Incorporating Your Business
The Following Information was
Provided by the Office of the
General Counsel
- U.S. Small Business Administration
Summary
If you are the owner-manager of a small
business you may have been wondering about the advisability
of incorporating your business, particularly if you are seeking
equity capital.
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This Management Aid does not discuss the
advantages and disadvantages of the corporate form; its purpose
is to acquaint you with some of the basic steps involved once
you have decided to incorporate.
This Aid is not to be considered a substitute
for professional advice. Legal guidance will insure that (a)
the articles of incorporation and the bylaws are tailored
to the needs of your particular business enterprise, (b) you
understand the various aspects of the tax obligations involved,
and (c) you will be in compliance with the State, local, and
Federal laws affecting the corporation.
Laws governing the procedure for obtaining
a corporate charter vary among States. Detailed information
about the requirements of your State can be obtained from
the secretary or other official designated to supervise the
granting of corporate charters.
Choosing the Location
The majority of small and medium-sized businesses,
especially those whose trade is local in nature, find it advisable
to obtain their charter from the State in which the greatest
part of their business is conducted.
Out-of-State, or "foreign," incorporation
often results in the additional payments of taxes and fees
in another jurisdiction. Moreover, under the laws of many
States the property of a foreign corporation is subject to
less favorable treatment, especially in the area of attachment
of corporate assets. This legal difference could prove especially
hazardous to a small business.
On the other hand, you should look into
possible benefits to be gained from incorporation in another
State. Such factors as State taxes, restrictions on corporate
powers and lines of business in which a company may engage,
capital requirements, restrictions upon foreign corporations
in your State, and so forth should be taken into consideration
in selecting the State of incorporation. For example, you
should be aware that some States require a foreign corporation
to obtain a certificate to do business in their State. Without
such certification the corporation may be deprived of the
right to sue in those States.
The fee or organization tax charged for
incorporation varies greatly from state to state.
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Certificate Of Incorporation
Generally, the first step in the required
procedure is preparation, by the incorporators, of a "certificate
of incorporation." Most States used to require that the
certificate be prepared by three or more legally qualified
persons, but the modern trend is to require only one incorporator.
An incorporator may, but not necessarily must, be an individual
who will ultimately own stock in the corporation.
For purposes of expediting the filing of
articles, "dummy" incorporators are often employed.
These dummy incorporators are usually associated with a company
that performs this service or with an attorney for the organizers.
They typically elect their successors and resign at the meeting
of the incorporators.
Many States have a standard certificate
of incorporation form which may be used by small businesses.
Copies of this form may be obtained from the designated State
official who grants charters and, in some States, from local
stationers as well. The following information is usually required:
1. The corporate name of the company. Legal
requirements generally are (a) that the name chosen must not
be so similar to the name of any other corporation authorized
to do business in the State as to lead to confusion and (b)
that the name chosen must not be deceptive so as to mislead
the public. In order to be sure that the name you select is
suitable, check out the availability of the name through the
designated State official in each State in which you intend
to do business before drawing up a certificate of incorporation.
This check can be made through a service company. In some
States, there is a procedure for reserving a name.
2. Purposes for which corporation is formed.
Several States permit very broad language, such as "the
purpose of the corporation is to engage in any lawful act
or activity for which corporations may be organized."
However, most States require more specific language in setting
forth the purposes of the corporation. Even where State law
does not require it, the better practice is to employ a "specific
object" clause which spells out in broad descriptive
terms the projected business enterprise. At the same time
taking care to allow for the possibility of territorial, market,
or product expansion. In other words, the language should
be broad enough to allow for expansion and yet specific enough
to convey a clear idea of the projected enterprise.
The use of a specific object clause, even
where not required by State law, is advisable for several
reasons. It will convey to financial institutions a clearer
picture of the corporate enterprise and will prevent problems
in qualifying the corporation to do business in other jurisdictions.
Reference books or certificates of existing corporations can
provide examples of such clauses.
3. Length of time for which the corporation
is being formed. This may be a period of years or may be perpetual.
4. Names and addresses of incorporators.
In certain States one or more of the incorporators is required
to be a resident of the State within which the corporation
is being organized.
5. Location of the registered office of
the corporation in the State of incorporation. If you decide
to obtain your charter from another State, you will be required
to have an office there. However, instead of establishing
an office, you may appoint an agent in that State to act for
you. The agent will be required only to represent the corporation,
to maintain a duplicate list of stockholders, and to receive
or reply to suits brought against the corporation in the State
of incorporation.
6. Maximum amount and type of capital stock
which the corporation wishes authorization to issue. The proposed
capital structure of the corporation should be set forth,
including the number and classification of shares and the
rights, preferences, and limitations of each class of shares.
7. Capital required at time of incorporation.
Some States require that a specified percentage of the par
value of the capital stock be paid in cash and banked to the
credit of the corporation before the certificate of incorporation
is submitted to the designated State official for approval.
8. Provisions for preemptive rights, if
any, to be granted to the stockholders and restrictions, if
any, on the transfer of shares.
9. Provisions for regulation of the internal
affairs of the corporation.
10. Names and addresses of persons who will
serve as directors until the first meeting of stockholders
or until their successors are elected and quality.
11. The right to amend, alter, or repeal
any provisions contained in the certificate of incorporation.
This right is generally statutory, reserved to a majority
or two-thirds of the stockholders. Still, it is customary
to make it clear in the certificate.
If the designated State official determines
that the name of the proposed corporation is satisfactory,
that the certificate contains the necessary information and
has been properly executed, and that there is nothing in the
certificate or the corporation's proposed activities that
violate State law or public policy, the charter will be issued.
Officers and Stockholders
Next, the stockholders must meet to complete
the incorporation process. This meeting is extremely important.
It is usually conducted by an attorney or someone familiar
with corporate organizational procedure.
In the meeting the corporate bylaws are
adopted and a board of directors is elected. This board of
directors in turn will elect the officers who actually will
have charge of the operations of the corporation--for example,
the president, secretary, and treasurer. In small corporations,
members of the board of directors frequently are elected as
officers of the corporation.
Bylaws
The bylaws of the corporation may repeat
some of the provisions of the charter and State statute but
usually cover such items as the follows:
1. Location of the principal office and
other offices of the corporation.
2. Time, place, and required notice of annual
and special meetings of stockholders. Also the necessary quorum
and voting privileges of the stockholders.
3. Number of directors, their compensation,
their term of office, the method of electing them, and the
method of creating or filling vacancies in the board of directors.
4. Time and place of the regular and special
director's meetings, as well as the notice and quorum requirements.
5. Method of selecting officers, their titles,
duties, terms of office, and salaries.
6. Issuance and form of stock certificates,
their transfers and their control in the company books.
7. Dividends, when and by whom they may
be declared.
8. The fiscal year, the corporate seal,
the authority to sign checks, and the preparation of annual
statement.
9. Procedure for amending the bylaws.
Special Tax Laws
At the time of the first meeting of the
corporate board of directors and prior to issuance of any
shares, you might consider adoption of a plan under a section
of the Internal Revenue Code (IRC 1244) that grants ordinary
rather than capital treatment of losses on certain "small
business stock." Among the requirements of qualification
as "section 1224 stock" are: (1) the stock must
be common stock, (2) the stock must be issued by the corporation
for money or other property pursuant to a written plan containing
several limitations, and (3) the amount of contribution received
for the stock and equity capital of the corporation must not
exceed maximum dollar limits.
You should be aware, also, of the possibility
of electing subchapter S status (IRS 1371-1379). The purpose
of subchapter S is to permit a "small business corporation"
to elect to have its income taxed to the shareholders
as if the corporation were a partnership. One objective is
to overcome the double-tax feature of the present system of
taxation of corporate income. Another purpose is to permit
the shareholders to have the benefit of offsetting business
losses by the corporation against the income of the shareholders.
Among the qualifying requirements for electing
and maintaining "subchapter S" eligibility are that
the corporation has no more than 35 shareholders, all of whom
are individuals or estates; that there be no nonresident alien
shareholders; that there be only one class of outstanding
stock; that all shareholders consent to the election; and
that a specified portion of the corporation's receipts be
derived from actual business activity rather than passive
investments. No limit is placed on the size of the corporation's
income and assets. It is important to note that these requirements
can change over time. It is always a good idea to check with
a qualified legal representative to ensure that you have the
latest information before making a decision on corporate status.
If you plan to transfer property to a corporation
in exchange for stock, you should realize that such a transfer
is a taxable transaction unless the transfer complies with
the provisions of IRC section 351.
Other Considerations
If your business is at present a sole proprietorship
or partnership, you will need to secure a new taxpayer identification
number and unemployment insurance account. You should find
out in advance whether present licenses and leases will be
transferable to the new corporate entity.
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