What Is Incorporation (And When Should You Do It)?
Hint: Not every business should incorporate right away.
Hey, I’m Casandra. Welcome to a ✨ free edition ✨ of my newsletter. I share really good business ideas to help you start and grow a business.
If you’re not a premium subscriber, here’s what you missed recently:
Become a premium subscriber to access the full archive (including research-backed business ideas). Premium subscribers also get access to premium perks.
When starting a new business, most of us get really eager to make it official. It’s exciting! Although it takes a lot of time and work to build a successful business, most of us want to feel the warm embrace of success (hello, dopamine!) as soon as possible.
So, we take action to make it feel real. We buy a domain name, create a brand, make a website, change our email signature, open social media accounts, and incorporate a business. Often, we get so excited about what could be that we do all these things before we’ve even validated the business idea.
Spending a lot of time on business setup can be a major distraction before the business gets traction. But incorporating a business can also saddle a business with a lot of cost and complexity that it may not be ready for.
This is why I don’t explicitly recommend incorporating every new business!
Today, I’ll share:
The pros and cons of incorporating a business and my framework for knowing when to incorporate your business.
Different options for incorporating a business in the US.
How you can avoid getting stuck with a costly, complex structure that needs to be maintained.
How to make incorporating a business easier and more affordable.
Exactly how and why I incorporated Really Good Business Ideas.
Quick reminder: I’m not a lawyer or an accountant. I’m just sharing what I’ve learned as an entrepreneur who has started multiple businesses in multiple countries (some incorporated, some not). This information is meant to help you start thinking about incorporation more broadly. I recommend contacting a professional for help if you do decide to incorporate a business.
Why Incorporate?
People typically incorporate for one of four reasons.
Limited Liability: Incorporating your business into its own entity protects your personal assets. For example, if your company got sued or filed for bankruptcy, a settlement can typically only be recovered from the company’s assets (there are exceptions to this).
Tax Benefits: Certain tax benefits are only available to corporations. For example, corporations can carry losses forward, lowering taxes in future years, and corporate owners can pay themselves a salary, subject to employment tax, without paying (self) employment tax on the remaining profit.
Credibility: Businesses that have been incorporated are typically seen as more credible. But this isn’t just about ego. When you're incorporated, it’s often much easier to access funding, insurance, permits, licenses, and partnerships for your business.
Perpetual Existence: Corporations don’t die with their owners. Incorporating your company is the best way to ensure a smooth transition to new ownership if you want your company to live on after you sell it, retire, or pass away.
Should You Incorporate?
Despite the benefits of incorporation, I strongly believe that not everyone should immediately incorporate their business.
As hard as it is to admit, most new businesses don’t get very far. And incorporating adds a lot of complexity and costs:
Incorporating costs money. New businesses are usually cash-strapped, and that money may be better spent on other priorities such as product development or marketing.
You may need to file an annual corporate tax. Most people hire an accountant for this, and corporate tax returns usually cost more to file than personal tax returns.
Corporations need to be dissolved. You can’t just stop filing corporate tax returns if you give up your business. You’ll need to dissolve your corporation officially, and guess what: that costs money, too.
This can add a lot of financial strain and stress to first-time entrepreneurs.
So, who should incorporate?
Serial entrepreneurs: If you’ve started successful businesses in the past, you probably have the necessary experience to choose a solid business idea and get it off the ground successfully.
Businesses that need a lot of investment. If you need to take on external investment in the form of loans or private investors, you’ll likely need to incorporate to be eligible for that funding. But even if you fund the business yourself, you should consider incorporating. Investing, say, $20K is a pretty good sign that you’re serious and ready to add the additional complexity that comes from incorporating.
Businesses with cofounders. Starting with a corporation is often a good idea if you have business partners. Partners add complexity, and corporate structures are designed to address this.
Businesses with liability concerns. If there’s an increased risk of things going wrong with your business, you may want to incorporate it for liability protection. In particular, food and cosmetics businesses, which can make people sick, should think about this, as should businesses that sell products where people can easily be injured using them.
You don't have to incorporate your business immediately if you’re unsure about it. You can start as a sole proprietor and incorporate the business later. However, be aware that there may be tax consequences when transferring business assets from yourself to the newly formed company, so be sure to consult an expert.
Common Business Structures
There are several options for structuring a business in the US, whether you choose to incorporate it or not.1
Sole Proprietorship — Best for first-time businesses with low liability risk that aren’t ready to incorporate.
Remember, if you choose not to incorporate, you can simply run your business as a sole proprietorship.
You will report revenue and expenses on your personal income tax and pay employment taxes on the profit (like would be deducted from a paycheck).
However, your business and personal liability will not be separated, and your personal assets will not be protected from business debts.
This option is extremely simple because it doesn’t require you to do anything different besides track business revenue and expenses and include them on your personal income tax return. Once your business gets traction, you can form an LLC (and elect to file taxes as an S corp, if appropriate).
Limited Liability Company (LLC) — Best for small companies.
An LLC is typically the best option for most small businesses.
It’s a fairly simple structure to set up.
It provides liability protection for the business owner.
It has flexibility regarding how it’s taxed: as a sole proprietor, a C corporation, an S corporation, or even a non-profit.
C Corp — Best for big companies with a lot of shareholders.
Most large companies are incorporated as C corporations since they support complex structures with many shareholders. C corporations are subject to the 21% corporate tax rate but have other tax benefits, such as the ability to carry losses forward.
This means that profits are taxed twice. First, the corporation pays the 21% corporate tax on profits, and then shareholders pay an additional tax when the remaining profits are paid out as dividends. If a single owner incorporates as a C corp, they’re likely to pay a lot more tax than if they used a different structure.
S Corp — Best for small companies that are generating consistent profit.
S corporation status can be confusing since it’s a tax status assigned to other corporate structures. Any for-profit company, including an LLC, can elect to be taxed as an S corporation—as long as it is eligible. I won’t cover all the eligibility requirements here, but most small businesses will generally be eligible.2
The S corporation election was designed to help small businesses avoid the double taxation that C corporations experience.
If you elect for taxation as an S corporation, you (as the owner) can pay yourself a reasonable salary from the S corporation, which is subject to employment taxes. The remaining profit that stays in the company is not subject to corporate tax and can be paid to you in the future (at which point it would become subject to employment taxes).
Most small businesses can save money by filing as an S corporation once they’re consistently profitable, but the exact profit threshold when this becomes advantageous will vary.
Note: I only covered single-owner, for-profit business options here. There are several additional options for non-profits and partnerships!
How to Incorporate a Business
The incorporation process has many legal steps, such as writing bylaws and appointing directors, and it’s important to do everything properly. Unless you’re already an expert on this process, I do not recommend doing it alone.
Instead, I recommend one of the following options:
Hire a lawyer to help you incorporate. If you have a lot of questions, a complex business structure, or other unique needs, it’s probably best to hire someone you can work with directly. Ask around for recommendations or look for someone with experience in your industry.
Use an automated incorporation service. If your incorporation is going to be straightforward, you can use an automated service like Stripe Atlas. It’s incredibly easy to sign up online, pay a fee (typically much less than you’d pay a lawyer), and they will handle everything. The process is quick, and all the documents you need will be accessible to you anytime in your online account. They’ve also made setting up a Stripe Payments account and a business bank account for your company seamless.
Bonus: Really Good Business Ideas Structure
After reading all this, can you guess what type of company structure I chose for Really Good Business Ideas?
Really Good Business Ideas is an LLC, set up using Stripe Atlas. Here’s why:
I have extensive entrepreneurship experience, so I had high confidence in my commitment to the business and the likelihood of success.
Since I felt comfortable skipping the validation phase, incorporating at the beginning means I won’t have to deal with the messiness or possible negative tax implications of switching to a corporation later.
I don’t have any partners and don’t plan to have any shareholders in the future, either.
I have flexibility for how I am taxed based on my profit. I can elect to go through revenue and expenses like a sole proprietor, or I can elect to be taxed as an S corp instead.
Personal liability protection is never a bad thing.
I wanted to register my business name before someone else did.
My business name and plan are broad enough to pivot within the existing company structure if needed (rather than dissolving this company and starting a new one).
Remember, as good as it feels to make things official, sometimes incorporating a business right away can place unnecessary strain on it! In most cases, it’s much more important to validate your business first by customer getting your first customers!
To endless possibilities,
Casandra
PS. If you found this useful, please tap the ❤️ below. It helps me out a lot!
An LLC is not full protection from personal liability, at least in our state. It's a good buffer but it's not perfect. Insurance does add to the buffer. Folks should definitely talk to an attorney in their area or an organization that aids entrepreneurs, like an incubator. The SBA can also point folks in the right direction.