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Posted on January 25, 2022 by Thomas Lester

Capitalizing a new business entity is a vital step of the formation procedure. Failing to take the step may result in serious legal problems if the entity is ever sued. Thus, what's capitalization and what actions must be taken?

Capitalizing Your Corporation

"Capitalization" basically refers to financing your corporation. In essence, you're providing substance to the thing in the kind of cash or property. Normally, the funding process works in two ways.

Corporate Stock

You must own stock in a company to be considered a shareholder. You're already familiar with this concept if you exchange on the stock exchange. As an example, assume you purchased stock in Sirius Radio in anticipation of Howard Stern moving into the channel. You bought stock through a broker or retirement vehicle by exchanging money for stocks. Technically, you're a shareholder in the business. Your own corporation is the same.

The fact that you paid money to have a company formed doesn't make you a shareholder. You have to exchange property, services or cash to receive stock from the thing. Only then are you a shareholder in the thing. This is more easily explained with an example.

Assume I begin a company for the purpose of providing consulting services to other companies. The company is formed with 10,000 stocks and I will be the sole shareholder. I have money and certain assets that I will use as part of the enterprise. I decide to swap $3,000, a copier, fax machine and computer equipment for inventory in the thing. This exchange ought to be reduced to writing, but will constitute the capitalization of the corporation.

Corporate Loan

You may also loan money to a corporate entity for startup expenses. There's absolutely no prohibition against a shareholder supplying money to a company. The loan process shouldn't completely replace buying stock. From a tax standpoint, however, dividing your initial capitalization to a partial loan may have different benefits.

Inadequate Capitalization

State laws govern the creation of a corporation. Inevitably, these laws set forth amounts or formulas for determining the minimum capitalization amount needed for a corporation. You have to examine the laws in your state to ascertain the amount and be sure you meet the contribution minimums.

Failure to correctly capitalize you corporation could lead to disaster if the entity is ever sued. To put it simply, the suing party may assert that the absence of capitalization means the corporation wasn't a viable thing because it had insufficient funds to back debt obligations. The argument becomes complex, but suffice to say you're in serious trouble if a court agrees with the argument. Normally, the court will"set aside" the corporate thing, exposing each shareholder, officer and director to the possibility of personal liability.

Clearly, such a scenario could be a disaster.

In Closing

If you have obtained a corporation from online company, you've got work to do. Be certain that you determine the minimum capitalization requirements in your state and comply with them.