee for the articles of incorporation. After putting the finishing touches on your articles of incorporation, send it to your local Secretary of State office along with the specified fee.
Choose Your Corporation Type
Choose S corporation status. While this is an optional step, it could be a good way to avoid double taxation without giving up the liability protections of a corporation. If you don't take any action, you'll automatically be classified as a standard C corporation.
Create a Business Bank Account
Create a new business bank account. Because you don't want to mingle your personal funds with your company's funds, you'll need to open a different bank account that's just for business.
Hold a Board of Directors Meeting
Record all meeting minutes in a notebook. Your minute book is the place to write down everything that happens during a board meeting. It helps you keep people accountable and is an accurate record of every action and discussion.
Hold a board meeting. Once you've obtained a minute book, put it to good use by holding your very first board meeting. At this meeting, you'll discuss the goals, vision, and structure you have in mind for the corporation.
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What's the difference between a corporation and an LLC?
A corporation issues stocks to its shareholders and can transfer ownership to other individuals or entities. An LLC does not have shareholders, but rather members. Members do not have stock options, but membership interests. It is also more difficult to transfer member ownership; however, this information would typically be outlined in the administrative documents.
What's the difference between a C corporation and an S corporation?
A C corporation is a corporation taxed separately from those who own it, whereas an S corporation chooses to pass corporate income, losses, and credits to its shareholders for federal tax purposes.
Can I switch from an S corporation to a C corporation?
Simply, yes. An S corporation can transfer to a C corporation by removing the S election, or the IRS can terminate it. It is best to consult with a tax professional to understand any tax implications.
What is the safest form of business entity?
A C corporation would typically be the safest business entity because it affords the greatest amount of liability protection for its shareholders.
What is the best business entity for tax purposes?
Sole proprietorships could be considered the best business entity for tax purposes because the business itself does not pay taxes, as it is a “pass-through entity” or “fiscally transparent entity”.
Who are the members of a corporation?
Members of a corporation include shareholders, directors, employees, and management. Shareholders are the owners of a corporation. Directors and management are responsible for operation and decision-making. Employees are responsible for carrying out the purpose of the corporation.
How long does it take to become a corporation?
The length of time it takes to become a corporation is dependent on the state. Often the turnaround time is 10 days. However, it can take up to three to four weeks.
How much does it cost to set up a corporation?
The cost of starting a corporation is state-specific. Generally, it can result in a fee of $600 to $1400.
Does every business need to incorporate?
There is no simple answer to this question, as it depends on your business circumstances. For example, you need to consider how much your business makes in revenue and in profit, your business goals, your personal tax situation, the type of business you have, and any possible liabilities that you may need to protect.
Can a trust own a corporation?
Yes, a trust can own a corporation. In this case, any profits will be paid directly to the trust.
Can a corporation own an LLC?
Whether a corporation can own an LLC is a state-specific question. However, generally, states do not have requirements on ownership, and thus members may include individuals, corporations, and other entities. There is also typically no maximum number of members. It is best to verify membership and ownership with your state’s Secretary of State office.