How to incorporate a startup

Introduction
Benefits of incorporating your startup
Challenges of incorporating your startup
How to incorporate your startup
Get started with Stripe

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

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

What’s in this article?

Benefits of incorporating your startup
Challenges of incorporating your startup
How to incorporate your startup

Benefits of incorporating your startup

Though incorporating a startup isn’t the simplest process, it offers substantial benefits. Here are the main reasons why incorporating your startup can be smart:

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 your home and savings, are typically protected. This consideration is particularly important for startups because about 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: Incorporated businesses have an easier time changing ownership or adding 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: Incorporation may allow for more favorable tax treatment of business income. Businesses may also be able to write off a greater number of expenses as deductions.
Credibility: Using Inc. or LLC in your business name—something only corporations can do—can lend an air of legitimacy to your business. 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 organizational 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 your startup

Though most businesses find it relatively straightforward to incorporate and solidify their existence as a legal entity, 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 requires filing fees and, potentially, seeking legal consultation, which can be a financial burden for a new business.
Paperwork: Incorporating involves significant paperwork and administrative duties, including filing the initial articles of incorporation and dealing with ongoing compliance reports.
Tax complexity: Though incorporating 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. 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: A corporation’s decision-making process can become complicated and slow because of its board of directors and other stakeholders—in contrast to the agility of unincorporated businesses.
Double taxation: In certain types of corporations, profits may be taxed at the corporate level and again 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 financials 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 you decide to sell the business or leave, 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 your startup

Incorporating a startup is a major milestone for any business—it has a substantial impact on how you operate, raise funds, and grow. Here’s a quick guide to the process:

Types of corporate structures

One of the first decisions you’ll have to make is choosing the type of corporate structure that best suits your startup’s needs. In the US, startups can choose from several types of corporate structures, each with pros and cons. Below are the most common types:

Sole proprietorship: This business structure is the simplest. It’s a one-person show in which the business and owner are the same entity for 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, like a corporation, provides some protection from personal liability but allows for more flexibility regarding taxes. It’s a popular choice for 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 host 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.
Nonprofit corporation: If your business is centered around social, educational, or charitable work, a nonprofit structure could be a viable option. It allows you to acquire tax-exempt status but requires that profits be reinvested into the organization’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 your startup depends on different factors, including the startup’s goals, number of owners, and financial situation.