Allison Harrison
November 21, 2016

Why and How to Incorporate Your Business: A Startup Guide

When considering your business's foundation, one crucial factor is whether you envision the company going public. For General Partnerships and Limited Liability Companies (LLCs), this isn't feasible unless you intend to change your business structure. If your business is in its early stages, you might wonder if forming a corporation is necessary.

Legal Formalities of Incorporation

Incorporating primarily aims to limit personal liability for business obligations. However, it involves costs for setup and dissolution, along with additional record-keeping and reporting requirements compared to other business structures. Depending on your circumstances, a corporation may offer tax benefits but could also result in double taxation.

Addressing Your Business Needs

The following summary serves as a startup guide to addressing your business needs. It's not a comprehensive guide to forming a corporation but aims to assist you in making informed decisions. For advanced accounting or tax assistance, consider consulting a knowledgeable tax attorney or accountant.

Legal Formalities

  • Charter: Your charter specifies the corporation’s name, the types of stock it is authorized to issue, the rights, and preference of any preferred stock. It will also specify the office and agent for the service of process in the state in which you incorporate.
  • Bylaws: Bylaws specify rules regarding the governance of the corporation (notice and quorum requirement for the board and shareholder meetings, number, and qualifications of directors, voting standards, proxy voting, appointment of officers and stock certificates).
  • Corporation Governance Principals: Corporate governance principles are common for public corporations (boards and committees, director responsibilities, content and frequency of board meetings, and director compensation).
  • Shareholders Agreement: Shareholder’s agreements will address many issues, such as stock transfer restrictions, board representation, buy-sell rights regarding the Corporation’s shares and employment of shareholders.

Advantages to the Corporate Form

  • Transferability of Ownership Interest: Incorporation results in the use of transferable securities to represent the shareholder’s interest in the common business enterprise. Thus making the transfer of the ownership interest quite simple.
  • Perpetual Existence of the Corporation: This offers great certainty to both creditors and investors, especially if they must commit capital to the business for a prolonged or indeterminate period.
  • Limited Liability of Shareholders: Investors risk only their purchase price paid for their shares and have no additional liability for debts incurred by the corporation. Shareholders' personal assets remain protected as they are not liable for business debts and actions of a corporation. Shareholders are only responsible for their investment in the company's stock. However, in a small, new corporation, regulations may require personal guarantees from the shareholders.
  • Centralized Management: Corporations vest management authority in a corporation’s board of directors. A corporation’s shareholders have no statutory authority to manage the corporation. A board of directors does not make the day-to-day decisions regarding the corporations business. Rather, the directors must appoint officers to run the business subject to the board’s oversight.
  • Raising Capital: Venture Capitalists (“VC’s”) are drawn to invest in your business when you organize it as a corporation as opposed to a partnership or LLC.  Venture Capitalists are investors who provide capital to Start-Ups or support small companies that wish to expand but do not have access to equities market. High risk and great potential are a few of the factors that draw in VCs. VCs will raise money by selling interests in an investment funds formed and managed by the VCs.
  • Planning for the Future: Corporations are more attractive to buyers than a partnership. The new buyer removes himself from liability for any wrongdoings by the previous owners. When your business is a sole proprietorship, the new owner retains personal liability for any mistakes or illegalities by the prior owner. The corporate form protects against this situation with the limited liability of its shareholders.

Disadvantages of the Corporate Form

  • Forfeiting Personal Opportunities: Since a board of directors, rather than you, runs the Corporation, individually, you must forfeit your duties as sole decision maker and therefore forfeit opportunities you wish to explore.
  • Overhead and Compliance: Forming a corporation requires paperwork, including the documents listed above. Apart from these start-up documents, state agencies require a corporation to file annual reports. Therefore, corporations are often more expensive to start up than other types of business structures. Depending on state law, a corporation must keep records of annual corporate formalities. Compared to other business entities, a corporation’s  record keeping can take a lot of time and effort that a small business does not have at its disposal.
  • Double Taxation: In some cases, the government taxes corporate earnings twice. This happens once at the corporate level when the business earns the income, and again at the individual level when profits are distributed. Avoiding double taxation is possible by forming an S corporation (“S Corp.”). This is a smaller form of corporation that is taxed differently than a C corporation. In an S corp., earnings flow through the tax returns of the individual shareholders rather than being taxed at the corporate level.

Forming a Corporation is an important legal step in developing your business. If you have any questions regarding forming a Corporation,  or steps to take with your newly formed business, please contact Columbus, OH small business attorney Allison Harrison.