Introduction
“Should I incorporate my business?” is a popular question many small business owners ask today. Many businesses begin as sole proprietorships, but as they grow and become successful, the idea of incorporating the business becomes a serious discussion. Making your business a legal company depends on many factors. Some of them are:
- How much does your business earn monthly and annually?
- What goals do you have for your business?
- What is your business niche?
- What is your tax situation like?
This article will discuss what incorporation means, the steps to follow when incorporating, the benefits and downsides, when you should incorporate, and when incorporation is not the right thing to do.
Disclaimer: This article is informational only. It is not a legal advice or from a legal entity. You can get legal guidelines on how to incorporate a business from the small business association in your country.
Key Takeaways
- Incorporation means that your small business is a legal entity that is distinct from you, the business owner.
- One of the first steps to take when incorporating is to choose a business name that is memorable and distinctive.
- Corporations and limited liability companies are the two important corporate entities that determine your incorporation process.
What does Incorporating a Business Mean?
When you hear the word “incorporation”, what do you think it means? To incorporate a business means to register it as a limited liability. This means that your small business is a legal entity that is distinct from you, the business owner.
Although incorporation is not mandatory, it is still an important step for your business. Businesses that are at high risk of facing lawsuits or carrying debts, like construction companies, medical firms, and realtors should consider incorporation. Doing this can help the owners protect their personal assets from legal conflicts or lenders’ claims.
Incorporation is also important for firms that are looking for external financings, like angel investments or venture capital. Investors are more likely to approve well-structured businesses.
Before you decide to incorporate, it is vital to discuss it with experts, e.g. your accountant and legal consultant. They will help you make an informed decision.
Steps to Take When Incorporating Your Small Business
Once you’re sure that incorporation is the best choice for your business, it is important to know the steps to take when carrying out this legal action. Here are some important steps to follow:
- Choose a business name
- Choose your business location
- Secure important licenses or zoning permits
- Choose a corporate entity
- Choose an incorporating agent
- File your articles of incorporation
- Write your business bylaws
- Secure other federal and state permits and licenses
Choose a Business Name
The first step in your incorporating process is choosing a business name that is memorable and distinctive of your brand. You can start brainstorming name ideas that align with your firm’s value and target market. Choose a name that is not in use by another business. If possible, use business name generators to come up with the perfect name for your brand. After choosing a name, register it with your location’s business registration office.
Choose Your Business Location
The next thing to do is choose a location for your business. Getting a location is important for your business registration and compliance with your state’s regulations. The process of choosing a location requires researching state laws, obtaining the necessary permits, and verifying if the area is suitable for your business. The location can be a virtual or physical address or a P.O. box. Speak with your legal advisor to make sure that your location legally complies with your state laws.
Secure Important Licenses or Zoning Permits
This involves applying for any important licenses or permits to operate your business in the chosen location. You must comply with the necessary zoning laws of the locality and get permits from the local offices. Securing important licenses and zoning permits helps you to avoid legal problems and ensures that your firm operates ethically and legally in the area.
Choose a Corporate Entity
The next thing to do is to choose a corporate entity. There are two primary corporate structures you can choose from. They are corporations and limited liability companies. Limited liability companies are often chosen by small businesses because of their liability protection which separates personal assets from the business. LLCs also provide flexible management and ownership structures.
Corporations on the other hand are more intricate but come with several benefits for small businesses seeking to have multiple ownership or raise capital. Choosing a corporation requires you to draft bylaws, file articles of incorporation, and obtain the needed permits and licenses.
Choose an Incorporating Agent
This company or individual will help your business receive legal documents and ensure that your firm is compliant with the necessary government regulations. You need to choose a reliable firm or individual for this. Make sure the agent is familiar with your state’s laws and works in the same state as your business.
File Your Articles of Incorporation
This document is especially important when establishing your business as a corporation. It will include important details about your firm such as its name, the location, and the names of your directors. Prepare your articles of incorporation and file them on time. The process involves writing the document based on your state’s requirements, paying the necessary charges, and filing the document to the right state office.
Write Your Business Bylaws
What rules are governing the internal operations of your business? Or what are the roles of your directors, how do you make decisions, and what are the procedures during meetings? Your corporate bylaws will contain this information. You will speak with your lawyer when writing this to ensure that the bylaws are compliant with the laws of your state.
Secure Other Federal and State Permits and Licenses
The last step to take is to secure all important federal and state licenses and permits. This involves getting an employer identification number (EIN) from the IRS, opening a business account, getting important insurance policies, and securing other licenses required for your niche.
To secure these licenses and permits, you will need to research the requirements for your niche, submit the required paperwork, and pay the necessary fees. Make sure you obtain all the necessary licenses and permits to avoid legal implications.
Benefits of Incorporating Your Small Business
What are the pros of making this decision? Let’s look at four benefits:
- Limited Liability
- Fundings and Tax Advantages
- More Opportunities
- Succession Planning
Limited Liability
When you are a sole proprietor, you tend to use your savings to cover debts in your business. There will be no difference between your small business and your savings. By incorporating, you draw a line between both parties. You separate your records and accounts from your business. Incorporation also protects your assets from financial woes.
Funding and Tax Advantages
Getting a loan as an incorporated business is easier than as a sole proprietor. It is also easy for you to sell off some of your business shares for an investment. Tax rates for incorporated small businesses are usually low in comparison to personal taxes. This offers tax advantages like tax deferral or tax savings to your business.
More Opportunities
By adding LLC or Inc. to your business name, you make it look more corporate and professional. This extra symbol will help you stand out from your competitors.
Also, as a sole proprietor, you are the owner, staff, and management of your business. There is no difference between you and your enterprise. By incorporating, you become a separate entity from your firm. You can decide to join forces with a business partner in the future to add more funding to your enterprise.
Another way incorporation helps is by improving your reputation. Some customers only work with an incorporated business. When you take this step, you are likely to bring in more customers and make more sales.
Succession Planning
A corporation is a distinct entity from a business owner. It has equal rights under many countries’ laws as a natural person. This means that a corporation can get loans, acquire assets and enter contracts. So even when the business owner dies, the corporation will continue to exist and can be transferred to the shareholder’s heirs. This is not possible for sole proprietorships.
Downsides of Incorporating Your Small Business
While you have seen the advantages of incorporating your small business, it is also good to weigh the disadvantages of taking this decision too. Here are some of them:
- More Accountability for Business Owners
- More Tax Payments
- Incorporating Costs
- Administrative Burdens
More Accountability for Business Owners
There are several laws you must follow as a shareholder of a corporation. Failure to comply with the rules can cause disqualifications and financial penalties. In the worst-case scenario, you could end up in jail.
More Tax Payments
In some cases, you might end up paying more tax as a corporation than when you were not. This happens because small business tax deductions are not always available to corporations.
Incorporating Costs
It is not cheap to incorporate your business. You’ll have to pay an opening fee, followed by annual or bi-annual fees. This is besides your business licensing fees and other expenses. You will also need to hire a tax specialist and a lawyer to help you with the process. Their fees can be expensive too.
Administrative Burdens
Since the corporation is a distinct entity, you will need to keep it up to date with the right authorities. You will have to create bylaws and keep detailed meeting reports and annual reports consistently. If you hate paperwork, running a corporation might be a burdensome task.
When Should You Incorporate?
The best time to incorporate is when you need to do so. It shouldn’t come as soon as you start your business, but you can always have it in mind. Here are three things that can influence your decision:
- You are making money
- You want to sign a big contract
- You want partners or hire employees
You are Making Money
It is important to wait until your small business is financially stable before incorporating. The entire process is complicated and expensive. If you are not earning enough to manage your sole proprietorship, it is not wise to incorporate yet.
You Want to Sign a Big Contract
If you commit to a contract as a sole proprietor, you become responsible for the contract as an individual, not as a business. The risks and financial expenses will be on you. But as a corporation, your business will be liable not you.
You Want Partners or Hire Employees
When you want partners or wish to hire staff, it is wise to incorporate your company first before making any of these decisions. This way, you wouldn’t be directly responsible for them, but your company will.
When You Shouldn’t Incorporate
When is it not the right time to incorporate it? Here are some to keep in mind:
- You are the business
- You are experiencing losses
You are the Business
Owner-operated businesses will not fully benefit from incorporating. This is because the owner is the business. The owner renders the services to customers. For instance, Ryan has a plumbing business. He has a family and his children are not interested in going into the business. In his case, Ryan can choose not to incorporate.
You are Experiencing Losses
Not all businesses start on a good note. Others take years before they start making profits. If your small business is losing money, it is not a good idea to incorporate it yet. It is expensive to carry out this process and you wouldn’t want to take such a financial risk when experiencing losses.
Conclusion
You don’t need to incorporate your enterprise. It is an option, not a necessity. However, it is important to register your business. No two businesses are alike, so as you grow yours, speak to the right professionals, i.e. your tax specialist and lawyer before deciding whether to incorporate or not.
Frequently Asked Questions about Incorporating Your Small Business
There are a lot of questions you might have about incorporation. Here are some questions and answers you need to know:
Should I Incorporate My Business?
The answer depends on several factors. These are your business goals, your tax situation, your business niche, how much you earn, and your legal liability.
When Should I Incorporate?
You need to weigh the benefits and downsides of this before deciding. Speak to your accountant, tax official, and lawyer about this.
How much will it cost to incorporate a business?
The cost of incorporating your business varies from state to state and from one entity to the other, but typically you might pay from $100 to $10,000 for registration and legal fees.
How long will it take to incorporate your business?
The time it will take to incorporate a business can vary by the type and location of the business, but generally, it takes a few days to several weeks. In some locations, you might be asked to provide an additional processing fee if you want to speed up the process.