8 Legal Tips for Starting a Corporation
Getting started with a new business can be daunting, and incorporating is one of the first steps you might take. This article discusses 8 legal tips for forming a corporation. It includes information about where to form your new company, considerations for your certificate of incorporation, and more.
1. Incorporating out of state will NOT help you save on taxes.
Corporate income taxes can vary widely depending on which state a corporation operates in. South Dakota and Wyoming, for example, have no corporate income tax whatsoever. Iowa has the country’s highest corporate income tax rate of 12%.
Since business owners can incorporate outside the state where they operate, some might try to incorporate in a low-tax state. But entrepreneurs seeking to incorporate should beware: this strategy will NOT save taxes. This is because states impose income tax based not only on incorporation but also on the physical and economic presence of a business in the state. So if you operate a business in California but incorporate in Delaware, you will end up paying both California and Delaware taxes.
2. But, don’t count out incorporating out of state for other reasons!
Even though incorporating out of state won’t save you taxes, there may still be benefits to doing so. Three major benefits are privacy, access to legal systems, and attracting investors.
Nevada is a popular state for incorporation amongst business owners who highly value privacy. Unlike in other states, business owners do not have to list their names in order to incorporate their business in Nevada. An agent, like an attorney, can be the only person named on the public records for a Nevada corporation.
Delaware is a popular state for incorporation because its business laws are well-developed. The state is known for its efficient and predictable business court system. Most large corporations in the United States are incorporated in Delaware.
If you plan to grow your business by attracting large institutional investors, like venture capital investors, these firms will usually prefer that your corporation be incorporated in Delaware.
3. Incorporating isn’t enough to protect your personal assets from liability.
The main benefit of starting a corporation is to protect the owners’ personal assets in case the business is sued or owes money to creditors. But incorporating is not always enough to prevent a court from handing over an owner’s personal assets to a creditor.
To make sure that personal assets are protected you also have to follow certain formalities to convince a court that your corporation is real. Here is a checklist of formalities that every corporation should follow in order to protect the personal assets of its owners.
Corporate Bylaws: A corporation needs to have a formal set of bylaws that describe how the corporation is governed. This includes information about the board of directors, board meetings, and rules for amending the bylaws.
Board Meetings: Even if a corporation only has a single shareholder, the corporation needs to hold board meetings. In the case of a corporation with a single board member, this can be accomplished in five minutes at the board member’s computer. The sole board member just needs to take notes describing the decisions they made. As odd as this may sound, it is an important formality that might prevent a court from determining that a corporation is just an extension of the owner. If the court views a corporation as an extension of the owner, it may assign the owner’s personal assets to a creditor.
Shareholder Meetings: Like board meetings, shareholder meetings are typically required to take place at least once per year. If a corporation has a single owner who serves as the sole board member, the process for this meeting will be similar to the one described above.
Meeting Minutes: Meeting minutes serve as proof that the board and shareholder meetings took place. They should be signed and dated by the corporate secretary. For a single-owner corporation, this will often be the sole shareholder or a close family member.
Keep Finances Separate: It’s crucial that the owners of a corporation open a separate bank account for the business. Corporate money should not be used for the personal expenses of the directors or officers. Business-related expenses, like financing a business trip or taking a client to lunch, are fine. Likewise, personal funds should not be comingled with business funds unless the business owner making a formal capital contribution to the corporation. Good bookkeeping practices are fundamental to proving that corporate funds were not mixed up with the owner’s personal funds.
4. Set a low par value share for common stock
Par value is the minimum value for which the shares of a corporation can be sold. It’s important to realize that par value is not the value that an owner must sell their shares for in the future. Shares can be sold for any price that a buyer is willing to pay. For this reason, when incorporating a new corporation, the par value should be set low. This will provide more flexibility to the owners, allowing them to acquire a higher number of shares for the same amount of money. They can later divide those shares into different ratios if and when they wish to sell or give away part of their corporation. Additionally, states that require a par value may prevent shareholders from receiving the par value in a distribution. The par value of a corporation’s stock is often set at less than one cent per share, such as $0.00001.
While some states require a par value, others allow business owners to elect no par value. This option also gives increased flexibility to the business owners. But, electing this option may have tax implications depending on the state.
5. Authorize more shares than you plan to issue
Just like setting a low par value, this tip is all about flexibility. Newly incorporated businesses often authorize millions of shares, which the initial shareholders acquire at a very low par value. The shares the owners acquire are known as “issued” shares.
If you are incorporating a new business, consider authorizing more shares than you plan to issue. This will allow you more flexibility in the future when dividing up ownership with other parties, like an investor or a family member you wish to involve in the business.
6. Don't try to save employment taxes by calling employees contractors
This tip applies to any business that will hire workers. You might hear that hiring independent contractors can save you money over hiring regular employees. As a business owner, you are not responsible for paying any part of employment taxes for contractors. Businesses do not have to provide benefits to independent contractors.
But you should be aware that if you treat your workers as employees, simply calling them contractors is not enough to avoid these expenses. If a state or federal court or agency determines that your workers are employees, failing to treat them as such can result in major financial penalties. These penalties include back-pay and back-taxes owed to the employee and the government.
To determine if your workers should be classified as independent contractors or employees, check out this article.
7. Make sure intellectual property is owned by the corporation, not employees or consultants
This tip is especially important if your company is a tech company, or produces another type of intellectual property. Most types of intellectual property, by default, belong to the person or persons who created it.
In the tech world, this means that a software programmer owns the rights to the code they create. In other contexts, a writer who writes a book owns the copyright for that book. But what happens if Google hires an employee to create code for a project? What happens if they hire a contractor to create the code? In the context of a book, what happens if a writer hires someone to design a book cover?
For Google, the answer is probably that Google makes its employees and contractors sign an agreement assigning the intellectual property to Google. If your corporation generates intellectual property, make sure that your agreements make clear that your corporation will own it. Otherwise, someone else may have rights over the technology, writing, music, or art that you need to operate your business.
8. Don't forgo official policies and handbooks
If your corporation is brand new, it may be hard to see the value in developing corporate policies, procedures, and handbooks for employees. However, these resources are important for you and your employees from the minute that they are hired, if not earlier. They make clear your expectations for employee conduct and explain the company’s position on important employment issues like workplace harassment and discrimination.
SCORE, a nonprofit organization that partners with the U.S. Small Business Administration (SBA), offers resources to help create these policies.
Conclusion
To help you get started, we’ve compiled a list of some important legal tips to keep in mind when forming your new corporation. This includes which state to incorporate in, what should be included in your certificate of incorporation, and advice on corporate policies. If you’re looking for more information about incorporating or specific advice for your business, don't hesitate to contact an attorney for personalized advice. Although legal help might seem expensive, it is often much cheaper to get advice when you start than to fix mistakes down the road.
