What is Incorporation and Why is it Important for Business?
Incorporation is the act of establishing a new business as a separate legal entity. Basically, it is a legal process in order to form a corporate entity or a company. You might be wondering why you would ever want to incorporate a business. Well, an incorporated business has a separate legal identity from its owners or shareholders. It safeguards the owners’ personal assets, as well as provides a business with enhanced credibility and better opportunities to expand. In this article, we will explore the legal concept of incorporation, discuss the benefits and drawbacks of incorporating a business, as well as look at the formation of a corporation.
Incorporation of a company
To begin with, let us consider the term incorporation in more detail. When a business is incorporated, it means that it has been registered with a governing authority as a separate entity. A corporation can be defined as an autonomous legal entity carrying on business with limited liability and perpetual succession. The word corporation generally means an entity, while incorporation is the process of formation of this legal entity.
This means that once a business is incorporated, it is a separate legal entity that owns assets and can sue or be sued in its own name. Being incorporated means an organization can do business under its own name. Additionally, these corporations can be termed as ‘Inc.’ or ‘Limited’ in their names. Thus, the basic concept of incorporation is to limit the liability of shareholders by segregating business assets from their personal assets. This reduces the owners’ liability, especially when a corporation has a large number of shareholders.
What is incorporation?
Incorporation is the process by which a business is transformed into a legal entity. This is done by filing the required documents with the relevant authorities, typically the Articles of Incorporation or Certificate of Incorporation. With the filing of incorporation documents, the business is formally organized and given corporate status. This is done with the help of the state or federal government, and the process must be carried out in accordance with applicable incorporation law.
This mechanism protects owners and investors and provides greater financial security. In essence, limited liability allows the integrity of the business to stand independent of its owners’ private wealth. This means that in the event of a lawsuit, owners would not be held responsible. Therefore, the owner’s personal assets are protected from any potential liability.
The legal background of incorporation
In the United States, corporate law governs corporations’ creation, structure, and operations. The corporate form is the most prevalent business structure in the U.S., and typically certain aspects of corporations are governed by federal law, while state law governs the primary formation, structure, and management of corporations.
Although there are specific rules governing the formation of corporations that vary from state to state, the incorporation process involves filing articles or charters or a certificate of incorporation with the Secretary of State. In order for any changes to be made to the articles and by-laws, it requires a formal amendment procedure. Thus, the framework for how corporations are formed, operated, and managed is established through state law.
Who owns a corporation?
Corporations are separate legal entities that are owned by their shareholders. These shareholders typically elect a board of directors, which then appoints corporate officers to carry out managerial duties on behalf of the corporation, who works towards the goal of increasing shareholder value. The directors are also responsible for maintaining corporate records and overseeing the business’s activities. In most cases, a shareholder is entitled to a portion of company profits.
This is known as profit or share ownership, and it provides an incentive for shareholder investment. In addition to this, a corporation may be owned by a single shareholder or a group of multiple shareholders. However, the shareholders are not liable for the actions and finances of the business, as the liability is held separately by the corporation.
Why should companies incorporate?
As a business grows and expands, it is likely that you will need additional funding to continue operations. As an individual, you will be subject to personal liability for any debts or obligations incurred by your business. However, once your business has been incorporated, limited liability protects your personal assets from any potential lawsuits or debts. Generally, the owners of corporations are not held responsible for the company’s financial obligations.
The clear protection and separation of corporate assets and shareholders’ personal assets reduces the owners’ liability. As such, the incorporation of a company can create a sense of security and trust in regard to your finances.
What are the major benefits of incorporation?
The incorporation of a company can provide several benefits; the following are a few advantages of incorporation:
- Asset protection – The asset protection of a company involves the protection of personal assets from liabilities and lawsuits. As such, incorporation greatly limits the personal liability of a business owner. In other words, your personal assets, such as your cars, house, and other assets, are protected from any potential claims or liabilities that may arise due to your company.
- Protection from IRS audits – The IRS is a federal tax collection agency of the United States responsible for regulating tax collection and enforcing tax laws. When compared with sole proprietorships, corporations have a greater level of protection and are less vulnerable to IRS audits. While in recent years, IRS has audited a higher percentage of sole proprietor tax filings when compared with corporate filings.
- Increase their credibility – The incorporation process increases a business’s credibility and can help form a stronger brand name. As an example, when INC is added to the end of any corporation’s name, it is immediately recognizable as a business enterprise. This recognition can help your new business gain more credibility among consumers and investors.
- Increase investment chance – Incorporation establishes a legal entity that maximizes the potential of obtaining needed funding. As such, a corporation is designed so that its structure enables it to raise money more easily through the sale of securities known as shares.
- Tax benefits – Corporations can enjoy tax advantages, especially with regard to retirement plans, medical insurance paid to employees, real estate investments, and other tax-deferred perks. Thus, the incorporation of a company can allow for greater tax benefits and a reduction in your overall tax liability.
Are there any disadvantages of incorporation?
Well, there are certain disadvantages to the incorporation process. From corporate disclosure, formalities, and expenses to greater social responsibility and the separation of control from ownership are some of the disadvantages that you may experience when choosing to incorporate your business. As a matter of fact, when you incorporate your business, you face significantly more reporting requirements than you would as a sole proprietor.
The additional responsibilities and accountability that come with incorporation often result in a higher level of expenses and fees. However, the benefits of incorporation outweigh the disadvantages, as these are more than offset by the sense of security provided by incorporation. As a result, the incorporation of a business is a decision that should be carefully weighed and considered.
Formation of an incorporation
Now that you know the basic information about incorporation, it is time to learn about the process involved in forming a company. The formation of incorporation is dependent upon state laws and regulations. Although the basic elements of incorporation are the same throughout the country, they may vary slightly from state to state. Thus, it is advisable to consult with a corporate attorney in order to learn about the specific requirements that must be met in your state, as well as other forms and procedures that are necessary to incorporate your business.
How to structure incorporation?
The primary point of the structure of a company is to establish separate legal entities for the business, owners, and managers of the company. Following are the steps involved in setting up a corporation.
- As a first step, you need to choose an appropriate business name for your corporation. The name of your business should be chosen carefully, as it will be a reflection of your business. Therefore, it is crucial that the name is legally available for use.
- The preparation of the Memorandum of Association and Articles of Association should be done in accordance with the laws and regulations that govern your state.
- After the pieces of these documents are completed, they must be printed and signed. In addition, the Articles of Association must be stamped by your corporate after being vetted for the accuracy of the information in accordance with your state’s regulations.
- Then, you will need to obtain a power of attorney that is used to authorize someone else to represent your business. This person is known as an agent and has the authority to access business records, make contracts, handle legal matters, and more.
- Once you have completed all of the steps of the incorporation process, you will need to submit additional documents such as the consent of directors, a notice of registered address, and particulars of directors.
- After you have prepared the documents and completed all of the statutory requirements for your company formation, you will be required to pay certain registration and documentation fees.
- Once you have paid the fees associated with the incorporation of your company, you will be issued a Certificate of Incorporation. Once this is done, your corporation will be officially created.
Legal benefits after incorporating your company
As a result of following the steps that are required to incorporate your company, you will be able to obtain many legal benefits. Here are a few of the most common legal benefits you will receive from incorporating your business.
- Limited liability protection
- Perpetual succession
- Separate property
- Transferable shares
- Capacity to sue
How does reporting work after incorporation?
Post-incorporation, you must ensure that your business documents are updated regularly. The term corporate compliance is a collection of policies and procedures that must be implemented to ensure that the company is in compliance with the laws and regulations. The annual filing process is a significant aspect of corporate compliance and involves meeting certain deadlines.
Generally, the Secretary of State, where your business is incorporated, requires your business to submit important information on an annual basis. Thus, it is advisable to obtain the relevant information and guidelines that are released by your Secretary of State in order to meet your yearly deadlines.
Does incorporation affect the ownership of a business?
When a company is incorporated, it removes the limitation by allowing the owners to transfer their interests without unanimous consent. In addition, the rights of each individual shareholder are protected since they have the same level of protection as that of a corporate entity. Additionally, when it comes to enforcement action and potential liability, shareholders are not exposed to any more risk than that which is associated with a corporation. In this regard, the effect of incorporation on a business’s ownership is considered positive and beneficial.
Need any assistance in incorporating your business?
The key to a successful business is the ability to sustain high levels of profitability and continued growth. In this regard, incorporation gives you a number of advantages. From tax benefits to the creation of legal entities for your business, these advantages make incorporation one of the best ways to build and sustain a successful business. Eqvista provides assistance in the incorporation process, ensuring that your business is legally registered. The team of partners at Eqvista will provide the best advice and guidance on the incorporation of your business. Contact us today.