When to incorporate or form an LLC

Small business owners are often advised to incorporate early in the startup process. That way, they can limit personal liability and unlock other benefits of a formal business structure.

For these reasons, small businesses are often advised to incorporate early in the startup process. That way, they can minimize exposure liability and take advantage of the benefits of incorporation.

There are also important compliance responsibilities that must be met to keep your business in good standing with the state and to maintain limited liability.

This article covers what incorporation means, when to do it, what to consider before creating an LLC or corporation.

What does it mean to incorporate a business?

Technically, "incorporation" refers specifically to creating a corporation, while "formation" or "organization" describes creating other types of business entities, such as an LLC. That said, "incorporation" is commonly used to describe the process of registering a business with the state to create a formal business entity, whether that entity is a corporation, LLC, or another structure.

Once formed, this legal entity exists independently of its owner or owners. A corporation or LLC can own property, borrow money, enter into contracts, and sue or be sued, among other functions.

Forming a corporation or LLC also provides the owners with limited liability protection, since the business's assets, debts, and liabilities are legally separate from the owners’ personal assets, debts, and liabilities. However, corporations and LLCs differ in several ways, including management structure, ownership, and taxation.

For more information, see LLC vs. Inc: Understanding the differences between an LLC and a corporation.

Determining the best time to incorporate or form an LLC

While there is no definitive “right time” to incorporate, you should consider establishing your LLC or corporation before facing one of these scenarios:

• Entering into contracts: Having a corporation or LLC can protect you from personal liability when you are conducting business on behalf of the company and signing contracts or other legal documents. If you initially sign a contract as a sole proprietor and then incorporate your business later, you will still be personally responsible for that contract.
• Establishing ownership roles: Conflict between owners on matters such as equity splits and other issues can often lead to complications. Early incorporation can mitigate these concerns, ensuring that co-founders are aligned from the outset.
• Limiting liability exposure: Some industries, such as healthcare and construction, often face a higher risk of civil lawsuits. Your company may also be sued by customers who are dissatisfied with your services and products, experience interruptions or loss of service, or sustain injuries related to the company’s operations, staff, products, and services. In addition to having the necessary insurance, establishing your business as an LLC or corporation can create a separation between your personal assets and your company's liability in the event of a lawsuit.
• Hiring employees: Employers can be liable for the actions and mistakes of employees during the course of business. Incorporating before you bring on staff can help shield your personal assets from claims related to their conduct.
• Applying for a loan: Lenders prefer working with an incorporated business and may be reluctant to provide a loan to a sole proprietor.
• Raising capital: For businesses that eventually seek to issue stock, a C corporation can easily issue shares to raise capital for further expansion.
• Protecting IP: Intellectual property, such as patents, copyrights, trademarks, and trade secrets, can be a valuable business asset. Having your LLC or corporation own the IP directly can help avoid ownership disputes that may complicate future investments, partnerships, or acquisitions.
• Needing credibility with vendors and partners: Vendors, customers, and potential partners often see incorporated businesses as more legitimate and established than sole proprietorships.

Note: The end of the calendar year can pose challenges for businesses looking to quickly establish their incorporation. Secretary of State offices often experience a surge in paperwork filing during this time, leading to delays in processing. If you want your LLC or corporation to be established with a future effective date of January 1, it's important to plan ahead. Bear in mind that not all states may have the option for future effective date filing.

What to consider before incorporating or forming an LLC

While incorporation or forming an LLC come with real benefits, there are legal and financial responsibilities to consider. These include:

• Formation and ongoing compliance requirements: While compliance tasks vary from state to state, at a minimum you'll need to file formation documents with your state's business entity agency (usually the Secretary of State's office) and pay a formation fee. You must also maintain a registered agent, file annual reports, and pay annual state franchise taxes.
• Loss of good standing: "Good standing" refers to a business entity's compliance with its state's requirements, such as annual reports and franchise taxes. When a corporation or LLC loses good standing, it may face fines and penalties, difficulties in securing capital and financing, administrative dissolution of the entity, and the loss of limited liability protections for the owner(s)/members.
• Corporate formalities: Corporations face stricter governance formalities than LLCs, such as holding annual shareholder meetings, adopting bylaws, and issuing stock to owners. LLCs have more flexibility here, though maintaining an operating agreement and keeping good records is still recommended.
• Piercing the corporate veil: LLCs and corporations can be at risk of “piercing the corporate veil” and losing the protection and benefits provided by the business structure. This is where a court disregards the business's separate legal status and holds owners personally liable. To avoid this, LLCs and corporations must operate independently from their owners, fulfilling any required corporate formalities and keeping business and personal assets separate.

How to incorporate a business

To form an LLC or corporation, you must file formation documents with the state agency responsible for business entities, often the Secretary of State's office. For an LLC, this document is called the Articles of Organization; for a corporation, it's called the Articles of Incorporation.

• Select a business name: LLCs and corporations must follow specific state naming rules, which typically require the name to be distinguishable from other registered businesses in the state and to include a designator identifying the entity type (ex. "LLC" or "Inc.").
• Appoint a registered agent: A registered agent is a person or company designated to receive legal documents, such as service of process and state correspondence, on behalf of the business. States require the agent to have a physical address in the state of registration and be available during normal business hours.
• File formation documents: Articles of Organization or Articles of Incorporation are submitted to the Secretary of State’s office (or equivalent agency).

Keep in mind that there are various steps to complete after formation, such as creating an operating agreement (LLCs) or bylaws (corporations), obtaining an EIN, and getting the right business licenses and permits. Corporations and LLCs are also subject to different formation and post-formation requirements, so it's worth understanding those requirements for your chosen structure before you file.

For more information, see: 

• Legal requirements for starting a business
• Guide to forming an LLC
• Guide to forming a corporation

BizFilings can help

Learn about business formation and incorporation options, what they mean, how they work, and why they are important. 

Then use our Incorporation Wizard Tool to help you determine the right type of business structure.