Incorporating a startup in the US means setting up a business as its own legal entity, separate from its owners. This process often involves filing documents with the US government – usually the secretary of state's office in the business's state – and paying a fee. Once the startup has been incorporated, it's subject to specific US laws and regulations but gains certain advantages, such as limited liability and easier access to capital. Incorporating a startup can make it easier to manage taxes, ownership and liability.

Below, we'll look at the key steps involved in incorporating a startup in the US. These include the benefits of incorporation, what challenges a business can expect and the processes involved. Here's what businesses need to know.

What's in this article?

• Benefits of incorporating a startup
  
• Challenges of incorporating a startup
  
• How to incorporate a startup
  

Benefits of incorporating a startup

Although incorporating a startup in the US isn't the simplest process, it does offer substantial benefits. Here are the main reasons why incorporating a startup in the US can be a smart move:

• Limited liability: One of the major advantages of incorporation is the separation of personal and business assets. If the business incurs debts or faces legal issues, personal assets, such as homes and savings, are typically protected. This consideration is particularly important for startups because around 80% of US startups don't survive past the first year.

• Access to capital: Incorporation can make it easier for your business to raise money. Investors are more likely to put money into a corporation than an individual. Likewise, financial institutions may find it less risky to lend money to an incorporated entity.

• Easier transfer of ownership: It is easier for incorporated businesses to change ownership or add co-owners because the business structure allows for the issuance of shares, which offers a streamlined and flexible way to transfer ownership stakes, raise capital by selling shares to investors and reward employees through stock-based compensation.

• Tax benefits: In the US, incorporation may allow for business income to be treated more favourably from a tax perspective. Businesses may also be able to write off a greater number of expenses as deductions.

• Credibility: Using "Inc." or "LLC" in a business name – something that only corporations can do – can lend an air of legitimacy. This may help in gaining the trust of potential customers and partners.

• Longevity: A corporation continues to exist even if the owner leaves or dies, which makes it easier for the business to survive.

• Formal structure: A corporation has a set organisational structure, which often includes a board of directors. This can simplify decision-making and governance.

• Ownership versatility: Corporations can have multiple classes of stock, which allows for different types of ownership with varying levels of control.

• Employee benefits: It's easier for incorporated businesses to set up retirement funds, stock options and other perks for employees. These measures can attract higher-quality talent.

• Strategic growth: Incorporation can open doors for partnerships and joint ventures that may be out of reach for sole proprietorships or partnerships.

Challenges of incorporating a startup

Although most businesses find it relatively straightforward to incorporate and solidify their existence as a legal entity in the US, incorporating can come with challenges. As with most business-related obstacles, the best first step is knowing what to expect. Here are some common roadblocks:

• Initial costs: Incorporating a startup in the US requires the payment of filing fees. Businesses will also potentially need to seek out legal consultation, which can be a financial burden for a new business.

• Paperwork: Incorporating involves a significant amount of paperwork and administrative duties, including filing the initial articles of incorporation and dealing with ongoing compliance reports.

• Tax complexity: Although incorporating in the US has many tax benefits, the process also introduces more complicated tax filing requirements. This often requires hiring an accountant, which adds to operating costs.

• Regulation: Corporations are subject to a variety of local, state and federal regulations in the US. Compliance can be time-consuming and, if mishandled, can lead to fines or legal trouble.

• Ownership dilution: Raising capital often involves issuing shares, which can dilute the ownership stake of the original owners. This can lead to less control over the business in the long term.

• Decision-making: In contrast to the agility of unincorporated businesses, a corporation's decision-making process can become complicated and slow because of its board of directors and other stakeholders.

• Double taxation: In certain types of US corporations, profits may be taxed at both the corporate level and when profits are distributed to shareholders. This can lead to double taxation.

• Public scrutiny: Depending on the type of incorporation, a business may need to disclose financial and other sensitive information. These disclosures subject the business to increased public scrutiny.

• Employee burden: Providing employee benefits, such as retirement plans and stock options, can be a complex undertaking that requires additional administrative efforts.

• Exit strategy: If a decision is made to sell or leave the business, the formal structure and obligations of a corporation can make this process more complicated than it would be for a sole proprietorship or partnership.

How to incorporate a startup

Incorporating a startup is a major milestone for any business in the US – it has a substantial impact on how the business operates, raises funds and grows. Here's a quick guide to the process:

Types of corporate structures

One of the first decisions that will need to be made is choosing the type of corporate structure that best suits the startup's needs. In the US, startups can choose from several types of corporate structures, each with their own pros and cons. Below are the most common types:

• Sole proprietorship: This is the simplest business structure. It's a one-person show in which the business and the owner are the same entity for both tax and liability purposes. It's easy to set up but doesn't provide personal-liability protection.

• Partnership: A partnership involves two or more people who agree to share in the profits and losses of a business. Different forms of this arrangement include general partnerships and limited partnerships. General partnerships divide control and profits among all members, while limited partnerships allow for members to have a smaller role, limiting their liability but also their control over the business.

• Limited liability company (LLC): This structure, as with a corporation, provides some protection against personal liability, but allows for more flexibility regarding taxes. It's a popular choice thanks to its adaptability and more flexible governance requirements.

• Corporation: This is a more complex structure that involves issuing stock, creating a board of directors and adhering to a range of regulations. Two of the major types of corporations are C corporations and S corporations.

  • C corporation: This is the standard corporation. It provides the most liability protection but is subject to double taxation.
    
  • S corporation: Similar to a C corporation, an S corporation allows profits and losses to pass through to shareholders for tax purposes, thus avoiding double taxation.
    

• Non-profit corporation: If a business is centred around social, educational or charitable work, a non-profit structure could be a viable option. It allows the business to acquire tax-exempt status, but also requires profits to be reinvested into the organisation's mission rather than distributed to shareholders.

Each of these structures has its own set of legal requirements, benefits and drawbacks. The right choice for a particular startup depends on various factors, including the startup's goals, the number of owners and its financial situation.

How to incorporate a startup, step by step

Incorporation involves steps that help to establish startups as a separate legal entity. Below is a step-by-step guide to incorporating your startup.

• Researching and deciding on the best type of business structure: Based on the business needs, goals and financial considerations, a business will need to decide what structure – such as a sole proprietorship, partnership, LLC or corporation – works best for them.

• Choosing a business name: Businesses need to make sure that the name they choose is available in the US state in question and does not infringe on another business. Businesses may also want to check for domain availability if they plan to have a website.

• Registering the name and trademark: Once a name has been chosen, the business should register it with the necessary US governmental bodies. They may also want to file for a trademark to protect the name.

• Appointing a registered agent: A business's registered agent will be responsible for receiving legal documents on behalf of the corporation.

• Drafting and filing articles of incorporation: These are the official documents that establish the business as a corporation in the selected US state. They must be filed with the secretary of state's office or another appropriate state agency.

• Getting an employer identification number (EIN): In the US, an EIN is the businesses equivalent of a Social Security number. Businesses will need one for tax-filing purposes and to open a business bank account.

• Opening a business bank account: Personal finances should be separated from business operations by opening a bank account to be used solely for business transactions.

• Creating corporate bylaws: These are internal rules that manage the operation of a corporation. Although not all corporations are legally required to have bylaws, they are highly recommended for clarity and structure.

• Issuing stock and establishing ownership: Corporations will need to issue shares to signify ownership. They should maintain accurate records of this.

• Holding an initial meeting of the board of directors: In this meeting, the business will appoint officers, approve bylaws (if applicable) and set the fiscal year, among other tasks.

• Registering for state and local taxes: Incorporated businesses must ensure that they register for any state and local taxes that apply to them, such as sales tax and employee withholding tax.

• Getting necessary permits and licences: Businesses should research what federal, state and local permits and licences they need to operate, and obtain them before doing business.

• Setting up accounting and record-keeping systems: Accurate bookkeeping is key. Businesses can hire an accountant or use software to keep track of income, costs and taxes.

• Filing regular reports and taxes: Depending on the business structure and location, businesses may be required to file quarterly or annual reports and tax returns.

• Maintaining corporate compliance: To stay in good legal standing, businesses must keep accurate records, hold annual meetings and make sure that they meet all deadlines for filings and fees.

Best practices for incorporating a startup

Incorporating a startup in the US involves more than just following legal protocols. Businesses should consider the following best practices for extracting maximum value and managing scalability and risk.

• Time it right: Timing can have a huge impact on a business's tax obligations and liabilities. If possible, businesses should incorporate at the end of a calendar year to avoid unnecessary complications.

• Consult seasoned advisers: Even with the most careful planning and diligent research, problems can arise. Working with legal and financial advisers who specialise in startups can help businesses to avoid costly mistakes.

• Use vesting schedules: Businesses should establish a stock option plan that uses vesting to incentivise long-term commitment from their team.

• Choose the right state: Incorporating in a US state such as Delaware can provide advantages in terms of investor familiarity, legal precedent and flexibility. These can apply even if the business doesn't operate there. More than 66% of Fortune 500 companies are incorporated in Delaware, according to the state's Division of Corporations. However, this can involve extra fees and paperwork.

• Pre-emptively manage conflicts: By drafting a founders' agreement, businesses can outline what happens in the event of disagreements or if a founder leaves. This can minimise risk and avoid messy legal battles at a later stage.

• Optimise for tax benefits: Different corporate structures have different tax implications. For instance, S corporations allow income to flow directly to individual tax returns, potentially lowering tax burdens. However, they come with restrictions on the number of shareholders and the types of stock that can be issued.

• Execute comprehensive due diligence: Before incorporating, businesses need to conduct thorough research into their market, liabilities, intellectual property rights and other elements that may affect their business. This will give them the knowledge to choose the best corporate structure and strategies.

• Document everything: Businesses need to keep meticulous records of everything from employee contracts to board minutes. This makes due diligence easier for potential investors and is often a legal requirement.

• Establish strong internal controls: The more structured and controlled a businesses' internal processes are, the easier it will be for them to manage growth and satisfy legal requirements. This is especially true when it comes to financial practices.

• Be mindful of compliance deadlines: Missing a filing deadline can result in penalties and, in extreme cases, the dissolution of a business. Businesses should use reminders and consider employing compliance software.

• Secure intellectual property rights early: Businesses should file for patents, copyrights or trademarks as soon as possible to protect their assets. This can also make their business more attractive to potential investors.

• Plan for data protection: Businesses should implement comprehensive data security measures from the very beginning. This protects both the business and its customers and can be a selling point for potential investors.

• Vet potential investors thoroughly: Understanding the background and intentions of the business's investors can prevent conflicts and keep the business moving towards shared goals, especially if they are giving equity in return for funding.

• Establish an advisory board: An advisory board is made up of industry veterans who can provide expert advice without committing to the day-to-day involvement of a director. They can also be influential in networking and opening doors for a startup.

• Have an exit strategy in mind: Even at this early stage, businesses should think about how they may eventually sell the business, go public or transition ownership. This foresight can help with making wise decisions from the beginning.

Following these best practices regarding incorporation will help businesses ensure that their operations are legally sound and that they are well-positioned for challenges and opportunities.