How--and Why--to Incorporate Your Business

Here's a rundown of who plays what roles in a corporation:

• Board of directors: The original directors are designated in the Articles of Incorporation, which is the document filed with the state to legally form the entity. Directors oversee the officers of the company and assure that it operates according to law and corporate procedures. Directors have a fiduciary duty to the corporation to act in the corporation's best interest, not to their own best interest, among other legal duties. These duties are to protect the shareholders' investments in the corporation. Investors often want at least one representative on the board of directors, since the board formally controls the decisions of the company. However, sometimes investors avoid having any directors and arrange other contractual alternatives in order to avoid the fiduciary duty requirements to act for the benefit of the corporation rather than themselves. The board of directors appoints and may fire the corporation's officers, who are responsible for the day-to-day operations of the company.

• Shareholders: Shareholders are people who've been granted stock by the corporation in exchange for money paid or services performed for the corporation. The shareholders meet annually, at the corporation's annual meeting, to elect the board of directors. Shareholders are not financially liable for the debts of the corporation and are not legally liable for any wrongdoing of the corporation. Investors will be granted shares in exchange for their investment. Typically, they will want "preferred shares, which means that if there are minimal dividends or other negative financial events, they will have priority in getting their money over the "common stock" shareholders.

• Officers: Officers typically include at least a CEO and/or president, secretary and treasurer/CFO. Officers do not have the same heightened level of fiduciary duties to the corporation that the board of directors has.

After You've Incorporated

Once you're incorporated, be sure to follow the rules of incorporation. If you don't, a court can pierce the corporate veil and hold you and the other owners personally liable for the business's debts.

It is important to follow all the rules required by state law. You should keep accurate financial records for the corporation, showing a separation between the corporation's income and expenses and that of the owners'.

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The corporation should also issue stock, file annual reports and hold yearly meetings to elect officers and directors, even if they're the same people as the shareholders. Be sure to keep minutes of these meetings. On all references to your business, make certain to identify it as a corporation, using Inc. or Corp., whichever your state requires. You also want to make sure that whomever you deal with, such as your banker or clients, knows that you are an officer of a corporation.

To make sure your corporation stays on the right side of the law, heed the following guidelines:

• Call the secretary of state each year to check your corporate status.

• Put the annual meetings (shareholders' and directors') on tickler cards.

• Check all contracts to ensure the proper name is used in each. The signature line should read "John Doe, President, XYZ Corp.," never just "John Doe."

• Never use your name followed by "dba" (doing business as) on a contract. Renegotiate any old ones that do.

• Before undertaking any activity out of the normal course of business--like purchasing major assets--write a corporate resolution permitting it. Keep all completed forms in the corporate book.

• Never use corporate checks for personal debts and vice versa.

• Get professional advice about continued retained earnings not needed for immediate operating expenses.

This article was excerpted from the booksStart Your Own Business andEntrepreneur Magazine's Ultimate Book on Forming Corporations, LLC's, Sole Proprietorships and Partnerships, and the articles "Incorporation: Giving Form to Your Business" by Judith Silver and "Incorporating Your Business" by Rick Oster.

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