The formation of a new corporation has three stages: (A) making pre-incorporation decisions about issues such as the number of shares to issue, which can affect taxes by an order of magnitude as well as affect your ability to engage in certain financial contracts, (B) formally incorporating your company, and (C) taking certain legally prescribed post-incorporation actions such as holding an organization meeting, formally electing certain directors or officers, and adopting bylaws. In this article, I’ve organized the requirements and best practices for all of these stages into a single step-by-step guide with detailed explanations of how to make each decision and how to avoid certain tax & legal pitfalls that I’ve learned about over the course of starting seven companies and now investing in others. This is a much longer article than your typical copypasta “how to incorporate” blog article, but I highly recommend reading the entire thing to save yourself from unnecessary four to five-figure costs and seven-figure liability exposure.
The purpose of incorporating a business as a c-corporation is two-fold: to take advantage of tax benefits and to limit the liability of shareholders when things go wrong in the business. Unfortunately, it’s all too common for inexperienced founders (cough, me when forming my first company, cough) to assume that any of the online incorporation services or guides is about as good as any other as long as they file my formation documents. That assumption is false, and I will explain why in the relevant steps of this guide.
Step 0: Determine Your Business Category
Some types of heavily-regulated businesses must follow different procedures for incorporation. If your business falls into any of the following categories, I highly advise you to seek out a lawyer to assist in incorporation. If you don’t fall into any of the following categories, then proceed to step 1 below.
Business Categories with Special Incorporation Requirements
- Insurance carrier
- Public utility company (electricity, gas, water, etc)
- Bank
- Registered investment company
Step 1: Avoid the Incorporation Mistake that Renders up to 40% of Corporations Worthless
The Mistake
The first “c” of “c-corporation” refers to the tax rules of subchapter C of the IRS income tax code, and these tax rules are determined federally by the IRS (although states do impose a few corporate tax rules as well). However, since each corporation must incorporate in a particular state with its own particular state corporate laws, the liability protections that a corporation offers are NOT determined federally but rather differ on a state-by-state basis.
In fact, the tax status of “c-corporation” can actually be used by an LLC business entity, so the primary purpose of forming a company as a corporation at all is really just to take advantage of the state-level liability laws (for shareholders, corporate officers, and the corporation itself). Corporations have centuries of additional case law beyond what LLCs have in this regard so their liability rules are much more predictable.
Every state has slightly different rules when it comes to incorporating a c-corporation in that state, and these state-specific incorporation differences REALLY matter. Failing to follow the rules of incorporation precisely can jeopardize not just your entire corporation, but also the liability limitation afforded to shareholders. In this Cornell law review article analyzing almost 1600 legal cases, it was found that a whopping 40% of the time courts decided to “pierce the corporate veil” (which is a fancy way of saying the courts decided to disregard the corporate entity and hold shareholders directly liable for debts, fines, or damages). This means that 40% of corporations that needed liability limitation the most were no better off than had they not formed a corporate entity at all. So why were those companies denied limited liability status, and how can you avoid that situation for yourself?
The Solution
First of all, incorporate in Delaware rather than another state! Delaware courts uphold the corporate liability shield much more frequently than other states.
Secondly, one of the top predictors of whether or not a court will decide to throw out limitation of liability is how well corporate formalities are followed, including whether the company’s incorporation process followed the required steps appropriate to the state of incorporation and the type of business activities expected from the company.
Unfortunately, many online incorporation services advertise their services in multiple states, sometimes under different names but ultimately all run by the same people using the same software and documents without making all of the necessary customizations that each state needs. I’ve spent thousands of dollars on several different online incorporation services, and almost all of them failed to follow some detail of the required formal process.
Also unfortunate is the fact that state governments don’t necessarily have the time or information to thoroughly check that each incorporation (or post-incorporation) process is done correctly, so you may receive a state notice that your company has been incorporated even if the post-incorporation process performed by the incorporator was not done entirely correctly–a shortcoming you’re only likely to discover down the road if you are sued or have a big investor pull out of your series B fundraising round.
The good news is that it is relatively straightforward to avoid this trap once you are aware of it. Each state has a section of its state law that is titled something like “Corporations” or “<State Name> Business Corporation Act”. This act of state law will describe exactly what formalities are required of a corporation. Most of that chapter won’t be relevant to incorporation, but a few sections will be and those are the sections you should be familiar with as a founder. For Delaware, corporate law is codified in Delaware Code Title 8: Corporations. In this article, I’ll cover all the important information from Delaware Title 8 for incorporation so that you don’t have to parse through it all yourself.
Step 2: Hire a Registered Agent
The Registered Agent Requirements
A registered agent is an individual or company officially designated as the entity who will receive legal papers on your corporation’s behalf and forward such papers to you. These legal papers may be correspondence from the state regarding your corporation’s incorporation, annual report, taxes, etc, or it may be on behalf of another party who is suing your company. It is legally mandated that every Delaware corporation have a registered agent with a registered office address in the state of Delaware, and it is highly recommended that you outsource this to a third-party company rather than having the corporation serve as its own registered agent to avoid becoming subject to Delaware’s corporate income tax (which is distinct from Delaware’s corporate franchise tax).
You are responsible for providing the name, business address, and business phone number of a real person within your company to your registered agent and updating this information any time it changes. This person is your designated contact who will receive communications from the registered agent. If you are starting small scale, this designated contact can just be you with your home mailing address. Failure to notify your registered agent of changes to the contact information of your designated contact is grounds for your registered agent to stop servicing you, which puts your corporation’s legal status in jeopardy.
Avoiding Charlatans & Ignorant Agents
I cannot emphasize enough the importance of choosing a trustworthy and reliable company to act as your registered agent. Your registered agent may receive very sensitive legal and potentially financial information about you and your company. If they misuse your information or are even just slightly negligent, the consequences could be extreme for your company. Unfortunately, many online registered agent services are very questionable at best.
For example, one popular online registered agent service is “Harbor Compliance”. However, on one of their web pages advertising their Delaware registered agent service, they used the wrong legal term for the corporation document that is filed with the state. The name of this document differs by state (e.g. in Florida it is called “articles of incorporation” whereas in Delaware it is called “certificate of incorporation”). On the Harbor Compliance web page, the term used was “certificate of formation”. Keep in mind, this is supposed to be a company doing the super detail-oriented nitty gritty legal things necessary to keep your business compliant, yet they aren’t even using the correct legal jargon. That’s like getting letterhead from a Massachusetts lawyer that says “State of Massachusetts” rather than “Commonwealth of Massachusetts”: It is an understandable mistake, but immediately puts the credibility of the lawyer into question since he should have known that fact since the first day of studying Massachusetts law. You don’t want a lawyer making such basic mistakes to represent you, and similarly, you don’t want to hire a registered agent compliance company that makes such basic mistakes.
As another example, there is a popular registered agent service called “Harvard Business Services” (unaffiliated with Harvard University — they use the name just to benefit from the mental association people make). If you read the fine print of their agreement terms, you’ll see that the contract doesn’t actually become effective until their company files your company’s formation documents. In other words, they are so certain that they can upsell you on not only buying their registered agent service but also their incorporation service that they worded their contract accordingly. Unfortunately, this means that if you are just hiring them for registered agent service and they make a mistake, you very well may not be able to hold them accountable since “technically” your contract with them did not yet start.
I could go on, but I hope you get the idea: most online incorporation services are complete bogus that will not do the job correctly. Unfortunately, the only registered agent service I have researched and found to be completely up to expectations is CSC Global. Their registered agent service is around $300-$420 per year which is significantly more than most registered agent companies advertise, but as I just mentioned, most registered agents are not doing their job correctly, and their bad job can put you personally at risk if your company is sued. I’m not sponsored by them, but every company I’ve formed since doing this deep dive into registered agents has been formed with CSC Global as its registered agent, and I’d recommend you do the same. Something like 65% of Fortune 500 companies and over 10,000 law firms use CSC Global as their registered agent, so your corporation will be in good company.
Step 3: File your Certificate of Incorporation
The certificate of incorporation is the most important document of your company’s existence. It is the constitution of your company–the highest level “law” of your corporate land. The Delaware Division of Corporations provides a certificate of incorporation template, HOWEVER, there are still several mistakes you can make using this template related to the corporation’s name, nature of the business, and authorized stock information. I recommend reading the discussion of these details below to avoid filing delays and to avoid paying thousands of extra dollars in taxes each year.
Corporate Name
The name of the corporation must contain one of the following words (or abbreviations thereof, with or without punctuation): “association”, “company”, “corporation”, “club”, “foundation”, “fund”, “incorporated”, “institute”, “society”, “union”, “syndicate”, or “limited”.
The name must not contain the word “bank” unless in a context which is clearly not in the context of a financial institution and which could not reasonably mislead any member of the public into thinking the company was a financial bank of any sort.
Except as permitted by section 395 of Title 8, the name must not contain the word “trust”.
The name must be distinguishable from all existing company name records and reserved name records on file with the Division of Corporations in the Department of State.
Registered Office & Registered Agent Information
The certificate of incorporation must include the address (including street, number, city, county, and zip code) of the corporation’s registered office in Delaware and the name of the corporation’s registered agent at such address.
The Nature of the Business
You must state the nature of the business. Typically, you will want to just keep this as general as possible with a single sentence such as “The purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware”. If you state anything more restrictive, that restriction will legally bind you, but you gain no benefit from having imposed that restriction on yourself. Some online incorporation services may ask you for a business purpose and actually include that specific purpose in the certificate of incorporation (you don’t want that).
Authorized Stock Information
If the corporation will only authorize one class of stock (i.e. just common stock and no other type of stock), then specify the total number of shares of this class that will be authorized along with the par value of each share or a statement that all such shares are to be without par value. If you already have investors lined up, then you’ll probably end up negotiating specific rights for some type of preferred stock that you’ll need to authorize as well, and I recommend speaking with a lawyer in that case. However, if you don’t yet have investors lined up, then I recommend keeping things simple by just authorizing one class of stock: basic common stock. You can always go back and have a lawyer file an amendment to authorize special classes of preferred stock later if you need to. For the rest of this section, I’ll assume you’ve gone with this simple option.
When choosing the number of common shares to authorize in your certificate of incorporation, it’s important to consider the tax implications. Every corporation incorporated in Delaware must pay an annual franchise tax. Delaware allows you to choose between two methods for computing the amount of the franchise tax (and these two methods can produce drastically different tax liabilities so it’s definitely worth taking the time to choose wisely).
The first franchise tax method is called the “authorized shares method”. This method determines your franchise tax liability based purely on the number of shares of stock your corporation has authorized. The details of this method are summarized in Table 1.
| Number of Authorized Shares | Total Franchise Tax Liability |
| 5,000 shares or less | $175 |
| 5,001-10,000 shares | $250 |
| 10,001 shares or more | $250 + $85 per additional 10k shares (or portion thereof)* Ex: 100,000 shares would equate to $1,015 in taxes Ex: 1 million shares would equate to $8,665 in taxes * The maximum tax liability is capped at either $200k or $250k, depending on the size of the corporation |
The second franchise tax method is called the “assumed par value” method, and in general it is much more complex than the first method. However, I will assume that your corporation will only have a single class of stock (i.e. just common stock) and that this stock will have a nonzero par value (e.g. $0.0001 / share). Under these simplifying (and recommended) conditions, the method applies as follows.
- Calculate: Fully Diluted Market Cap (FDMC) = (number of authorized shares) * (total assets of the company) / (number of issued shares)
- Calculate: Assumed Par Value Capital (APVC) = max( FDMC, (number of authorized shares) * (par value of one share))
The total franchise tax liability under this method is then the result of rounding up APVC to the nearest million, dividing by $1 million, and then multiplying the result by $400. The final franchise tax due will be at least $400.
Note: The number used for the total assets of the company in the calculations above should be computed in the same manner as on IRS form 1120 schedule L, which does include the value of “amortizable intangible assets” such as patents or copyrights.
Example: Suppose you authorize 1 million shares with a par value of $0.0001 each. You then issue 250k shares to yourself in exchange for $50k. The company’s only assets are the $50k of cash from that transaction.
The fully diluted market cap (FDMC) is then calculated as FDMC = (1 million shares) * ($50,000) / (250k shares) = $200k. The par-value market cap is only (1 million shares) * ($0.0001 / share) = $100.
The assumed par value capital (APVC) is then APVC = max( $200k, $100 ) = $200k. To get the final tax bill, we then round up to the nearest million (rounding up $200k gives us $1 million). We then divide by $1 million, which gives us just “1”. We then multiply by $400. 1 x $400 = $400, so that is our final tax bill.
Compare that $400 tax bill to what we would have gotten had we used the authorized shares method. With 1 million authorized shares, the authorized shares method would give us a tax of $8,665! So in this example, the assumed par value capital method is significantly better.
In general, the authorized shares method will be better if you don’t need more than 10k or 20k shares. If you anticipate slower growth that is mostly bootstrapped in terms of funding, then this is probably fine. You’d only owe $250 or $335 in annual franchise tax, and if you eventually need more shares, you can always do a stock split and/or authorize additional shares in the future.
However, if you anticipate fast-paced hiring, you’ll probably want to start off with a more standard number of shares such as 1 million or 10 million so that you can motivate new employees with equity compensation. The larger number of authorized shares means the vesting schedule can be more finely tuned for these employees, and, in addition, human psychology just means bigger numbers sound more enticing to employees even if they could have owned the same percentage of the company with fewer shares if fewer total shares had been authorized.
You don’t need to specify which method of franchise tax calculation you will use in your certificate of incorporation. In fact, you can switch methods from year to year depending on which is cheapest as your assets, number of issued shares, and/or number of authorized shares changes. However, it’s useful to make a best guess ahead of time so that you can plan how many shares to initially authorize because that number must be included in the certificate and will immediately start accruing tax consequences as soon as you file.
The official Delaware law regarding franchise taxes is available in Title 8 chapter 5 and is also summarized on this official franchise tax help page.
If you do decide to issue more than one class of stock, I would strongly suggest you get a lawyer to help you incorporate, since in this case you’ll also have the option to specify in the certificate of incorporation what voting rights and other governance protocols you want to have in place for each class of stock.
Information of Incorporator(s)
Specify the name and mailing address of the incorporator(s).
An incorporator is a person or company responsible for filing the certificate of incorporation with the state. If you use an online incorporation company, then that company or one of its employees will be the incorporator. If you file the certificate of incorporation yourself through the state’s online portal, then you will be the incorporator. If you hire a law firm to form your company, then one or more of the lawyers at that firm and/or the law firm itself will be the incorporator(s).
The incorporator may or may not have additional duties after incorporation depending on whether or not initial directors are specified in the certificate of incorporation.
Decision: Whether or Not to Specify Initial Director(s)
You have a choice whether or not to specify the initial director(s) for the board of directors in the certificate of incorporation. If you choose to specify the initial director(s), then you must provide the name and mailing address of each director.
Usually, you (and perhaps a confounder if you have one) will be the initial director(s). The main reasons you might choose not to specify this in the certificate of incorporation are (1) because the certificate of incorporation is a public document accessible by anyone, meaning the mailing address you provide might get spam and scam mail, and (2) because if you change your mailing address after incorporation, you’ll need to file a formal amendment to your certificate of incorporation rather than just making a change to your private bylaws.
If you do decide to include yourself as an initial director, then I recommend using a PO box mailing address so that at least your home address is not publicly revealed to scammers.
If you decide not to specify initial directors in the certificate of incorporation, then either act as incorporator yourself or find a very trustworthy company to incorporate for you. The reason for this is that if you do not specify initial directors, then the incorporator is responsible for taking certain formal actions on behalf of the company after the incorporation process has been completed. The exact actions to be taken vary by state. The sad fact is that I have hired online incorporator companies where I opted not to include myself as an initial director in the certificate of incorporation only to find that the incorporator did not follow the legally specified next steps appropriately, leaving me with a corporation that had ambiguous legal status.
Signature
The certificate of incorporation must be signed by the incorporator(s) per section 103.
Filing
The certificate of incorporation must be delivered to the office of the Secretary of State, together with any taxes and/or fees that apply. The official “filing date” shall be the date when the Secretary of State officially endorses the certificate of incorporation in its records.
You can submit your certificate of incorporation for filing using the Delaware Secretary of State’s document upload service. The upload process will also ask you whether you would like expedited service. Unless you want to wait several weeks, I suggest you choose the 24-hour expedited filing service. The filing fees will depend upon your choices for the number of authorized shares and the par value of shares. See the fee schedule for details.
Step 4: Hold Organizational Meeting
After the certificate of incorporation has been filed, an organizational meeting must be held for the corporation. If one or more initial director(s) were named in the certificate of incorporation, then the meeting must be held by the director(s); however, if initial director(s) were not named, then the meeting must be held by the incorporator(s).
The following actions must be taken in the meeting:
- Adopting initial bylaws
- Electing directors (if the meeting is of the incorporators) to serve until the first annual meeting of stockholders
- Electing officers (if the meeting is of the directors)
You should probably also pass a banking resolution to authorize someone to create a corporate bank account on the company’s behalf. Additionally, you should pass an initial share purchase agreement for you and any cofounders you have to actually buy stock. This is an important step that must be done in order for you to actually own the company.
It may seem silly at such a fledgling stage of your company, but it is very important to follow the formal requirements for this meeting since courts will only take your corporation seriously if you take corporate meetings seriously. Alternatively, the state of Delaware allows this first meeting requirement to be waived if each of the mandatory actions listed above is taken by written consent of the incorporators or initial directors, as applicable. Be sure to keep a thorough record of either meeting minutes or written consent of the corporate actions.
You can read the complete meeting requirements for yourself in Delaware code Title 8, section 107-108.