As a startup founder, one of the most important decisions you have to make is about the legal structure of your business. It affects everything from how you file taxes to the number of shareholders your business can have to the type of assets your business can or cannot own. While you can consider several legal structures, this guide focuses on startup incorporation.
If you’re reading this, you’re probably thinking of forming a corporation. While the process of incorporating might seem daunting, it need not be. In this guide, we’ll cover the most important details you need to know about how to incorporate a startup.
What Does Startup Incorporation Mean?
Incorporating your startup means establishing your business as a formal legal entity that is separate from its founders or owners. When you incorporate your startup, the state under which you incorporated recognizes your business as a separate legal entity or “person.”
The default business entity is a sole proprietorship. If you start a business today without any formal registration, you are automatically a sole proprietor. Operating as a sole proprietorship may be right for a small business owner with no plans for expansion, but most businesses want to grow, acquire assets, or seek funding.
If you plan to raise investors' funds or grow your startup into a public company, you’ll need to incorporate your business.
Some of the benefits of incorporating your business include:
- Limited liability protection: Limited liability is a business ownership structure that protects the personal assets of business owners or shareholders from losses and debts. With limited liability protection, owners and shareholders are only liable for the amount they invested in the business. Incorporating a business confers this protection on all owners.
- Access to funding: Incorporating a business allows you to sell shares or a part of your business to raise funds. Most venture capitalists won’t even consider funding an unincorporated business.
- Credibility: Formal registration with the state can make your business more credible to potential customers.
Types Of Legal Entities: Business Structure Options To Consider
In a strict sense, a corporation refers to a separate legal entity created with the purpose of operating for profit. A corporation can own assets, enter into a contract, sue and be sued, pay taxes, and borrow money from financial institutions. Below are the main types of corporate entities to consider when incorporating your startup.
- C Corporation (C-Corp): A C-corporation is the most common form. This type of corporation fully protects owners from personal liability in the event of a lawsuit. The corporation is taxed as a business entity while owners receive profits and must also pay taxes at an individual level — also known as double taxation.
- S Corporation (S-Corp): An S-corporation is similar to a C-corp in all other respects, except the number of shareholders and method of taxation. The number of shareholders in an S-corp is limited to 100, while there’s no limit for a C-corp. Taxes in an S-corp are not filed separately but by shareholders under personal income tax after subtracting a dividend from the business's net income (whatever money is left if you were to pay yourself a “reasonable” salary in the business).
- Limited Liability Company (LLC): An LLC is a unique corporate entity that combines the benefits of a sole proprietorship with the limited liability protection of a corporation. While one or more individuals own an LLC, a corporation is owned by shareholders. An LLC may be taxed as a sole proprietorship, C-corporation, or S-corporation. LLCs are a popular choice among business owners who want limited liability protection without the taxation hassles of a corporation.
C-Corp vs. S-Corp Comparison
What Is The Best Way To Incorporate A Startup?
The C-corporation is the preferred type of corporation for most investors. Here’s why:
- Ability to issue stocks: Incorporating as a C-corporation allows your business to issue stocks. If you are a sole proprietor, limited liability company, or partnership, you cannot break apart your company into shares. However, if you want funding, investors will want a piece of the business, and the best way to do this is to issue stocks.
- Zero restrictions on the number of shareholders: There are no restrictions on the number of shareholders allowed in a C-corporation. You can also sell an unlimited number of shares.
- Better tax system for shareholders: C-corp shareholders only pay income tax dividends. Compare that to an LLC, where all owners pay tax on the company's annual earnings, whether they receive a distribution or not.
- Easy distribution of ownership: Owners can freely transfer shares in a C-corp to any shareholders. However, S-corp shareholders must be U.S. citizens, residents, or “natural” persons. LLC owners can not issue shares at all, so the only way to bring on new investors is to revise the operating agreement. This makes C-corps the easiest structure for distributing ownership.
How To Incorporate A Startup In 3 Steps
While the corporation startup process is extensive, and we recommend working with a law firm or legal advisor (more on this below!), founders can get started with these three steps.
1. Name your startup.
This is usually the first and most important step for new businesses, not only because you want something unique and memorable but also because you can’t use a name already taken. You’ll need to perform a thorough search for registered corporations in your state to be sure there are no conflicts.
Consider these important questions:
- Would your name compete with that of another business? This could be a marketing headache.
- Can you get a domain name for your chosen name?
- Can you use the name in future trademarks?
- Can you conduct business in other states under the chosen name?
The goal is to choose a memorable name that will stick with your business for a long time. Keep in mind that when you name a company, you are filing a legal document, and it might be challenging to change the name in the future.
2. Select a location.
Where should you incorporate your startup?
It's common to incorporate under the state's laws where you'll primarily do business, but you could also incorporate in a different state. For example, incorporating in Delaware is a popular choice for many venture-backed tech startups because of its well-developed corporate laws. However, doing business in one state and incorporating in another could mean additional filings and taxes, so be sure to weigh your options carefully.
Once you've selected a location, you'll need to get a business address, which is required for incorporation. You may consider a virtual or shared workspace address if you are not ready to rent an office space.
3. File articles of incorporation.
The process varies by state, but you'll generally need to do the following:
- Visit the Secretary of State website for the state where your business will be incorporated.
- Download (or preview) the relevant forms for your chosen business entity.
- Fill in all the information, then file for incorporation by submitting relevant documents online, by fax, post, or in person.
Each state has a different set of rules and guidelines, so you must look up the state guidelines and follow through with all the requirements, regulations, and processes.
Once you've filed for incorporation, it can take anywhere from two to five weeks to receive your certificate of incorporation. One way to ensure speedy processing is to provide all relevant information at the time of filing and ensure the information you provide is accurate — be sure to have handy social security numbers or all owners and bank account information.
Tip: Consider working with an attorney or an online legal services provider like LegalZoom to ensure you file articles of incorporation correctly. Getting expert advice upfront can help you avoid costly mistakes.
Maintain Excellent Financial Records With Zeni’s Financial Services
Getting incorporated is just the first step. You'll need to comply with applicable federal and state laws to ensure your business remains in good standing with the state, so proper financial reporting is crucial.
As an incorporated business, you must legally have accurate financial records, up-to-date tax filings, annual reports, and more. Staying on top of all these requirements can be overwhelming for many startups.
This is where financial service solutions like Zeni come in.
Zeni is a full-service AI-powered finance platform that provides intelligent bookkeeping, accounting, and CFO services for startups and small businesses. Zeni is like having a financial team that can help you dive deeper into your numbers and advise on issues like handling and paying your incorporated business taxes and how your business taxes affect your shareholders and income taxes. With Zeni, you get the technology and human expertise you need to maintain stellar financial records and make informed decisions.