The process of startup incorporation can seem complicated, if you are doing it for the first time as an entrepreneur. No ifs and or buts about it.
Whether you are still considering starting a business, or have already made a decision to move forward with incorporation - it really helps to know each step in the process to get your new company formed properly.
There are legal, financial, and practical concerns that you need to address at every step of forming a company. That is why it’s essential to take a step back and make sure you are well prepared. The last thing you want is to rush through the process to "get up and running" before your organization is ready.
We have helped hundreds of companies incorporate, and, based on our experience, we’ve put together a battle-tested pre-incorporation checklist.
Here are the 6 things you need to remember about before incorporating your startup:
1. Choose your business entity (LLC vs C Corp)
When starting your own business, you need to ask yourself what type of business entity has the right structure for your business goals. There are essentially four distinct organizational types from which to choose when starting a new business - limited liability company (LLC), C Corporation, sole proprietorship, and a partnership.
Limited Liability Companies (LLCs) are a very flexibleorganizational structure which allows a firm to set up a more direct ownership (but also tax liability) setup for founders and stakeholders. Instead of issuing stock, an LLC may issue a set of membership interests, each with their own set of voting rights.
With all that flexibility, why aren’t most startups formed as LLCs?
Investors strongly prefer C Corporations due to the tax advantages, the biggest one being the Qualified Small Business Stock (QSBS) exemption. LLCs are not qualified for this tax exemption, and LLCs that convert into C Corporations are not eligible either, according to IRS tax laws. Additionally, the legal structure of C Corporations makes it easy for the owners to transfer equity between the shareholders, which makes it the best choice, if you’re planning to sell the business or attract outside investors.
Typically, a startup will authorize 10 million common shares when first incorporating. Preferred stock will be issued in the future when the company will raise its first priced round.
Find more details in our article: C Corporation or LLC: Which is the best entity for your startup?
What about sole proprietorship and partnership?
Sole proprietorship is the easiest type of business to start up or shut down, because of lack of government regulation. These kinds of businesses are very popular among sole proprietors, self-employed people, and consultants. Most small businesses start out as sole proprietorships and either stay that way or grow and change to a limited liability entity or corporation.
Partnerships are agreements between two or more people to run a business together and share its profits and losses. Professionals like doctors or lawyers frequently choose limited liability partnerships.
2. Choose the state of your startup incorporation
Once you've determined that incorporation is the best option for your business, you must choose where to incorporate it. The majority of startup entrepreneurs choose to form their businesses in Delaware. Why?
Most corporate attorneys know Delaware law well, making it easier and cheaper to get legal advice since the law firms will have contract templates on hand that work for Delaware companies.
When calculated correctly, the Delaware Franchise Tax is among the lowest in the United States. All corporations registered in Delaware pay their annual franchise tax when submitting an annual report, both of which are due on March 1 every year. Your registered agent will notify you of these filing deadlines.
Delaware provides significant legal and financial advantages to businesses, including a distinct corporate court system that rapidly resolves legal issues.
Read more about Why Most Startups Incorporate In Delaware?
3. Pick a business name and check its availability
Choosing the right corporate name for your startup may be far on your list of priorities, after all, it’s just a name, right? Well, there’s a little more to it. The more your brand identity says the less time you have to spend describing it. Thus saving time and money in marketing down the line.
So how do you know you’ve chosen the right business name?
- It’s easy to pronounce
- It’s easy to spell
- It’s easy to remember
- You can find it online
- It conveys the meaning of what your product does
Once you’ve picked out a name, you should check whether you can register a company with that name. The Secretary of State will reject your incorporation filing if you try to register a new business with a name that is the same or similar to an existing company registered in that state.
Want a more detailed analysis of naming your startup the right way? Check out our article on the topic.
4. Determine the equity split among co-founders
If there is more than one business owner at the outset of the company, you’re going to have to decide how you split the equity between each other. For the sake of clarity on roles and ownership distribution in the company, it's best to have that conversation before you incorporate. After all, founder disputes constitute 65% of startup failures.
In addition to figuring out what percentage each of the founders would own, you should also agree on a vesting schedule for your shares. Learn more about how vesting schedules work for startup founders.
Don’t know the first thing about how equity works and how to divide it between you and other co-founders? Well, good thing we’ve developed a startup equity calculator that can make it much easier for you.
If you want to find out more about the ins and outs of equity distribution read our article on How to Split Equity Between Co-founders.
5. Pick the members of the board of directors
Every corporation has a board of directors, and the number of directors is set in the bylaws of the business. Typically at an early-stage startup, the only board members are founders and possibly an investor board member. When forming a new company, the founders will sign intellectual property assignment agreements and indemnification agreements when joining the company board.
Your new business must have at least one director if it is incorporated in Delaware. California rules differ from Delaware rules in that a California corporation may have only one director before any shares are issued; once shares are issued, a California corporation may have a number of directors equal to the number of shareholders; but once there are three or more shareholders, there must be at least three directors.
When you incorporate on Capbase and form a Delaware corporation, the first step is to name your board of directors. Be cautious since the board of directors hires and fires the CEO of the firm. As businesses develop, one of the most pressing challenges for founders is board control.
6. Choose officers of the corporation
A corporation must have the following officer positions:
- President and/or Chief Executive Officer
- Treasurer and/or Chief Financial Officer
A single individual may hold all three jobs. Although Delaware does not need a Treasurer or Chief Financial Officer, it’s common practice to designate one because a Treasurer must be identified on certain California filings.
Filing Articles of Incorporation
After completing all the steps from the abovementioned list, you should be ready to file your articles of incorporation.
What are articles of incorporation?
Articles of incorporation are often confused with bylaws, which are the rules and regulations that govern a corporation and help set the roles and responsibilities of the company's directors and officers. Together, the articles of incorporation and the bylaws make up the legal backbone of the business.
Here’s what that process of filing articles of incorporation looks like:
- Articles of incorporation must be filed in order for a new or existing business to be set up as a professional corporation, a nonprofit corporation, or another type.
- Each state has different rules about what paperwork is needed and how to file articles of incorporation.
- Officials at the state level look over applications for articles of incorporation. If the person filing follows the rules and pays the right fees, officials will let the company know when the certificate of incorporation is ready and their company is legalized.
Capbase is a commercial licensed registered agent in Delaware and makes it easy to incorporate a Delaware corporation. It only takes two business days to incorporate. Get started here.
When can I get my federal employer identification number (EIN) and open a business bank account?
After you incorporate, your startup will need to get an EIN from the IRS, which is a prerequisite to setting up a corporate bank account and getting ready to do business.
What’s more, an employer identification number is needed to hire employees and file your annual corporate income tax returns.
In most cases, the company's bylaws give the company directors permission to get an EIN and set up a bank account for the newly formed corporation.
Find out more details about getting an EIN for your startup.
Whether you’re just a small business owner, or you’re looking to launch a venture capital-backed startup, it’s essential to know the exact steps you need to take in order to successfully form your new company.
Doing business after incorporating as an inadequate business entity, can save or cost you millions in taxes.
So should you hire a law firm to deal with all of that? Not necessarily.
We built Capbase to simplify the process of incorporating a startup, issuing equity, and keeping your company compliant with IRS and both state and federal laws. Learn more about how you can use Capbase to get your startup off the ground and focus on developing a product instead of worrying about the legal and financial aspects of starting a company.