People are often told that starting your own business is one of the best ways to get rich in America, or at least make a good living. What we are not told however is exactly how to start a business, what different types of businesses are there and what are the advantages and disadvantages of each.
This article attempts to answer these questions so that by the end of this article you will have a basic understanding of how to create your own corporation and why you are doing it.
Before you can decide what type of business you will setup you need to decide what you want to do. Do you want to open a gas station or a technology firm? Do you want to sell drinks at your own bar or sell software online? Will you primarily work by yourself or are you looking to build a big company with many employees? The answer to these and other questions about what type of business you want dictates what type of business structure you should have. Once you have figured out what you want to do, there are basically 3 types of business structures you can form.
3 Basic Types of Business Structures
1. Sole Proprietorship
If you want to go into business by yourself and you don’t think you will ever have any employees you have the option of setting up a Sole Proprietorship, which basically means “a company of one”. You are the only person in the company and you make all the money. You also PERSONALLY retain all the liability if anything goes wrong (like getting sued by a client or customer.
If you think that you will have one or more owners of the business you must either create a partnership or a corporation. A partnership basically assumes you will be liable for the business as individuals.
If you are looking at having one or more owners within your business as well as having owners outside of the business (example stockholders), you want to setup a Corporation. A corporation is an entity separate from the individuals who own it. You can think of a corporation as a big box full of business and the business owners and shareholders all own a little piece of the box. The corporation retains any liability for the actions of the business and you as an individual are completely insulated.
This article focuses on business type number 3 - the steps to form a corporation. Other articles will follow that discuss the creation of Sole Proprietorships and Partnerships.
Steps to Setup Your Corporation
Pick a name for your corporation. This name is important as it will be your corporate name of the business. The good news is that if you decide later that another name is better to operate under you can set up a DBA (Doing Business As”). The DBA is the name that your customers know you as (ex: Acme Corporation, dba “The Cool Company Name”. Your corporate name is the name that the IRS and the government recognize as your legal corporate name.
Make sure your name is available. You have to make sure your corporate name is not being used by any other business. This usually requires:
1) a search of corporate names first on Google and then
2) searching in the list of business filings in the county or state database. Visiting the county office to do this search is mandatory or else you may waste a lot of time picking a name already in use. The final step
3) is placing an ad in a newspaper under filing of fictitious business names. If the name is not found online and no one responds to your fictitious business name ad with any complaint, then the name is legally available for you to incorporate under.
Register your business name. If you are using a DBA you will probably need to register that name with the state your business is located in. This link to Business.gov will take you to a page that shows you what the filing requirements are in your state. If you are just registering the name of your corporation, registration will automatically occur when you file/ submit your Article of Incorporation.
Choose the directors of your corporation. Before you can form your business you need to know the ownership structure. The people in charge of the corporation (CEO, COO, CFO, Treasurer, etc.) are called the directors or board of directors. When these people meet to discuss corporate matters they are said to have a “board meeting”. Board meetings usually include at a minimum the CEO and secretary (to take the meeting minutes), but usually includes all major board members and key shareholders. When you are first forming your corporation you may not have enough people to complete a board full. At a minimum you need to specify the CEO – Chief Executive Officer (signs documents as the head of the corporation), COO – Chief Operating Officer (responsible for all business operations and activities), CFO – Chief Financial officer (manages the money for the business) and Secretary (documents all corporate activities via board meeting minutes) in order to file.
Determine the initial stock ownership of the corporation. When you establish your corporation it is an entity that anyone can own. It is your job as the board of directors to determine the initial breakdown of that ownership through stocks. Stocks can be initially granted to individuals or people can pay you to own stock. There is no limit to the number of shares you can issue when you form your corporation and technically there is no exact value you can place on each share. Shares are simply a way to divide the company into pieces. For example, you can say that your corporation will initially issue 1 million shares of stock and those shares will be divided equally between CEO, CFO, COO and Treasurer. Each person would own 250,000 shares of stock and if you say that those shares are worth $1 each you have a $1 million corporation. You can issue more shares later at any time so that others can buy into the company but when you do people will only buy shares based on the “reasonable” value of the company in terms of assets, clients, contracts and market size. Even so, “reasonable value” is whatever you can get people to buy the shares for. If you establish a share price of $1 and offer 50,000 shares that is your prerogative and it is a way to “capitalize” or fund your corporate activities.
File the Articles of Incorporation. The Articles of Incorporation are the legal papers that make you an official corporation and give you authority to do business under that corporate name with your board of directors and subsequent employees. Articles are filed with the Secretary of State and can be filed by you or a lawyer. The cost to filing will range from $35 to $300 depending on the state you file in. The Articles of Incorporation include: your corporate business name and address; why you are doing business and what you plan to do; the name of the registered agent who will collect documents and do business on behalf of the corporation; and the stock breakdown of the corporation. To see what sample Articles of Incorporation look like, click this link for sample incorporation papers for the state of Illinois.
Write your corporate bylaws. The corporate bylaws documents how the corporation will operate and conduct business. The bylaws is an internal document that do not have to be filed with the state but they are extremely important to have and required in case of internal controversy or confusion as well as external audit by the state or potential investor(s). The bylaws usually include: the name and address of the corporation; the number of directors and corporate officers; the number and type of stocks the corporation will issue; the procedures for board meetings and record keeping; and the procedure for amending the Articles of Incorporation or the bylaws. There are many templates that you can use to create the bylaws. This link points to a sample corporate bylaws template.
Decide if you want to be an “S” corporation or a “C” corporation. The two most basic forms of corporation are “C” and “S”. C corporations are the standard corporation, while S corporations have differences in the way that they are taxed which are very important to you as the owner.
C corporations.C corporations are separately taxable entities that pay taxes at the corporate level. When taxes are filed (using Form 1120) the corporation pays all taxes. If corporate income is distributed to business owners through stock dividends then those business owners need to pay taxes on that income. This results in double taxation for the business owner as he pays taxes at the corporate level and at the personal level.
S corporations.S corporations are pass-through entities that pay no taxes at the corporate level. Form 1120S is filed for tax purposes, but it is informational only. The profits and losses of the business are passed through to the business owners and they are reported on business owners’ individual tax returns.
Personal Income Taxes.In both S and C corporations, taxes are paid on any salary drawn from the corporation.
If you want to be and S corporation you must file form 2553 with the IRS. C Corporations also have no limit on the number of shareholders, while S corporations are limited to 100 shareholders who must be US citizens. For this reason, publicly traded companies (companies on the stack market) are primarily C corporations. In general, S corporations are a good place to start, but if you plan for your corporation to grow to be large you should elect to convert, or start as, a C corporation.
Open a bank account. The corporation is a separate entity and must have a separate bank account from any shareholders. Once your Articles are approved you can go to any bank and setup an account under the corporate entity. Make sure you set the appropriate signers of all corporate checks (usually the CEO and the CFO).
Have your first board meeting. Usually board meetings are held at a minimum monthly but should be held at least quarterly. Your first board meeting should document: the formation of the company; the officers; the stock breakdown; the approval of the bylaws; and the issuance of stock certificates. This (and every board meeting) must be documented as formal meeting minutes taken by the board-designated Secretary. Corporate meeting books can be bought at most office supply stores (ex: Staples) or you can keep them electronically.
Issue stock certificates. For public companies, most stock transactions are handled electronically but for private companies stock certificates are very important. Stock certificates documenting the shares of each director can be printed online or purchased from most office supply stores.
That’s it! You’re on your way. Make sure you follow any specific legal requirements for your company (additional permits, or required documents) and go make some money.
If you setup your corporate name but decide later that another name is better to operate under you can set up a DBA (Doing Business As”). The DBA is the name that your customers know you as. For example: Acme Corporation, Inc. DBA “The Cool Company”
You can run your business in one state, but incorporate it in another. The reason for doing this would be to take advantage of tax laws or other laws in that state that favor corporations. For example, Delaware has more lenient tax and corporate laws that favor corporations. Many banks and credit card companies incorporate in Delaware (take a look at the back of your card).
You are completely in control of the number of shares of stock and the value of those shares when you form your corporation. How much you can sell those shares for is what people are willing to pay for them.
There are many templates to help you create the corporate documents you need. A good location to find these templates is Business.gov, but a Google search for “California articles of incorporation template” or “California corporate bylaws template” will work. Remember to enter YOUR STATE in the Google search.
Most people are familiar with trading stocks electronically using eTrade or a personal broker, but stocks are actually pieces of paper. When you form your corporation you will actually need to issue stock certificate to all shareholders.
This article assumes you have done all your pre-planning before incorporating to include the creation of a business plan, market analysis, securing funding, etc. Those topics will be covered in other articles in the Money Survival Guide.
If you don’t think that you can handle the corporation filing by yourself you should hire a lawyer to help you. The process of filing incorporation papers, including basic consultation and advice, should cost between $500 and $1500. If you don’t have that much to spend then you probably are not ready to start a business.
When setting up your board of directors you should try to have an odd number of board members. This way votes on corporate matters will not end up in a tie.
The bigger your board of directors is, the harder it may be to get things done as in-fighting and factions can develop that force you to spend more time on board politics than important business matters.
You do not need to divide 100% of your stock shares between the initial directors of the corporation. In fact it is not advisable to do as you will probably want to sell or grant shares to others (employees or third parties) later.
The filing of your Articles of Incorporation will cost between $35 and $300 depending on the state that you file in.