Initial Steps in Setting up a Business Entity - Explained
How to Set up a Business Entity?
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How Do I Set Up A Business Entity?
Once the decision is made, properly setting up a business entity requires a great deal of effort. Below we provide the primary steps involved in setting up the entity and preparing it to accomplish the startups objectives.
Note: Recall that a sole proprietorship and partnership may arise by the default actions of the business owner(s). This section refers to the process of registering an entity with the state and preparing the organizational governance documents.
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Where Do I Register a Business Entity?
First, the organizer (or incorporator) will visit the Secretary of States webpage and verify the availability of the intended business name. If the name is available and she is not going to immediately file all of the necessary documents, she will want to reserve the name. This will prevent others from taking the name in the interim.
How Do I Secure My Business Name?
You must do a name search with the secretary of state's office to see if the business name is available. This service is available on the SoS website.
What Documents are Required to Create a Business Entity?
You must file the application for formation (the articles of incorporation or articles of organization). Most states have an electronic system to prepare the application that takes the organizer through some simple steps to do this.
While this is a simple manner of creating the organizational documents, it is often advisable to add company specific provisions (such as restrictions on the right to amend the articles). The organizer can always prepare her own articles and upload it through the electronic system.
What Information is Required in the Application?
The basic information required to file a business entity with the Secretary of State includes:
- The name of the Business, followed by the abbreviation for the type of entity (,llc or ,Inc., etc.)
- Nature of the Business
- The name of the organizer.
- The name and address of the registered agent.
- The business location.
- Some states require the names of the members.
Some types of business entities require special provisions in the organizational documents. This is true for Non-Profits and Benefit Corporations (where recognized).
What is a Certificate of Organization?
This is a certificate provided by the Secretary of State's office showing that an LLC has been formed.
What is a Certificate of Incorporation?
This is a certificate provided by the Secretary of State's office showing that a Corporation has been formed.
What is a Charter?
It is another word for a Certificate of Incorporation. This is a certificate provided by the Secretary of State's office showing that an LLC has been formed.
What is a Franchise Fee?
A franchise fee is the state tax charged for registering a business entity. It is often included in the filing fee.
States have their own rates and method of calculating the franchise taxes or application fee for filing a business entity.
What Tax documents Do I File?
During the filing process, the incorporator will prepare and file Form SS-4 (Application for Employer Identification Number) with the IRS and also apply for a state tax reporting number. In this form, you will elect whether you will be taxed as a partnership or corporation (S-Corp or C-Corp).
The incorporator will file a similar form with the state taxing authority to get a state employer identification number.
If the business sells goods, it may also be necessary to apply for a state sales tax number.
Later, the incorporator or an appointed officer will undertake to set up deposit or withholding accounts for employee income and payroll taxes.
Luckily, numerous software products make it easy to withhold these taxes and report and deposit them with the appropriate taxing authority.
Do I Need Entity Governance Documents?
If you have multiple business owners, you should create a governance document to organize and control operations of the business. In a partnership, this is a partnership agreement. In an LLC, this is an operating agreement (or LLC Agreement). In a corporation, this is the bylaws. A corporation also commonly creates shareholder agreements.
The documents will govern nearly every aspect of the business operations including: decision-making; authority or voting rights of owners; composition of the board; etc.
The provisions typically included in the governance documents are numerous and can be complex.
What actions do the organizers of a partnership take?
GPs arise by default, while LPs and LLPs must be filed with the state. The formation of the partnership, however, is only one aspect of setting up the business entity. The next step is for the individual partners to enter into a detailed partnership agreement outlining the rights, authority, ownership, and liability of the individual partners.
Each partner must sign the agreement for it to be effective against that partner. The partnership may also ratify and agree to hold the organizer harmless for any activity in establishing the partnership.
What actions do the organizers of the LLC take?
The LLC is not required to have formal meetings, but the members should act quickly to adopt an operating agreement. This can be done during a meeting (my majority or super-majority vote) or through unanimous written consent outside of a meeting.
Like the partnership agreement, the operating agreement should cover all of the important structural, financial, and operational aspects of the business.
The LLC may also ratify or agree to hold the organizer harmless for activities undertaken in forming the LLC.
What actions do the incorporators and initial board of directors of a corporation take?
The Secretary of States Office will review the application for incorporation and either accept or reject the application. If the application is rejected, the department will indicate the deficiency in the application and allow amendment.
Once the corporate charter is issued, the corporation now exists. Now the incorporator has to take steps to set up the corporate structure.
The first step is to call a corporate meeting. In this meeting the incorporator will appoint the initial directors and the corporate secretary. The corporate secretary will record this action in the minutes and may prepare a resolution for the incorporator.
At this point the board of directors has authority. The board prepares and signs the Actions of Incorporator, which adopts or ratifies all previous actions taken by the incorporator and relieves her from her responsibilities.
Next the board will approve all expenses associated with formation, including any funds paid to the incorporator.
Now the board of directors must take numerous actions to completely setup the entity structure.
The next task for the board of directors is to adopt the corporate bylaws. This is done by identifying the bylaws in the initial meeting and voting on their acceptance. Again the corporate secretary may prepare a resolution for the boards signature.
At this point the board will proceed with the meeting in accordance with the rules for director meetings as laid out in the bylaws. The board will then address the following tasks in any given order:
- Authorizing the principal office or place of business;
- Preparing and filing of qualification to do business as a foreign corporation in any other states;
- Designating the corporate fiscal year;
- Ratifying the corporate Employer Identification Number;
- Designating the size of the board of directors (which is generally included in the bylaws);
- Undertaking the election of officers;
- Designating of management powers as appropriate;
- Authorization of corporate stock (number of shares and classes of shares if there are multiple classes);
- Approving the issuance of founders stock (common stock) to the business founders;
- Approving any stock option grants to founders (if applicable);
- Approving the minutes;
- Authorizing the corporate seal and stock certificates;
- Approving the subchapter S tax election for the corporation (if applicable);
- Authorizing the management to open bank accounts;
- Approving any proprietary information and inventions agreements;
- Approving any indemnification agreements with officers and directors;
- Approving any stock option or issuance plans or option agreements
Many of the actions of the board are authorized in the articles of incorporation and bylaws.
The board can only act within the bounds of these governing documents.
What actions do the shareholders of the corporation take?
The initial meeting will generally conclude by a call for the shareholders (i.e., founders) to vote to formally elect the board of directors. Remember, the initial board of directors was appointed by the incorporator.
It is important to have the newly minted shareholders to follow the bylaws and formally elect the standing members of the board.
Generally, the shareholders will also vote for secondary tasks, such as approving the indemnification agreement for officers and directors and approving the stock option or issuance plans.
Note: Many of these actions (by directors or shareholders) may be taken outside of a formal meeting through signed consents. When this happens the consents must generally be unanimous, unless the bylaws expressly indicate otherwise.
Corporate formalities require that the company maintain records of all corporate meetings, resolutions, stock issuances, and initial capitalization data.
Most corporations use commercial software to track this information.