Incorporation is the process of legitimizing your business and the process varies from state to state. That’s why it’s so beneficial to get a lawyer for your startup, as it can be easy to miss steps and end up with an invalid business.
Prior to filing any paperwork, you will need to make decisions about your business, including its name, filing location (state fees and taxes vary) and corporation type. There are three corporation types you can file as, each with their own benefits and downsides:
- Benefits: C Corporations, or regular corporations, are legally independent from their owners. Owners are not liable for the business’s losses or taxes and will share personal investment losses with the other shareholders of the company. C Corporations can also be extremely beneficial for tax reasons, as many aspects of the corporation are tax deductible and have many tax deductions available.
- Downsides: C Corporations are complicated, tax-wise, and require financial advisors to ensure all rules and regulations are being properly followed. Due to these complexities, double taxation is regular for C Corporations, where shareholders are often employees and will get taxed for both the personal income of their salaries and the dividends of the company’s profits.
- Benefits: S Corporations, or Small Business Corporations, are set up more like partnerships or sole proprietors than C Corporations. All profits and losses go through the owner’s person income tax, which avoids double taxation. Start-up losses can get written off, and the corporation offers liability protections.
- Downsides: S Corporations are limited to one type of stock and have an upper limit of shareholders. This, as well as the pass-through tax structure, aren’t enticing to investors/venture capitalists who want to ensure their large investments are insured.
Limited Liability Company (LLC)
- Benefits: As stated in the name, LLCs have limited liability. Unless they have signed a personal guarantee, members cannot be held accountable for losses. LLCs are also subject to flow-through taxation where the profits, losses, and expenses go through the company to the members, avoiding both double taxation and the liability of having the taxes go through a sole proprietor. Meeting minutes are not required and profit distribution is flexible between partners and members.
- Downsides: LLCs do not have an unlimited lifespan, and will dissolve in the instance of bankruptcy or the death of a member. They are also more complicated than S Corporations and require specific classifications regarding leadership for accurate taxation purposes. This also makes it more difficult for LLCs to go public in the future.
Once the classification of the company has been determined, stock options and leadership have to be chosen. Only then can a certificate of incorporation be obtained and the paperwork be filed.
Starting a business is complicated and often expensive work. It requires large amounts of foresight and planning. Inexperienced entrepreneurs as well as seasoned veterans of the business world understand the value of having legal counsel every step of the way, as even minor mistakes could affect the fate of the company.