Incorporation is one of the most foundational steps in bringing your startup to fruition. Not only is it necessary to open a business bank account, but the business structure can provide your company with several benefits. These include tax structures that can save money, liability protection that can safeguard personal assets, and investor approval to help your startup raise funding.
In this article, we’ll explore the pros and cons of incorporation and break the process down into manageable steps: the what, the why, and the how — with some tips along the way.
What is an incorporated business?
An incorporated business has filed articles of incorporation with the Secretary of State and has its own entity status, meaning it can buy and sell property, engage in lawsuits, pay taxes, contract and hire people, and more.
The Internal Revenue Service (IRS) considers incorporated businesses as tax entities distinct from their business owners. This includes C-corporations and S-corporations, and means that a business owner’s personal assets are protected through limited liability. Depending on the state, initial incorporation costs range from $50 to $250.
Pros and cons of incorporating a business
Incorporation can give your company notable advantages, but it also has implications when it comes to tax structures and costs. You'll want to weigh the pros and cons relative to your business's needs.
The pros of incorporating your startup
- Investors like corporations. Many startup investors are only legally permitted to invest in corporations and no other business structures. Additionally, due to the regulations on ownership, taxes, and management that corporations have to follow, many investors prefer to fund corporations. Investments in corporations are inherently more secure, which bodes well for venture capitalists hoping to invest in a reliable business and fetch an attractive return on their investment.
- They allow for changes in ownership. C-corporations and S-corporations are not subject to dissolution if one of the founders decides to move on; the business can continue to exist. By contrast, LLCs rely on consistent membership or face being shut down. Corporations can provide your vision with longevity and security. They can be especially useful for founders who’d like to diversify their projects.
- Your personal assets are protected. Every corporation is granted limited liability, which protects the business owner’s personal assets from corporate debts. The "limited" element of limited liability refers to the maximum amount your personal assets can be implicated in corporate liabilities. Let’s say your liability limit is $20,000, and the company gets sued for $100,000. If your company can’t pay this amount, then you’re only potentially personally liable to pay $20,000 on the suit, according to the protection from your liability limit. This also ensures that your personal cars, bank accounts, homes, and boats are unlikely to be exposed to risk or seized for corporate purposes. This separation can offer both your and your corporation's assets more security.
The cons of incorporating your startup
- Annual reports and fees can add up. Every corporation must file annual (or biennial, depending on the state) reports to the Secretary of State in their state of incorporation. Your company reports must be rigorously documented and will cost between $50 to $455 to file each year. Failure to file on time can compromise your company’s good standing with the state and can cost your business a late filing fee of $10,000 or more.
- Operations have rigid rules. Corporations have hard and fast rules on nearly every facet of their businesses, including corporate bylaws, governance, meetings, documentation, board of directors, and elected officers. The stakes are high: if you don’t comply with these rules, your company can be forced to cease operations altogether. On the other hand, sole proprietorships and LLCs have more flexibility in how their businesses operate internally. Be sure you’re ready to abide by the rules before you incorporate your business.
- Be prepared for double taxation. One drawback with corporate taxes is that corporations are taxed first on income and then again on dividends. This setup is generally referred to as double taxation. While a corporation is paying its own taxes, you and your shareholders can still get personally implicated in dividend taxation, so keep this in mind when distributing your equity.
Which businesses should incorporate?
As mentioned above, there are advantages and disadvantages to incorporating. Based on that criteria, these three types of businesses are well-suited to incorporate.
- Startups. Investors often prefer and are sometimes only allowed to invest in incorporated companies. If investor backing is something your startup might need now or in the future, positioning your business to attract the people who can make it happen is a smart choice.
- Ecommerce. Incorporation creates a tax entity distinction between personal and professional taxes that allows fast-growing online sellers to avoid personal-professional tax-blended messes.
- Growing LLCs. If your LLC is starting to outgrow its operating agreement, or the pass-through taxation isn’t suiting your personal finances, or you’re hoping to garner new investments, your company is probably a good fit to start the incorporation process.
When to incorporate your startup
Knowing when to incorporate can be challenging. Start with our suggestions below, but always consult with law and tax professionals before making the decision.
- At $100,000 annual revenue. There’s no set revenue number after which to incorporate that will apply to all companies. If your startup is focusing on growth over profit or your product has a slow customer acquisition funnel, it might make sense to delay incorporation. However, if you’re earning at least $100,000 in revenue each year, then the cost-benefit ratio on aspects like formation fees, taxation, and dividends could be worth undergoing the structure change.
- When your personal taxes are too high. If your startup has been operating with a pass-through taxation system, meaning that you’re paying company taxes on your personal filings, your company’s growth could take a chunk out of your personal wallet come tax season. If the costs of paying business taxes on your own filings have outweighed the business benefits, it’s time to switch.
How to incorporate a business
The steps below will help you incorporate your business efficiently and confidently.
1. Name your business
Existing companies, skip to step 2. If you’re starting with only a business idea, you’ll first need to select and possibly trademark your unique company name.
Tip: Should you incorporate or trademark first? It depends on your goals. Trademarks provide more security than simply naming a company and starting operations, but they also take longer to process than incorporation (three to six months versus zero to four weeks, respectively). If your goal is to operate immediately, incorporation can come first. If your goal is to secure your brand long-term before you start operations, trademark first.
2. Write bylaws
If you already have a company in operation, you’ll want to translate your current operation agreement to comply with the state-required bylaws for a corporation, which tend to be more strict than the operating agreements of other business structures. New companies can simply write their bylaws fresh. Visit your state of incorporation’s Secretary of State website to find the exact specifications for your company’s bylaws.
Tip: Which state should you incorporate in? There are many factors involved in choosing a state to incorporate in, including initial filing fees, annual filing fees, and the state’s legislative ecosystem. Consult with law and tax professionals to get specific advice.
3. File articles of incorporation
The act of filing varies slightly by state, but the overall process is the same.
- First, head to your chosen state’s Secretary of State website.
Tip: Generally, these websites are formatted as www.sos.[STATE].gov. For example, California's can be found here.
- There, you’ll be able to either file for incorporation online or download a PDF of the articles to print, fill out, and fax or drop off in person.
Tip: Some states have a ~$15 paper filing fee. Filing online is generally the fastest and cheapest approach.
- Enter your information into the forms. All states ask for similar information, such as company and officer name and address.
Tip: Check out your state’s filing details and keep the needed information handy before sitting down to complete the forms.
4. Collect your incorporation certificate or receipt
How long it takes to incorporate varies depending on the state you file with. This timeframe can be anywhere from a day to four weeks. The short processing period is one of the reasons many businesses choose to incorporate in Delaware. Once you receive it, ths certificate officially means you own an incorporated company. Congratulations!
Tip: You’re now primed to get an EIN (employer identification number), which enables you to open a business bank account.
Top incorporation services for startups
Several businesses offer incorporation services, but they differ in cost, ease of use, customer support, and other services offered. Below, we’ve listed popular incorporation services along with annual costs and the services they offer.
- Stripe Atlas ($400): Stripe Atlas charges $400 (using this link) to form a C-corporation in Delaware, obtain an EIN, establish a registered agent in Delaware, issue stock to founders, join the Stripe Atlas community, create a Stripe account to accept payments from around the world, create a U.S. business bank account, and receive discounts to services from Stripe's legal and tax partners.
- Clerky ($407): Clerky charges $407 to form a C-corporation in Delaware, as well as to provide annual report and franchise tax reminders. This price includes an expedited filing fee, and Clerky promises to have a business incorporated within 2-3 business days.
- Capbase ($999/year): Capbase charges an annual subscription fee of $999. For this fee, it forms a C-corporation in Delaware, creates a stock plan, sets up a board of directors, registers a company in a chosen state, and sets up a company bank account. This fee also includes several services that extend throughout the lifetime of a business, including managing cap tables, organizing legal requirements, and helping with due diligence.
- Firstbase ($399): Firstbase charges a one-time fee of $399 for services like LLC or C-corporation formation, Wyoming or Delaware registration, EIN setup, and U.S. business bank account setup. It also establishes a physical address in the U.S., offers registered agent services, and provides lifetime support.
Incorporating your startup
It’s important to take stock of where your business is before deciding to incorporate.
If you currently have an LLC, incorporation can be a natural next step. Research the exact costs to incorporate in your preferred state, including initial filing fees, annual filing fees, and tax rates to determine if a change in structure is worth the effort and cost at this time. If it makes the most sense to remain an LLC, then at least you’ll have the research prepped for when you are ready to progress.
If you’re running a sole proprietorship, incorporation can seem especially daunting—going from almost total operational freedom to legally binding bylaws is a pretty big leap. Always speak with law and tax professionals before deciding.
Incorporation has a lot of moving parts, but many businesses find the structure worthwhile. Make sure to research the legal, professional, and personal impacts of incorporation before you make your decision.