The BizFilings blog covering business tips and trends.
Incorporation: The First Step To "Going Public"
Published on Jul 17, 2012
Check out 'Incorporation: The First Step To "Going Public"' at 'Time to Start Up,' the small business blog by BizFilings.
The thrill of the opening bell, the bustle of the trading floor, the cryptic numbers of the stock ticker--many entrepreneurs got their first inklings of a future calling when they saw a market in action, whether it was by watching "Wall Street" or taking a stock exchange tour on a school field trip.
Maybe your goal has always been to found a publicly traded company, or maybe you've just started to think about a stock offering as a way to raise necessary financing for expansion. Either way, going public is an involved, multi-stage process, and one of the first steps on this exciting and potentially profitable journey is incorporation.
What does it mean to incorporate? For many entrepreneurs, their business feels like an extension of themselves. From one perspective, this is a positive. It means business owners expend a tremendous amount of effort in starting and growing their enterprises, and are totally committed to its success. From another perspective, it's healthy -- even essential -- to have a little separation between yourself and your business. That's where incorporation comes in.
It's common for a startup to be a sole proprietorship, which means the business entity is owned and run by a single individual, who is on the hook for all the debts and other liabilities of the company. The upside is that this is a simple business structure that does not require much red tape to set up. On the downside, the mixing of personal and business liabilities obviously presents a danger -- the failure on the business side can have a lasting impact on the personal fortunes of the owner. Incorporation is the process of separating the business as a legal entity apart from its founders and other shareholders.
Incorporating your business does not necessarily mean a perfect separation of personal and business liabilities. As an owner, you may still take on some debt that involves a personal guarantee, for instance. But incorporating does provide significant protection for the personal assets of an entrepreneur.
How does a business incorporate? Businesses are incorporated at the state level, and the process usually involves filing articles of incorporation with a designated state office. Each state has its own process and requirements, so if your business is located in multiple states, it's wise to incorporate in the location that offers the most benefits to companies like yours. Also, don't forget to foreign qualify your company if it is doing business in a state outside of its formation state.
Choosing a business name is a crucial step in the incorporation process, and in some cases, a business' official, legal name will be different than its trade name, or "doing business as" name. The U.S. Small Business Administration website contains a directory of state offices for filing DBA names.
Incorporating businesses also have to secure all required licenses and permits. The SBA also provides a directory of federal and state licenses and permits.
The process of incorporation is not prohibitively complex, but it can be time-consuming and confusing at times. Many business owners take advantage of services that streamline the process and provide guidance to ensure all legal obligations are met.
How Incorporation Impacts Financing
Stock sales: Once your company is incorporated, ownership shares can be sold in the form of stocks. An initial public offering of stock can bring in a huge amount of money to be used for business expansion. However, going public is not the best or even a viable option for many businesses. IPOs are risky, because pricing stock for a first offering is tricky. The goal is to price shares close to but just under their value on the market, so that the share price goes up slightly in initial trading. If the share price is set too low and it jumps way up once on the market, it means the business could have made more money than it did in selling its first shares. If the price is set too high, the shares will immediately decline in value, losing investors' money and dampening enthusiasm for the company.
If you're considering an IPO, it's crucial to work with an appropriate investment bank. To find a bank that's a good match, you can refer to the U.S. Security and Exchange Commission's New Registration Report, to see which banks are working with businesses similar to yours. Because the costs associated with IPOs are significant and stock offerings only make sense for companies that have prospects for robust yearly growth, going public is usually a way for mature companies to expand.
Taxation: Corporate taxation can be complex, and different rules, regulations and rates apply, depending on the type of business, its location and other factors. But in general, there can be financial benefits to incorporating, because in certain income brackets the federal tax rate for corporate profits is lower than the rate for personal income. Also, there's incentive to finance a corporation by investing in other public companies, because a high percentage of the dividends from these investments can be deducted.
Many incorporated businesses are known as "C corporations" because they are taxed according to rules in Subchapter C of the first chapter of the Internal Revenue Code. There are other kinds of corporations, however, and they are taxed differently. For instance, an "S corporation" is taxed according to Subchapter S, and there are some potential benefits associated with this. The main benefit is that these corporations are not taxed "twice," with both the corporation and shareholders being taxed. In an S corporation, the businesses' profits and losses can be considered as part of a shareholder's personal tax return, so the business itself does not get taxed. But keep in mind that the rules governing taxation of S corporations differ by state.
Other benefits: From a financing perspective, there are other advantages to incorporating and going public, although some of them are hard to quantify. For example, there is prestige that comes with being a successful public company, and this reputation can make it easier to attract private investment. Coupled with the direct access to capital markets that public companies have, this can be a formidable one-two punch when it comes to securing the capital needed for long-term growth.
Incorporation is a meaningful and exciting step in the growth of any company, but it should not be undertaken lightly. Consulting with accountants and attorneys is essential, and it can be invaluable to work with experts who specialize in guiding companies through the process, to minimize any "separation anxiety" as you make your business an independent entity.