Think of incorporating your business? Read this article to find out all about
Incorporating Tips – Capitalization
By Richard Chapo
Capitalizing a new business entity is a critical step of the formation
process. Failing to take the step can lead to serious legal problems if the
entity is ever sued. So, what is capitalization and what steps must be taken?
Capitalizing Your Corporation
“Capitalization” essentially refers to funding your corporation. In essence,
you are providing substance to the entity in the form of money or property.
Typically, the funding process works in two ways.
You must own stock in a corporation to be considered a shareholder. You are
already familiar with this concept if you trade on the stock market. For
instance, assume you bought stock in Sirius Radio in anticipation of Howard
Stern moving to the station. You purchased stock through a brokerage or
retirement vehicle by exchanging money for shares. Technically, you are a
shareholder in the corporation. Your own corporation is no different.
The fact that you paid money to have a corporation formed does not make you a
shareholder. You must exchange property, cash or services to obtain stock from
the entity. Only then are you a shareholder in the entity. This is more easily
explained with an example.
Assume I start a corporation for the purpose of providing consulting services
to other businesses. The corporation is formed with 10,000 shares and I am going
to be the sole shareholder. I have cash and certain assets that I am going to
use as part of the business. I decide to exchange $3,000, a copier, fax machine
and computer equipment for stock in the entity. This exchange should be reduced
to writing, but will constitute the capitalization of the corporation.
You can also loan money to a corporate entity for start-up costs. There is no
prohibition against a shareholder providing money to a corporation. The loan
process should not completely replace the purchase of stock. From a tax
perspective, however, dividing your initial capitalization into a partial loan
can have distinct advantages.
State laws govern the formation of a corporation. Inevitably, these laws set
forth amounts or formulas for determining the minimum capitalization amount
required for a corporation. You must review the laws in your state to determine
the amount and make sure you meet the contribution minimums.
Failure to properly capitalize you corporation can result in disaster if the
entity is ever sued. Simply put, the suing party may argue that the lack of
capitalization means the corporation was never a viable entity because it had
insufficient funds to back debt obligations. The argument gets complicated, but
suffice to say you are in serious trouble if a court agrees with the argument.
Typically, the court will “set aside” the corporate entity, exposing each
shareholder, director and officer to the risk of personal liability. Obviously,
such a scenario would be a disaster.
If you’ve purchased a corporation from online service, you have work to do.
Make sure you determine the minimum capitalization requirements in your state
and comply with them.
Richard A. Chapo is with
http://www.sandiegobusinesslawfirm.com - providing legal services to
businesses in San Diego and California.
Article Source: http://EzineArticles.com/