When it comes to deciding on a business structure, be it a partnership, limited liability company, or corporation, careful consideration should go into the pros and cons of each business type. Corporations are a common choice as they offer limited liability for business owners, who are the shareholders. Due to this, they are often the favored choice for investors as well as large companies.
What is a corporation?
Corporations may be defined as legal entities formed by individuals, shareholders, or stockholders with the primary goal of generating a profit. Therefore, corporations are permitted to own assets, enter into contracts and remit state and federal taxes, as well as loan money from banks and other financial institutions.
Depending on the goals of your business entity as well as the structure of ownership, you may consider different types of corporations:
B corporation
A B corporation, also known as a B-corp, may be formed in some states. While B-corps exist to generate profit, they also have a social mission. Additionally, they are subject to further reporting requirements to exhibit or illustrate how they are furthering their social mission.
S corporation
S-corporations or S-corps have a pass-through tax structure. They are not liable for corporate income tax. Instead, the shareholders are liable for personal income tax on their share of the business’s profits. Ultimately, this results in overall tax rate savings. In order to create an S-corp, you’ll need to form a corporation and then file Form 2553 with the Internal Revenue Service. This must be done to elect the S-corporation status. Additionally, to form an S-corp, you must meet certain requirements, like not having more than 100 stockholders or foreign shareholders and having only one class of stock.
C-corporation
A C-corporation or C-corp is a traditional corp that’s liable for corporate income tax. Many publicly traded, large companies are formed as C-corps. If you want to go public and retain a large sum of your earnings in the business or solicit venture capital, this may be a good choice for you. Forming a corporation is automatically considered a C-corp.
Who should start a corporation?
When it comes to personal liability, corporations offer the strongest protection to their owners. However, the amount of money involved in forming a corporation tends to be higher than in creating other types of businesses or corporate structures. They also require more operational processes, extensive record keeping, and reporting.
Unlike LLCs, partnerships, and sole proprietors, corporations pay income tax on their profits. Corporate profits may be taxed twice in some cases, first when the company makes a profit and the second time when dividends are paid to stockholders on their personal tax returns.
However, corporations have a 100% independent life that’s separate from its stockholders. If a shareholder sells his shares or leaves the company, the business will still go on relatively undisturbed.
Ultimately, when it comes to raising capital, corporations have an advantage since they can raise funds through the sale of stock which is also a benefit when it comes to attracting employees.
For medium or high-risk businesses, corporations are a good choice. For businesses that need to raise money, go public, or eventually get sold, corporations are definitely a good choice.
Advantages of a corporation
Let’s take a closer look at the advantages of incorporation below:
Unlimited life
The corporation owners’ are referred to as members, shareholders, or stockholders. Corporations are governed by a Board of Directors. However, the death or the incapacity to fulfill its duties does not mean that the entity doesn’t continue to operate. Ultimately, changes in the company’s charter will allow it to either be liquidated or extended.
Separate legal entity
Corporations are legal entities that are separate from their owners. Therefore, corporations may own properties, conduct business, sue and be sued, enter into binding contracts, borrow money and pay taxes.
Limited liability
With corporations, the owners of the company are only accountable for the amount invested. Therefore, lenders and creditors do not have a hold or claim to the owner’s personal assets for money owed by the stockholders. This is called liability protection.
Competent management of day-to-day company operations may not be handled directly by owners or investors. This is why the board of directors is elected when the corporation is formed so that the board may serve as a professional and competent governance team.
Easy transfer of shares
When it comes to selling the shares or stock of individual owners, publicly held corporations do not need approval from other stockholders.
Source of capital
Corporations are able to source funds by issuing bonds and selling stocks.
Disadvantages of a corporation
As is the case with every business structure, corporations as well, have a few disadvantages:
Incorporation costs
When compared to the costs of forming a partnership or sole proprietorship, it’s costlier to form a corporation.
Documentation
Aside from the incorporation documents, corporations must file corporate tax returns and annual reports as well as maintain licenses, accounting records, and other important legal documents.
Double taxation
Corporations are taxed twice. So taxes are remitted from the payments of dividends to stockholders as well as from the corporate earnings.
Steps to starting a corporation
The requirements to start incorporation vary from state to state. However, there are some general rules to follow:
1. Decide on a name
The first step in forming your corporation is choosing a business name. The name you choose must be significantly different from the existing business names in the state. You can determine the availability of a name online using your state’s Secretary of State website or, alternatively, another state agency that deals with business filings. Additionally, each state office will contain different rules pertaining to corporation names, and the rules must be complied with.
2. Recruit the board of directors
The Board of Directors is responsible for overseeing the operations of the corporation. So you will need to appoint an initial board. However, you may choose to replace the board with a more permanent one once a corporation has been created.
3. File Articles of Organization
When starting a corporation, you will need to file a document called the Articles of Organization or Articles of Incorporation. This document must be filed with the state business filing agency or Secretary of State. The process is usually done online, but requirements can differ from one state to the next. The Articles of Incorporation should include the following information:
- The corporation’s name
- Its purpose
- The principal place of business
- The addresses and names of the initial board
- The registered agent’s address and name
You’ll receive a Certificate of Formation once the articles are approved.
4. Create corporate bylaws
In order for your corporation to be recognized legally, you need to create corporate bylaws. These are the regulations and rules of the company outlining how it will be managed. You may choose to submit the bylaws either before or after you’ve submitted your formation documents.
When submitting your bylaws, include the following:
- The role of each officer
- The date the annual shareholders meeting takes place
- How business decisions are made
- Where and when dividends are paid
- The percentage of shareholders needed to make decisions
5. Hold a meeting for the initial board of directors
After creating the bylaws and your corporation has officially been formed, you need to hold a meeting for the Board of Directors. You may do so following the guidelines in your bylaws. During this meeting, you need to undertake a few actions, including approving the bylaws, appointing a permanent Board of Directors, appointing officers to take care of the day-to-day activities, authorizing the issuance of shares of stock as well as establishing the corporation’s accounting year. All meetings that include the Board of Directors must be recorded, and these records must be kept in a safe place.
6. Issue stock
One of the first things you need to do after formation is issue stock to the shareholders. When doing so, ensure that a record of the number of shares issued to each stockholder, as well as the price paid, is recorded.
7. Create a shareholder’s agreement
The shareholder’s agreement is optional; however, it can contribute to the success of your business in the long run. The shareholder’s agreement is a contract between the shareholders of a small company. It aims to determine how ownership will be managed in the event that a shareholder retires, dies, becomes disabled, or decides to leave the company. You can help avoid disagreements in the future and also ensure business continuity by signing a shareholders agreement.
8. Get an EIN
An EIN is also known as an Employee Identification Number. It’s a code assigned by the IRS to identify your business mainly for tax purposes. The EIN is also required when it comes to setting up payroll withholding, opening a bank account, and setting up state tax accounts. The EIN is free of charge when obtained from the IRS website.
9. Secure licenses and permits
Every business needs to secure relevant licenses and permits. However, depending on where you’re located and the type of industry you’re in, the requirements will vary from state to state. The SBA (Small Business Administration) contains a chart of industries that are subject to federal licensing. Feel free to reach out to local and state governments to determine what licenses and permits are required to legally operate your business.
FAQs
Are all corporations for-profit?
Most corporations are created to determine profit for their shareholders. But in some cases, corporations are created for other reasons, and these entities can include fraternal organizations or charities on nonprofit corporations or not-for-profit.
Do I need a DBA for my corporation?
A DBA is also referred to as a doing business as name, and although it’s not a legal requirement, if you plan on conducting business under any other name aside from the business’s legal entity name, then a DBA is necessary. The purpose of the DBA is to allow the public or potential customers to know who the real owner of the business is.
Who regulates public corporations?
Corporations are created or formed under the laws of the individual states in the US. Therefore, they are regulated by state laws. However, in the case of public corporations, they are regulated by federal law and mainly overseen by the Securities and Exchange Commission.
What is the difference between a general partnership and a close corporation?
Partnerships and corporations are different business structures. However, corporations are more complex than partnerships and include more people in the decision-making process. A partnership contains a minimum of two or more people that share ownership, while a corporation is an independent and separate legal entity owned by shareholders.
What is a corporation also referred to as?
A corporation is referred to as a C Corp or legal person due to the fact that it is considered a legal entity that is separate from its owners. When it comes to LLCs vs. corporations, they are similar in that they are both formed under state law, and both these corporate structures give you personal liability protection.