To incorporate a business, a company must file its formation documents within the respective state government in which it is based. A corporation or LLC is created as per the incorporation rules and regulations followed in the state.
Incorporation - Definition
A business or company is incorporated to create a standalone legal organization known as a corporation. A corporation will be able to take out loans, sign into agreements, hire workers, file tax returns and be liable to prosecution. It can also own assets that are different from its owners or shareholders assets.
Why incorporate a business?
A company or business should be incorporated to safeguard its shareholders’ interest. Shareholders aren’t liable for their corporations’ debts and other obligations.
If shareholders act as the guarantor of the loans taken up by the corporation, then they’ll become personally liable for their repayment and can be held accountable for the corporation's debt and other monetary obligations.
Directors of a corporation could be liable for the corporation’s loan repayment, in case there’s a violation of a fiduciary law like non-payment of company taxes.
Kinds of business entities - A comparative study
1. Partnership or Corporation
- A commercial entity held by more than one partner is called partnership. Partnerships are of 3 types, viz: General Partnership, Limited Partnership and Limited Liability Partnership.
- In the case of partnerships, taxes are applied separately on the business profits shared amongst the partners.
- Even the losses are proportionately divided amongst the partners and added to each partner’s overall share of profits.
- If one or more partners withdraws from the business, then that partnership will be considered as null and void.
- A corporation can function as a sole proprietorship, but most business owners prefer the former structure. When a company is converted to a corporation, it could be considered as a ceaseless, separate legal entity with conducive opportunities to expand and raise funds from investors or lenders or both.
- With a corporation structure in place, owners/shareholders’ personal assets stay out of reach of the lenders/investors and there’s a greater flexibility to transfer business ownership. Still, incorporating a business is a complicated affair and challenging to maintain.
For instance, a corporation should have good record keeping practices and its shareholders should conduct various meetings to comply with all the legal formalities required by law, like registering, maintaining, and preparing company tax returns.
2. Sole Proprietorship or Corporation
- In a sole proprietorship, both business owner and the business entity are same in terms of taxation and liability. In other words, a business owner’s assets might be at risk in case of a lawsuit filed against the business entity. Therefore, in the case of financial problems, creditors can liquidate the owner’s assets for loan repayments.
- A corporation is regarded as a totally separate business entity, both in terms of taxation and legality.
There are 3 types of corporations, namely: the Limited Liability Corporation (LLC), the S-Corp, and the C-Corp.
- Unlike a corporation, the tax return of a sole proprietor is prepared by the owner itself who may have a tough time securing capital due to lack of equity in return for an investment.
Articles of Incorporation
Whether a company wants to become a C corporation or an S corporation, the documents required therein is called the Articles of Incorporation or Certificate of Incorporation.
These documents give the state authorities with all the necessary information regarding a business. All the information provided in the Articles of Incorporation are considered as a public record, and so they are accessible to anyone seeking information about a particular company.
1. Company formation - What you’ll need
To incorporate a business, a company’s owner should file the following documents:
- Corporate name - A chosen name should be given, along with a corporate identifier. For example: ‘Corporation’, ‘Incorporated’, ‘Company’, or an abbreviation, like ‘Inc’. A primary check should be conducted to find out the availability of the chosen corporate name before submitting the Articles of Incorporation. In the case of online incorporation application, such a purchase of service should be mentioned in the application. The state authorities are empowered to approve the incorporation of a company to make sure that a name hasn’t been used by someone else before.
- Officers - Company’s turning into incorporation must have officers like a president, vice president, secretary and treasurer. These officials are liable to manage and control their corporation’s daily business activities. The inclusion of officer information isn’t compulsory in all states.
- Business objective - It should give out details about a company’s goals and what business it is supposed to do or services it intends to provide. Here are 2 kinds of business purposes that could be defined:
First is general. In certain states, a general-purpose clause is accepted, and the company must engage itself only in legal forms of business practices.
Secondly is specific. Other states that ask for more comprehensive details of a company’s products and/or services before granting any permission to operate a business.
Read more: Step by step guide to form a business
- Registered agent - Almost every state asks its corporations to have a registered agent in their incorporation. The registered agent will receive all the important legal and tax documents on behalf of the corporation and should have a legitimate physical address (not considering P.O. Boxes) in the state of incorporation. Registered agents must work during normal business hours as followed in the concerned state. Some business owners take advantage of registered agent service providers to make sure their important documents are handled professionally.
- Legal address correspondence - A company should have a proper address for correspondence. However, while seeking incorporation, legal or principal business address is regarded as an optional requirement in some states.
- Incorporator - An incorporator is a person or company that prepares and files the Certificate of Incorporation with the respective state. Many states have made it compulsory for the incorporators to include their name, signature, and address in their incorporation applications. For online incorporation, the incorporator must be a representative of the incorporation service agency.
- Company’s permitted shares of stock - Corporations should clearly mention the number of shares of stock they plan to put up on sale. Corporations (regardless of their size) with stock, can provide ownership within their organization. However, a corporation isn’t required to issue the total number of authorized shares they want to sell. Certain companies keep unissued shares to get owners later or grow their company’s ownership percentage for their present shareholders. Several states decide the franchise taxes on the basis of shares kept outstanding before issuing any large amount of stock.
- Preferred shares - If a corporation plans to sell both common and preferred shares of stock, that should be mentioned in the Articles of Incorporation. This kind of shares is given to shareholders as preferential payments of dividends or distribution of assets, as compensation should the company stops operating its business. A lot of small business owners only give out shares of common stock.
- Share par value - The par value of a share is the minimum assigned value and aren’t related to the actual value. For instance, common par values may have values like $0.01, $1.00 or no par. The original value of a company’s share is its fair market value or may be the price a buyer has agreed to pay. As for the public companies, original value of their shares of stock is decided by the price investors have consented to pay on a national exchange. In the case of companies, the actual value of their shares of stocks is decided by the corporation’s total value or book value.
- Directors - Several states have made it mandatory for the companies seeking to incorporate their business to provide their initial directors’ names and addresses in the documents. Directors are liable to oversee their company’s business affairs, and that includes crucial corporate decisions. They are mainly elected guardians of the corporation and are voted to power by their company’s shareholders and are empowered to appoint officers.
While forming a corporation or a sole proprietorship, consulting a reputed Certified Public Accountant (CPA) or tax attorney is always the best way to avoid any unnecessary legal hassles later.