How not to incorporate: nine major mistakes you never want to make - Legal Matters - Tutorial

Home Office Computing, Feb, 1994 by Stephen L. Nelson

As AN ACCOUNTANT AND WRITER, I HAD ALWAYS OPERated as a sole proprietor. But recently I incorporated a piece of my business--writing computer books. You might not think that writing books warrants incorporation, but most computer publishers offer contracts with stringent warranties against errors. Therefore, I needed incorporation so that my financial liabilities in any book publishing ventures would be limited.

In the past I had worked with attorneys to set up large corporations, but my computer book-writing venture was the first time I'd arranged a small-business corporation. Unfortunately, along the way I made some mistakes. When I talked with several entrepreneur friends, however, I learned I wasn't alone. Opportunities for error are ample when you incorporate a small business. Here's what I learned not to do from my own experience and that of other entrepreneurs I talked with.

1. Start without a budget. This omission sounds obvious, but it's too easy for the incorporation process to get expensive very quickly. In fact, it may be that you won't want to incorporate once you consider the total costs. In my case, total attorney fees at the outset looked to be somewhere between $800 and $1,000. I chipped this down to $550 by paying only for the articles of incorporation and the initial consultation; I did the organizational work myself. Then the state wanted a couple hundred for things like filing fees and business licenses. Of course, because the new corporation was also a new business, there were the usual start-up supplies: business checks, letterhead, and so on. All told, I spent around $1,000.

Realize, too, that you may find it significantly more expensive to do business as a corporation. You'll almost certainly want more legal counsel. And you'll likely need more income tax planning and preparation services. (Remember, you'll now have annual corporate tax returns to fill out as well as quarterly corporate payroll taxes for all employees-- counting yourself.)

2. Neglect to check out the name you pick. Avoiding this error can be tougher than it seems. When you incorporate, in essence, you're creating a new person who needs a name. Except the moniker you pick can't be misleading or confusing. You've got to ascertain that it is available in the state where you'll incorporate and in those states where you'll do business. You can often do this with a phone call to the secretary of state's office. Additional research might include calling directory assistance and reviewing the phone book, since too many people do not register their companies' names.

An unnamed client--let's call her Elaine-chose a name for her new computer consulting business last year without going through these steps. Unfortunately, Elaine also printed business cards and stationery using her company's name before she found out that it wasn't available in her state. Not only did she waste time and money, but she also confused clients and prospects since they thought her business had one name, and then she had to turn around and tell them it really had another.

3. Always hire an attorney. I used an attorney when I incorporated--and I got decent value for what I paid. Nevertheless, you need not always use an attorney to incorporate. In fact, one lawyer told me that he thinks most small single-shareholder corporations can do the job themselves. How? You can almost certainly trudge down to the local office supplies store and purchase an incorporation kit, which will provide fill-in-the-blank standard forms and instructions. In addition, Nolo Press ([510] 549-2001) publishes books and book/software sets for incorporating in California, New York, Florida, and Texas.

Todd Marshall wanted to incorporate his growing commercial printing business, DT Marshall. Rather than pay $500 to $1,000 to an attorney, he purchased a package of incorporation forms and a book on how to incorporate in Washington State. He read the book, filled out the articles of incorporation, and sent them in. A couple of weeks later, he received his certificate of incorporation from the state.

4. Neglect the other paperwork. To create a legal corporate entity, you file articles of incorporation with your state. But this is only the first chunk of paperwork you or your attorney must process. You still need to have an organizational meeting where you elect the board of directors (which in some states, like Delaware, can be just you), approve corporate bylaws, and authorize the issue of capital stock. After that, you'll need to have a board meeting to elect officers and make some needed corporate resolutions (such as authorizing the newly elected officers to open bank accounts). All of this minutiae must be documented minutes from meetings, consents in lieu of meetings, and so on and so forth. This extra paperwork isn't all that tough, but if you don't do it, the IRS might view your corporation as a sham.

This was one blunder I made. I left my attorney's office not understanding each of the additional things I needed to accomplish for me to really be in business. So I ended up getting the information from a book on incorporating small businesses (Inc. Yourself by Judith H. McQuown) and drawing up the papers myself.