What does incorporate mean?
How do you incorporate a business?
What are the benefits and drawbacks of incorporation?
What type of entities can you incorporate?
In this ultimate guide, we will break down the notion of “incorporate” so you know all there is to know about it.
We will look at what it means to incorporate a business, what it means to operate an incorporated business, the advantages and disadvantages to incorporate, the step-by-step process of how to incorporate, where you should incorporate and more.
This guide is a must-read for those looking to start a business, sole proprietors reconsidering their business structure, start-ups and individuals looking to learn more about corporations.
Keep reading, this guide is packed with loads of great stuff!
Let’s get started…
Table of Contents
What does incorporate mean
Incorporate is a term used to refer to the process of forming a legal entity or a corporation.
According to the Merriam-Webster dictionary, incorporate is defined as:
to form into a legal corporation
to admit to membership in a corporate body
What is notable with this definition is that “incorporate” or “to incorporate” means to create, form and bring into existence a corporate body.
Origins of the term incorporate
The term “incorporate” originates from the Latin term incorporātus meaning to embody something or to incarnate something.
The Latin meaning is quite fascinating!
When you incorporate a company, you are essentially creating a legal entity that you will embody or incarnate to conduct business.
Variations of the term in business
To refer to the process of creating a separate legal entity in the business world, we can employ different variations of the term ‘incorporate’.
Here are some variations or related phrases you’ll typically see:
- Establish a corporation
- Form a corporation
- Create a corporation
- Register a corporation
- File for a corporation
A corporate name must have a “corporate identifier” or “business entity identifiers” in its name to distinguish a corporation from other legal entities.
The corporate identifier is used at the end of your corporate name to signal to the public that this is a corporation.
If I say Apple, you will immediately think of the fruit but if I say Apple Inc, you immediately think of a successful global organization.
According to the California Code of Regulation, the following are examples of business entity identifiers:
- Professional Corporation
Incorporation vs corporation
The difference is quite simple.
Incorporation is the process of legally creating or forming (registering) a corporation.
Incorporation represents the acts and legal steps required to create a corporation (it’s what you do).
On the other hand, a corporation is an entity able to own assets, operate a business, exercise legal rights and be sued.
A corporate is a legal person or a legal entity able to exercise legal rights and assume legal obligations just like an individual (it’s what you are).
What is an incorporated business
When a company is incorporated, it acquires its own legal status, has its own business structure and is be considered separate from its incorporators.
An incorporated business can have:
This is quite significant.
A corporation can essentially exercise legal rights just like a person.
It can sue, can be sued, can own title to assets and can borrow money at the bank.
The laws allow you to create a corporation or limited liability corporation (LLC) to encourage you and entrepreneurs to take the leap of faith and start a business without worrying about losing or exposing personal assets.
An incorporated company shields your personal assets and limits your personal liability as the owner of the business or shareholder.
To start and grow a business, the corporate vehicle or an incorporated business gives you maximum leverage as you can potentially raise important sums of money.
The flexible ownership structure of a corporation allows you to issue shares of stock to investors in exchange for capital.
Eventually, if your business takes off, you may consider listing your incorporated business on the stock exchange (IPO) and sell your shares publicly (public corporation).
Advantages to incorporate
You are looking to start a business?
Are you part of a start-up and wonder “should I incorporate” or “why incorporate”?
What are the benefits of incorporating a business?
Are there any advantages to go through the hassle of forming a corporation and maintaining it?
Let’s face it, if you look at the majority of Fortune 500 or highly successful organizations in the world, most of them are incorporated businesses and operate their business under a corporate vehicle.
Let’s look at some key reasons why it may be beneficial to incorporate a business.
Limited liability protection
The most important reason why a person decides to incorporate a business is to benefit from the limited liability protection.
In other words, operating a business under a corporation, the business owner or shareholders do not expose their personal assets to the creditors of the business.
To operate a business means that you’ll need to sign contracts with employees, clients, vendors, suppliers, you’ll borrow money from the bank, you’ll have loans and debts to pay.
A company can hire employees, sign contracts and take on legal obligations without exposing you personally.
In the event of potential default by your company on its loan payment or debt, your business credit will not affect your personal credit and your personal assets will not exposed to seizure by the corporation’s creditors (unless you granted a personal guarantee!).
At the end of the day, you will not gamble your house, your car or your savings in your business venture.
Another important reason why incorporating a business is a good choice for many entrepreneurs is due to the fact that they can transfer or sell parts of the business to others.
You can entice investors, venture capitalists or others to invest in an equity stake in the company.
Other corporate vehicles like partnerships will not be as attractive to equity investors due to more rigid ownership structures
With a corporation, you can issue different types of shares (classes of shares) designed specifically to suit the needs of your investors.
Ownership in the company can be transferred, shares can be issued and redeemed in a streamlined fashion.
Once a corporation is formed, it acquires its own legal existences and can continue existing beyond the death of its founders.
A corporation may be formed by one or few incorporators technically live forever (that’s a stretch but you get the point).
As such, a company’s life can continue even when the original incorporators are no longer in the company or have passed on.
Did you know that the Hudson’s Bay Company or HBC was incorporated on May 2, 1670 and continues to exist even as of today!
A corporation is the preferred type of legal entity or vehicle investors prefer to invest in.
That’s because they can form a corporation having different classes of shares suitable for different owners.
If an investor wants to have control of the organization, you can issue common shares to them.
If an investor is going to be more passive and you do not want to give up share voting rights, you may want to preferred shares to the investor where you guarantee a certain dividend or return on the shares and withdraw their voting rights.
Your tax obligations can be a consideration when incorporating a new business.
When you run a business under a corporation, you’ll able to deduct or write-off many expenses related to your business.
For example, you’ll be able to deduct insurance premiums, transportation costs and other expenses you incur to run a successful business.
In many instances, you can reduce your overall tax exposure by earning your business income under the company, deducting your expenses under the company and paying income tax at the corporate rate.
Ideally, you should consult an accountant or tax specialist for a more personal assessment of what’s best.
Incorporating a company gives you the ability to make a tax election on your company’s tax treatment.
By default, your company will be considered a C Corporation (C Corp) for tax purposes.
This means that the company’s revenues will be taxed in the hands of the company at the corporate tax rate.
The shareholders do not have to report any corporate income on their personal income tax returns.
If your company is eligible and it makes sense for your business, you can also elect to be an S Corporation or S Corp.
The S Corp election provides you with pass-through taxation.
This means that the corporate revenues will pass through to the shareholders and be taxed on their personal income tax.
It’s similar to how an LLC is taxed where the members personally report the limited liability company’s earnings in proportion to their interest in the business.
Disadvantages to incorporate
Incorporating a company can bring you significant advantages like limited liability protection and a structure allowing you to attract investors.
However, you should also expect some disadvantages.
The first disadvantage to consider is incorporation costs.
Forming a company is not free.
You’ll need to consider the costs associated with filing your articles of incorporation or incorporation papers with the state in order to establish a company.
In addition to filing the paperwork with the state, you’ll need to assess whether you are comfortable in preparing the incorporation documents yourself or you’d want to hire a lawyer or a service company.
In some cases, certain companies offer you the possibility of incorporating a business online.
There are online filing service companies that offer incorporation services in a more affordable way than lawyers but give you limited or no legal advice
The incorporation cost of some states may be higher than others but you should not decide strictly based on the incorporation cost but rather based on your future goals and objectives.
Keep in mind!
You may find that you will be better off to incorporate in your home state rather than Nevada even though the filing fees appear to be lower in Nevada
Once your company is incorporated, up and running, you’ll need to maintain the incorporated status of the business.
In other words, your business must remain in good standing with the state where you registered your company.
In many states, you have Annual Fees or annual Franchise Tax to pay maintain your company’s status and file yearly paperwork.
It’s important to keep your company’s status to preserve your limited liability protection afforded by the law.
With company incorporation comes recordkeeping, maintaining a minute book, preparing corporate resolutions, documenting board meetings, documenting shareholder decisions and more.
In most jurisdictions, the corporation is legally required to maintain records of its business.
This means that you must ensure you comply with the laws based on which your company was incorporated.
For example, if you incorporated a Delaware corporation, you must comply with the recordkeeping obligations resulting from the Delaware laws
Every corporation must file an annual report in most states.
With the annual report, you confirm the registered information of the company and indicate whether or not things have changed.
The purpose of this requirement is to provide the public, investors and state agencies all the relevant information about your corporation, where it is formed, where it does business, name of your directors and registered agent information.
Some states require an annual report and some requiring it every two years (biennial report).
That can be called Statement of Information, Periodic Report, Annual Registration, Annual Report or Biennial Report.
An incorporated entity is subject to double taxation.
Double taxation means that corporate revenues are taxed in the hands of the corporation first and then when profits are paid out to shareholders in the form of dividends, the dividends are taxed in the hands of the shareholders on their personal income tax.
Hence, “double” taxation to indicate that the same revenue is taxed twice.
We are putting the concept of “double taxation” as a disadvantage in this guide as we consider that paying taxes twice on the same income is not advantageous for some.
Keep in mind!
Double taxation may not necessarily result in a higher tax cost for you if you set up your corporation properly
If you do your homework properly on the type of company you incorporate, consider your personal tax situation, even with a double taxation structure, you may end up saving money.
Type of entities you can incorporate
“Incorporate” or “incorporation” are generic terms referring to the process of creating a legal entity separate from its owner to conduct business or serve a mission.
What are the different types of legal entities that you can incorporate?
What type of business you can incorporate to give you limited liability protection?
In this section, we’ll look at the different types of legal entities you can incorporate or register to give you more protection than if you operate a business as a sole proprietor or under a general partnership.
C Corporation (C Corp)
When you file your articles of incorporation, you will create a corporation.
A corporation is a separate legal entity from its shareholders and, by default, it will be a separate taxpayer.
The corporate income is taxed in the hands of the corporation and does not affect the personal taxes of its shareholders.
This is the default taxation regime applicable to an incorporated business and we refer to such entities as C Corporations or C Corps.
The reason why it’s called a C Corporation is that it will be subject to the taxation regime under Subchapter C of the Internal Revenue Code.
A C Corporation can be the right entity for you if:
- You are looking to scale the business
- You are not looking to distribute the company profits to the shareholders so you can grow the business
- You want to make the business attractive for investors or potential buyers
- You expect your company to own real estate
- You want to separate corporate income from shareholder income
S Corporation (S Corp)
An S Corporation is formed the exact same way as a C Corporation or any other incorporated business.
You must file your articles of incorporation with the chosen state and pay your filing fees.
The difference is that if you meet the eligibility criteria, you can elect to have the corporate income taxed in the hands of the shareholder (pass-through taxation).
Keep in mind!
To qualify for an S Corporation election, you must have less than 100 shareholders, all shareholders must be residents of the U.S. and issue only one class of stock
Your company will be subject to the Subchapter S of the Internal Revenue Code and be allowed to have its corporate income taxed directly in the hands of its shareholders.
An S Corporation may be suitable for someone if:
- You want to take advantage of pass-through taxation
- You are not looking to introduce foreign (non-American) shareholders in your business
- You will not expand your shareholder base beyond 100 shareholders
- You will not rely much on external financings such as finding investors or VC’s
Limited liability company (LLC)
A limited liability company or LLC is a legal entity formed by virtue of the law just like a corporation or incorporated business.
The LLC will have a separate legal entity and will offer its members limited liability protection.
You can consider an LLC to be similar to an S Corp as it offers its members pass-through taxation.
In other words, the business revenues are taxed directly in the hands of its members.
You may consider forming an LLC if:
- You do not want to have the same level of formality as creating a corporation
- You may want to own real estate
- You will want to share business profits with the owners
- You may have some losses that you want to report on your personal income taxes
Professionals have the option of incorporating as well.
In fact, if you are a doctor, lawyer, accountant, architect or a licensed professional, you have the option of incorporating a professional corporation.
The professional corporation provides the professional service provider with the same advantages as a corporation such as limited liability and protection of personal assets against business creditors.
The professional corporation can choose to be taxed under the Subchapter C of the Internal Revenue Code and be taxed like a C Corp or elect to be taxed like an S Corp.
A nonprofit corporation or NPO (nonprofit organization) is a legal entity incorporated under the law for a specific purpose or mission other than earning a profit for its shareholders.
A nonprofit organization can have a public-benefit mission, a religious objective or a mutual-benefit purpose.
A nonprofit organization must serve the public in some ways and must report is revenues publicly so that the public and its donors can see how their money has been used.
Operating an NPO will allow the corporation to benefit from certain tax exemptions so they can achieve their mission and purpose.
Where to incorporate
When looking to incorporate a business, an important decision you must make is where to incorporate.
Should you incorporate in your home state?
Should you incorporate in another state?
You heard that incorporating in Delaware, Wyoming or Nevada could be advantageous, is that so?
For example, Nevada and Wyoming offer low filing fees and no franchise tax.
Delaware offers advantageous business-friendly laws.
If you are starting a new business and you have just a few employees and operating in your home state, it is generally better to incorporate in your own home state.
Keep in mind!
The additional fees and administrative paperwork may end up costing you more than the initial low filing fees
If you incorporate in Delaware for example but you conduct business in Florida, you’ll have to register your business in Florida as a foreign corporation.
Even though you’ll be operating in your home state, since your company was incorporated in another state, you’ll be considered “operating out of state”.
How to incorporate
Incorporating a company requires the filing of your articles of incorporation with the applicable state.
Here are the steps on how to incorporate a new business or a start-up.
State of incorporation
The first thing you should think about when looking to incorporate or you are considering the incorporation of a company is the state where you will incorporate it.
Should you incorporate it in Texas, Delaware, California, Florida or somewhere else?
Each state will have its own laws and specific requirements.
It’s a good idea to read through the relevant Secretary of State’s website (or equivalent agency) to get a good sense of your compliance obligations to incorporation and in the longrun.
To incorporate, you’ll need to think about your official corporate name.
When selecting a name, you must make sure that your company name does not conflict with that of another registered corporation.
A corporate name is made up of three elements: the distinctive element, the descriptive element and the corporate identifier (example: Mary’s (distinctive) Bakery (descriptive) Inc. (identifier)
Here is the minimum requirement that you must consider when choosing your corporate name:
- Your corporation name must be unique and no conflict with another registered business
- You must not use restricted words such as “bank” or obscene words
- Your company name must include a business name identifier such as “incorporated”, “corporation”, “company”, “inc”, “corp” or other
A company must have a business purpose.
The purpose can be general or specific.
A general-purpose company can be declared as: “to conduct all lawful business”.
A specific-purpose company will provide a specific type of product or service.
The specific nature of the business operation must be disclosed in your articles of incorporation.
Your company must have a business address in the state it was formed.
Your company’s business address is where it will receive its general mail and material such as a physical address or even a PO Box.
Articles of incorporation
You must file your corporation’s articles of incorporation with the applicable Secretary of State or equivalent agency.
Some refer to articles of incorporation as charter, certificate of incorporation or even letters patent.
Articles of incorporation are documents filed with the state where you are legally creating your company and contains relevant information about the corporation such as name, address, registered again, details about the company stocks and more.
You can prepare your articles of incorporation yourself if you have an idea what you are doing or you can have it prepared for you by a lawyer or service provider.
In your articles of incorporation, you’ll need to identify the incorporator or incorporators.
A company can be incorporated by one or more people.
You can even incorporate a company where the incorporator is a legal entity itself.
The incorporator is the person or entity filing the articles of incorporation, signing the documents and paying for the legal entity creation.
Board of directors
In some states, you’ll be required to identify the name and composition of your corporation’s board of directors.
The board of directors is usually composed of 1 to 3 individuals who make important decisions for the company.
A small company can have its owner and sold shareholder as its sole member of the board whereas a larger company can have a larger board and even have members that are not employees of the company.
You must also specify the number of shares of stock your company is authorized to issue along with the types of shares.
A company will always have common stock or common shares representing the type of shares issued to the owners.
A company can also create other types of stock such as Class A, Class B or Preferred Shares.
The rights and obligations associated with each class of stock are typically outlined in the articles of incorporation.
A corporation formed in a state must have an address in that state.
Typically, in many cases, the registered address will be that of the registered agent.
If you incorporate a California entity, you must have an address in California allowing your company to receive legal documents.
If your company is a Florida corporation, you’ll need an address if Florida.
The registered address a company’s formal address where the company receives formal and legal documents and the person receiving such documents is the registered agent or statutory agent.
You can elect to have a person over the age of 18 as your agent or you can hire a professional registered agent to act as your agent.
In some cases, hiring a registered agent is a better option as you may not have an office or anyone who can receive your company’s legal documents.
Certificate of incorporation
Once you filed your articles of incorporation, completed the filing forms with the relevant Secretary of State or equivalent agency and paid your filing fees, you will receive a confirmation that your company has been incorporated.
This confirmation comes to you in the form of a certificate of incorporation.
The certificate of incorporation and along with a copy of your filing documents will represent the first documents you’ll need to maintain in your corporate records (typically in a corporate minute book).
For the Secretary of State or equivalent agency to issue a certificate of incorporation, they need certain information, such as:
- Your corporate name
- Identification of your registered agent
- The company identifier such as “INC”, “CORP”, “CO” or “LTD”
- Name of incorporator
- Name of directors
- Name of officers
- Your business purpose
- Number of authorized shares
- The legal address of your company
Election of the board
With your corporate entity created, it’s time to elect the board.
The board of directors represents a group of individuals representing the shareholders of the corporation.
For a small company, the board can be composed of the sole founder of the company.
However, a board member does not necessarily need to be an employee of the company.
Public companies are required to have a board of directors.
Typically, the board is elected by the shareholders either in the context of a vote held at a meeting of the shareholders or through a shareholder resolution.
Adoption of bylaws
Another formality is to adopt your company’s internal rules and governing bylaws.
The bylaws are approved by the board of directors and it’s one of their first official acts they will pose on behalf of the corporation.
The bylaws will provide the internal rules with respect to the election of board members, shareholder meetings, term of office, share issuance, voting procedure and so on.
The bylaws are generally approved by the execution of a resolution of the board.
The final step in the incorporation process is the issuance of shares of stock to the shareholders of the company.
Typically, the articles of incorporation will authorize the company to issue an unlimited number of shares.
The corporation will issue a share certificate to its shareholders containing the following information:
- Name of the shareholder
- Certificate number
- Issue date
- Class of shares
- Number of shares
- Corporate name
Often, the founding shareholders will issue 100 common shares to the initial shareholders for a nominal value (or par value) of $1.00 per share
In exchange of the shares, the shareholders will pay an arbitrary amount to acquire the shares called nominal value or par value of the shares.
The company will record this arbitrary value of the shares to its balance sheet as the value of its share capital.
The nominal value of the shares does not represent the company’s fair market value of its shares nor has any bearing on the stock’s price
What does incorporated mean?
In business, the term incorporated means that a legal entity has been formed, constituted or created.
“An incorporated business” means a business that has been legally formed and recognized as a separate legal entity in accordance with the laws of the state where it was formed.
An incorporated company offers important advantages such as:
- Shields your personal assets from the business operations
- Allows you to make advantageous tax elections
- Provides you with a flexible ownership structure to have external investors invest in your company and acquire an equity stake in the business
Should I incorporate?
If you are looking to start a side gig or small business and earn a small revenue on the side, you may not want to incorporate a business and go through the hassles of incorporation, corporate maintenance, compliance, recordkeeping obligations, costs and so on.
However, if you are involved in a start-up, looking to bring investors, aspiring to do business outside of your home state at the national or international level, want to protect your personal assets from risk, you may want to incorporate.
How to incorporate a business?
Incorporating a business requires that you understand the requirements of the state where you want to incorporate and ensure you follow them correctly.
Generally, the steps are as follows:
- Verify that your chosen business name does not conflict with another (name check)
- Draft and sign your articles of incorporation (incorporation papers)
- Submit your articles of incorporation along with the necessary forms to your Secretary of State or relevant agency (filing)
- Pay your filing fees (filing fees)
- Get your certificate of incorporation (incorporation confirmation)
- Elect your board of directors (directors)
- Elect your officers (officers)
- Adopt your company bylaws (internal rules)
- Issue shares to your shareholders (shareholders)
Why incorporate in Delaware?
Delaware is a preferred state for many to incorporate a business as they have highly developed corporate laws and statutes considered “pro-business”.
To benefit from the legal flexibility offered by Delaware, many corporations choose to incorporate in this state.
Here are some reasons why Delaware has gained popularity for incorporating businesses:
- Delaware has an established and respected court system
- Delaware laws allow you more flexibility in structuring your board and shareholders
- Companies do not need to disclose the name of their officers and directors
- It’s the preferred state by VCs and investors
- Delaware offers some tax advantages
Why incorporate in Nevada?
Nevada is another state considered as a pro-business state.
Nevada has become a popular state to incorporate a business as:
- You do not have to pay state corporate income tax
- You do not have to pay franchise tax
- You do not have to pay personal income tax
- You have low filing fees
- Nevada has strong asset protection laws
- There are no minimum capital requirements to incorporate a company
- Nevada requires minimum disclosure of personal information
- Directors and officers do not need to live in Nevada
How to incorporate in California?
California is not perceived as a good state to incorporate a business or offers a poor business climate.
However, most of the leading technology ventures are incorporated in California.
If you live in California, it may be the right jurisdiction for you to incorporate your business.
Here are some advantages to incorporate in California:
- Some tax advantages for small businesses
- Credibility within your industry
Here are some drawbacks:
- Higher filing fees
- Franchise Tax
- Additional reporting requirements
At the end of the day, you may decide to incorporate in California for strategic purposes.
How does incorporation work
An incorporated company has several distinctive characteristics:
- It is owned by its shareholders
- The shareholders own shares of stock in the corporation
- The shareholders have limited liability and are not personally responsible for the debts and liabilities of the company
- It has a board of directors whose members are elected by the shareholders
- It can live for so long as it is profitable unless its life was set to expire, is voluntarily dissolved or is bankrupt
- It pays income tax on its own taxable income as a separate taxpayer
- Has legal rights like that of individuals whereby they can own land, property, sue and be sued
What are the benefits of incorporation?
There are many benefits in incorporating a company to start a business such as:
- Personal liability protection
- Tax advantages
- Enhanced business credibility
- Flexible financing options
- Preferred by investors and VCs
- Business name protection
How can I incorporate a business?
There are three main ways you can incorporate a business:
- Do it yourself
- Hire a lawyer
- Work with an online incorporation service provider
The most cost-effective way of incorporating is to handle the incorporation process yourself.
The downside is that you should know what you are doing.
Hiring a lawyer can be another option where things are doing in alignment with the law and state rules but you’ll pay a much higher price.
You can opt for a middle-ground position by working with an online legal filing service where they handle the paperwork for you without necessarily giving you legal advice.
What are the different types of incorporated companies?
There are many types of incorporated companies around the world such as:
- Limited liability partnership (LLP)
- Public limited company (PLC)
- Unlimited company (Unltd)
- Nonprofit corporation
- Professional corporation
- Public corporation
- Closed corporation