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Summary: Company incorporation is the process of forming a new corporation by registering the corporation with an appropriate legal body so that it’s recognized as a legal entity separate from its owners.
Company Incorporation
Company incorporation is the process of forming a new legal entity with limited liability, usually as the vehicle for a business. This means registering the business with an appropriate legal body so that it’s recognized as a legal entity separate from its owners. Incorporation also means that a business is operated in compliance with state, federal, and tax laws. Upon their registration, corporations are owned by shareholders and are usually controlled by elected or appointed boards of directors. They’re run according to bylaws that are drafted and adopted upon formation, and their ownership is divided into stock.
Incorporating a business allows it to be legally recognized as a separate entity from its owners, who act together and collectively as a corporation. This limits liability for its owners and lets the corporation indemnify or take responsibility for legal actions brought against people working on its behalf.
It’s important to note that in the US, the term “incorporation” can refer to registering organizations that follow different corporate structures and not only legal corporations. This can include structures like limited liability companies (LLCs) and non-profits, which also undergo a form of incorporation to be recognized as separate legal entities.
What are the different types of corporate structures available for incorporation?
Businesses can be incorporated in different ways depending on the goals of the incorporators and the jurisdictions in which they are formed in. The types of corporate structures available for incorporation differ between countries but generally include:
For-profit corporations
A for-profit corporation is a business designed to generate revenues through its activities. A for-profit is owned by shareholders who elect or appoint a board of directors to control the corporation’s management. The board appoints officers like the chief executive officer (CEO) and chief operations officer (COO), who provide leadership and direct daily activities. The owners, board, and officers are protected by limited liability against creditors and legal actions.
Shareholders in a corporation have the right to vote on important matters such as mergers and acquisitions. In some cases, when major corporate changes occur—such as a merger or a sale of the corporation—appraisal rights allow shareholders to demand a fair valuation of their shares and receive compensation if they disagree with the proposed changes. This protection ensures that shareholders are not forced to accept terms that undervalue their investment.
In the US, for-profit corporations are divided into S and C designations for tax purposes. An S corporation is a privately owned business that does not pay income tax but instead divides its profits and losses among shareholders who are taxed personally. In contrast, a C corporation is publicly owned and pays corporate income tax at a flat rate of 21%.
Public benefit corporations (PBC)
A PBC is an entity set up with the main aim of providing a benefit for the public good and a secondary aim of producing profits. Public benefits can include actions that benefit society, workers, or the environment.
Nonprofit corporations
Nonprofits can be incorporated in much the same way as for-profit corporations. However, their stated aims must be social goals and not producing profit for shareholders. Nonprofits don’t have shareholders but do have boards and officers who have limited liability. Nonprofits can include mutual benefit corporations like unions and clubs, public benefit corporations like charities and hospitals, or religious corporations.
Other types of structures that are not corporations but may be “incorporated” in the US include:
- Cooperatives: These are for-profit entities owned and operated by their members.
- Limited liability companies (LLCs): These entities are companies owned by members, rather than shareholders, and that operate as a pass-through entity in the United States. The owners are protected by limited liability. Note these are not the same as limited companies in other jurisdictions like the United Kingdom or Australia, which are usually not pass-through entities.
- Limited partnerships (LPs): These are companies owned by partners where at least one partner has limited liability for the company’s debts and damages while at least one other partner has unlimited liability.s
What are the pros and cons of incorporating a business?
It’s not necessary to incorporate a business, and depending on many factors, there are pros and cons involved. These include:
- Pros
Limited liability
The biggest advantage of incorporating a business is the ability to protect the owners from liability. As incorporation produces a separate legal entity, the owners are not liable for the debts, taxes, and damages claimed against the corporation. This limitation of liability generally protects all shareholders, board members, and officers so long as the corporation is run in a legal way.
Professionalism
Both customers and institutions see incorporated businesses as more reliable and credible than sole proprietorships. Customers tend to trust corporations more than individuals as they have been registered by a state or country and have had their actions scrutinized and approved. Banks and private investors are more inclined to lend money to incorporated businesses as their liability isn’t tied to the corporation’s liability.
Ability to hire
Unregistered businesses can’t hire workers, and even sole proprietorships are severely limited in their ability to employ others. This is one reason why a business is normally incorporated as it scales.
Attracting investors
Incorporated businesses can divide their ownership into stock and sell it to investors to raise capital. Because a corporation’s shares can be transferred or sold at any time, this offers investors liquidity should they decide to change where their money is invested. In the US, S corporations can only sell to 100 shareholders, but C corporations can issue different classes of stock to unlimited shareholders. This flexibility in raising capital makes C corporations particularly attractive for larger businesses looking to attract a wide base of investors.
Taxes
Unregistered businesses that don’t pay taxes are considered illegitimate and generally illegal in most countries. Registered corporations must pay tax on earnings but may be able to write off expenses or receive breaks and incentives from governments. This generally makes the taxes paid by corporations lower than for sole proprietorships.
- Cons
Loss of control
By incorporating a business as a corporation, the founder will necessarily lose total control over the company. Even if the founder becomes the majority shareholder, they’re still not the sole owner and will have responsibilities to the other shareholders. The board of directors will also have input into decisions on how the company is run, even if the founder sits on or even chairs the board.
Compliance
Incorporation means that a registered business will have to follow many laws and guidelines. Compliance with these statutes can be costly and produce a lot of time-consuming administration tasks.
Set-up and maintenance costs
Incorporation isn’t free. It typically requires a small registration fee and more significant legal fees; then, ongoing costs accrue for annual accounting and tax filing. These can make incorporation more costly than keeping a business as a sole proprietorship.
What is the cost of incorporating a business?
The costs of incorporating a business can vary depending on where it’s registered, its size, and its structure. However, incorporation generally includes a few important expenditures.
Most states or countries charge small fees for incorporation. Founders might need to pay to check name databases to ensure their corporation name is original and available. Small filing fees are usually also required for state or federal registration. Obtaining an employer identification number, registering an address, and opening a corporate bank account may also require fee payments.
Corporations will need to set up bylaws, which generally means they will need professional legal help. Accounting and tax filing will also have to be done by professional accountants and auditors.
What processes are involved in incorporating a company?
The process of incorporating a business varies in different states and countries. In general, though, incorporators will have to follow these main steps:
- Choosing a name: Every corporation needs a unique name as it will represent a unique legal identity. Usually, a name is selected and checked against databases to ensure it’s available.
- Registration: The incorporator must sign and file registration documents with a government office. These documents will register the name and corporate structure as well as authorize the issue of stocks.
- Bylaws: A corporation needs to develop and implement a set of rules for its own management, known as bylaws. These are generally developed with help from legal professionals and define the makeup of the board of directors and officers, stock ownership, and identification. The business becomes incorporated when the incorporator signs an “Action of the Incorporator” to implement these bylaws.
How do you choose the jurisdiction of incorporation?
Choosing where to incorporate a business is a big decision. Different countries or states within those countries have varying rules and regulations governing corporations that business owners need to evaluate. These include:
- Tax laws: Different jurisdictions may assess higher or lower corporate tax rates or offer credits to certain types of employers.
- Attitudes toward business: Some jurisdictions are very favorable to companies and help them operate with initiatives, tax credits, and emphasis on resolving legal disputes.
- Access to markets: Incorporating a company in or close to a country where it will do business helps it reach customers and partner with other companies.
- Privacy laws: Keeping specific corporate information secret may be an important strategy for a business. Therefore, it may choose a jurisdiction with strong privacy laws.
What are the ongoing legal and regulatory obligations of an incorporated business?
Incorporation is only the beginning of the regulatory obligations of a business. As a registered entity, a corporation needs to continuously file taxes, comply with labor laws, make annual reports, and operate within its bylaws to maintain its designation.
