Business incorporation 101: What you need to know to get started

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  1. Introduction
  2. When is the right time to incorporate a business?
    1. Personal liability
    2. Financial position
    3. Tax planning
  3. Types of business structures
    1. Types of corporations
    2. Other business structures
  4. How to form a corporation
  5. Pros and cons of incorporating
    1. Pros
    2. Cons
  6. How to choose the right business structure

Incorporating a business is the process of legally establishing an organization as a separate entity distinct from its owners, shareholders, directors, and officers. Businesses of every size can incorporate and there are designations specifically for smaller businesses.

This guide will cover what you should know about the business incorporation process: when to incorporate, how to incorporate, types of corporate structures, and how to choose the best structure for your business.

What’s in this article?

  • When is the right time to incorporate a business?
  • Types of business structures
  • How to form a corporation
  • Pros and cons of incorporating
  • How to choose the right business structure

When is the right time to incorporate a business?

The sooner a business incorporates, the sooner it can benefit from liability protection, tax advantages, and increased credibility. If you plan to expand your business, incorporating early can lay a solid foundation for future success. Incorporating can enhance your business’s image and credibility, making it easier to attract customers, partners, and employees. The following factors can also impact when to incorporate.

Personal liability

If your business activities carry major risks or liabilities, incorporating early can protect your personal assets from business debts and lawsuits. Incorporating before you sign contracts or hire employees can shield your personal finances from potential legal claims that arise from business agreements or employee actions.

Financial position

Incorporating early allows you to take advantage of tax benefits and can make your business more attractive to investors and lenders, because it demonstrates a higher level of professionalism and structure. The ability to raise capital through share issuance becomes invaluable if you expect to expand quickly.

Tax planning

Depending on your location and business structure, incorporation can come with tax advantages such as deductions for business expenses and potentially lower tax rates compared to individual income taxes. Talk to a tax advisor to determine the optimal time for incorporation based on your specific financial situation and goals.

Types of business structures

Each type of business structure serves different needs, and choosing the right structure depends on factors such as tax considerations, number of shareholders, and your desired level of liability protection.

Types of corporations

  • C corporation (C corp): This is the most common form of corporation. It provides liability protection to business owners and can have an unlimited number of shareholders. Shareholders are subject to double taxation: profits are taxed at the corporate level and again at the individual level when dividends are distributed to shareholders. C corps have the option of raising capital through stock sales.

  • S corporation (S corp): Designed for smaller businesses that meet specific criteria, S corps are subject to pass-through taxation, in which profits (and some losses) are passed directly to owners’ personal income without being subject to corporate tax rates, rather than double taxation. S corps have restrictions on the number and type of shareholders they can have, and they provide liability protection to business owners.

  • Nonprofit corporation: Nonprofit corporations carry out charitable, educational, religious, or scientific work. Nonprofits can receive tax-exempt status, meaning they are not subject to income tax on money they earn related to their nonprofit mission. They must reinvest any profits back into the organization’s objectives and cannot distribute dividends to members.

  • Professional corporation (PC): This type of corporation is often used by professionals such as doctors, lawyers, and accountants. It provides the same liability protection as a C corp but is meant for companies that offer professional services from licensed practitioners. Professional corporations mimic C corps in that they do not benefit from pass-through taxation.

  • Benefit corporation: This type of legal structure is for entities that generate profit while creating a positive impact on society and the environment. Unlike traditional corporations, benefit corporations must consider the effects of their decisions on all stakeholders, not just shareholders, but they do provide personal liability protection. Benefit corporations can elect S corp tax status if they meet the requirements.

  • Close corporation: A close corporation is similar to an S corp and provides similar liability protection but usually operates under less formal management and fewer administrative burdens. Often, shareholder agreements replace many of the formal governance structures (such as a board of directors) seen in larger corporations. Close corporations can elect S corp status and be taxed as an S corp.

Other business structures

  • Limited liability company (LLC): An LLC blends elements of partnership and corporate structures. LLCs provide liability protection but are not subject to double taxation. They are flexible in terms of management and do not require as many formalities as corporations (e.g., board meetings).

  • Sole proprietorship: Sole proprietorships are the simplest and most common structure, but they don’t come with liability protection. While they are not subject to double taxation, they are subject to self-employment taxes.

  • Partnership (general or limited): General or limited partnerships involve two or more owners sharing profits and losses. Limited partnerships offer limited liability for partners, while general partnerships can involve unlimited personal liability. Partnerships are subject to pass-through taxation.

How to form a corporation

The specific requirements and procedures to form a corporation can vary by location, so consult with an attorney or business advisor to ensure compliance with local regulations. The key steps required to form a corporation include:

  • Choose a business name: Select a unique name that complies with local naming rules. Ensure the name is not already in use, and consider conducting a trademark search to avoid potential legal conflicts.

  • Appoint a registered agent: Designate a person or business entity to receive legal documents and official correspondence on behalf of the corporation. The registered agent must have a physical address where the corporation is formed.

  • File articles of incorporation: Prepare and file articles of incorporation (sometimes called a certificate of incorporation). This document typically includes your corporation’s name, address, stated purpose, number of authorized shares of stock, and the name and address of your registered agent and incorporators.

  • Create corporate bylaws: Draft corporate bylaws for governing the corporation. Bylaws are internal rules and procedures for shareholder meetings, director elections, officer duties, stock issuance, and amendment procedures.

  • Appoint directors and officers: Elect a board of directors to oversee the corporation’s management and appoint officers (e.g., CEO, CFO, secretary) to handle day-to-day operations.

  • Obtain an employer identification number: Apply for an employer identification number (e.g., an EIN in the US). This is used for tax purposes and to open a corporate bank account.

  • Hold initial board meeting: Conduct an initial meeting of the board of directors to adopt bylaws, issue stock to shareholders, elect officers, and approve any necessary contracts or transactions.

  • Obtain necessary licenses and permits: Depending on your industry and location, you might need to obtain specific business licenses and permits to operate legally.

Once your business is incorporated, you’ll need to comply with ongoing requirements such as filing corporate tax returns, annual report filings, and maintaining proper corporate records.

Pros and cons of incorporating

Weigh the pros and cons of incorporating by looking at your business’s specific needs, goals, and circumstances. For many businesses, the benefits of liability protection and access to capital outweigh the drawbacks of increased complexity and regulation, but for others, simpler structures such as sole proprietorships or partnerships are more appropriate.

Pros

  • Limited liability: One of the primary benefits of incorporation is the protection it offers shareholders and their personal assets. Shareholders are typically only liable up to the amount they invested in the corporation, and further personal assets are protected from business debts and legal judgments.

  • Perpetual existence: Corporations continue to exist independently of their founders. If an owner sells their shares, retires, or dies, the corporation can continue operating without disruption.

  • Credibility: When potential customers, suppliers, and partners see “Inc.” or “Corp.” in your business name, it can boost your credibility by signaling a serious, committed business operation.

  • Access to capital: Corporations can raise funds through the sale of stock. This ability to issue shares can make it easier to attract investment compared to other business structures that do not have this option.

  • Tax flexibility: Corporations benefit from corporate tax treatment and potential tax deductions that are not available to sole proprietors or partnerships. For instance, a corporation’s health insurance premiums can be fully tax-deductible.

  • Stock options: Corporations can offer stock options or stock as part of compensation packages, which can be an effective way to attract and retain talented employees.

Cons

  • Cost: Incorporating a business involves initial formation costs and potentially higher ongoing expenses such as annual filing fees, franchise taxes, and costs related to compliance and maintaining corporate formalities.

  • Double taxation: C corps are subject to double taxation, which can reduce the overall amount of money shareholders receive from profits.

  • Administrative burden: Corporations are required to comply with more regulations and governmental oversight than other business forms. This includes maintaining detailed records, holding regular meetings, and filing annual reports.

  • Rigid management structure: Corporations have a fixed management structure that includes shareholders, directors, and officers. This structure can be cumbersome and less flexible than that of other business forms such as LLCs.

  • Potential for conflicts: As corporations grow and add shareholders, conflicts can arise among shareholders or between shareholders and management. These conflicts might concern the direction of the business, distribution of profits, or other key management issues.

  • Limited control: Issuing shares to raise capital dilutes ownership percentage. This can lead to a loss of control over business decisions if investors own a substantial portion of the company.

How to choose the right business structure

Your business structure impacts every aspect of your business—legal, financial, and operational—and choosing the right structure requires careful consideration of your needs, goals, and long-term vision. Consult with an attorney, accountant, or business advisor to better understand your specific situation and the legal and financial implications of each structure. These advisors can guide you toward the most suitable choice, but keep in mind that you can change your structure later if your business needs evolve.

Consider the following factors when determining the best business structure for your needs.

  • Liability protection: Limited liability structures such as corporations and LLCs protect your personal assets from business debts and liabilities.

  • Tax implications: Different structures have varying tax treatments. S corps and LLCs are subject to pass-through taxation, while C corps are subject to corporate taxation.

  • Management and control: Sole proprietorships offer complete control, while corporations have more complicated management structures.

  • Fundraising: C corps can provide more opportunities to raise capital from investors.

  • Administrative overhead: Some structures require more administrative work than others. Choose a structure that corresponds with your comfort level and administrative resources.

  • Flexibility: Consider the flexibility you need for future changes such as adding partners or converting to a different structure.

The content in this article is for general information and education purposes only and should not be construed as legal or tax advice. Stripe does not warrant or guarantee the accuracy, completeness, adequacy, or currency of the information in the article. You should seek the advice of a competent attorney or accountant licensed to practice in your jurisdiction for advice on your particular situation.

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