If you’ve ever asked yourself “What is a corporation?” and wondered about all the intricacies of creating and managing one, our article will provide useful insight into the process. We’ll start by defining what a corporation is and exploring the most common types of corporations. Furthermore, we’ll elaborate on all the advantages and disadvantages of forming a corporation in order to help you get a clear idea about whether this business structure is right for you.
At the end of our article, we added a section that details all the steps necessary to form a corporation, such as writing bylaws and selecting a name. Additionally, we included a detailed FAQ section that goes over some common dilemmas, like explaining the difference between a corporation and a company.
Before we move on to discuss the potential advantages and disadvantages you can enjoy if you decide to form a corporation, let’s define precisely what a corporation is.
What Is a Corporation?
A corporation is a type of legal entity that’s recognized by the state, owned by individuals, other entities, or shareholders, whose goal is to make a profit.
One of the main differences between corporations and other business entities is that the owners of a corporation are entirely protected from personal liability due to the fact that corporations are recognized as separate legal entities. In other words, the corporation and its assets are liable in case of a lawsuit or a debt, not the personal assets of its owners.
In order for a corporation to be formed, it has to pass a process called incorporation. This process entails the drafting of various legal documents required for the formation of the corporation, such as the name of the business and its location.
Before the business starts operating, the owners have to name a board of directors who are typically elected by the shareholders of the corporation. The role of the board of directors is to make decisions on behalf of the shareholders and manage the operations of the corporation.
But not all corporation are the same, so let’s explore that in the lines to follow.
Types of Corporations
These are the most common types of corporations.
A C corporation, the most common business structure in America, is a type of corporation where the owners/shareholders are taxed separately from the corporation as a legal entity. It’s named after the subchapter of the Internal Revenue Code (subchapter “C”) where regulations regarding taxing are described. One of the main advantages of C corporations is that they can be owned by entrepreneurs who live outside the US.
Another common type of corporation is an S corporation. An S corporation differs from a C corporation in terms of taxation – the owners/shareholders aren’t taxed separately, but the profits and losses of the corporation are included in their personal tax return. The owners get to enjoy all the benefits associated with forming a corporation without the double taxation. An S corporation can have up to 100 shareholders.
Just like their name suggests, non-profit corporations are corporations which don’t generate any profit. They can exist for a specific cause or to serve the general public good. One of the greatest advantages of non-profit corporations is that they’re exempt from paying taxes.
Limited Liability Companies
A limited liability company (LLC) is a business structure that protects its owners from personal liability in case of a lawsuit, claim, or company debt. The laws and regulations regarding LLCs differ from state to state. This type of business entity isn’t liable for double taxation – the members of the LLC report the profits and losses on their personal tax returns. This, along with other advantages like having an easy set-up, make LLCs one of the most appealing business structures in the US.
A public corporation is a corporation that’s owned and managed by the state itself.
A conglomerate corporation is a type of corporation that owns and manages various smaller corporations.
Advantages of Forming a Corporation
Let’s explore some of the biggest advantages that come with forming a corporation.
One of the biggest reasons business owners choose to incorporate their business is because of limited liability. A corporation allows its owners to protect their personal assets, like cars, real estate, and equipment, in case something goes wrong. Instead, the assets of the corporation would be up for grabs.
In case of a financial emergency, corporations can rely on selling stocks to get more money. Shares can be sold at any time to fellow investors, and investors typically find corporations more credible than other types of business entities. Additionally, corporations have a higher chance of being granted a business loan from a bank since they’re seen as more reliable and profitable in the long run. Ultimately, corporations have better access to capital than sole proprietorships or partnerships, which can be a useful benefit if you have big dreams and ambitions regarding your business.
Business entities like sole proprietorships and partnerships are incredibly vulnerable to being liquidated due to the smaller number of owners. In case of an illness or death, the business is either terminated or transferred to another owner. With corporations, there’s rarely a risk of liquidation. In case a stockholder or an owner needs to take time off or is unable to follow through with some professional arrangements, the other members or the board of directors would be able to take over without major complications. Business would continue as usual and there won’t be any major financial losses.
Knowing your time off won’t cause any damage or financial loss to the business certainly takes away some of the stress associated with running a business, which is one of the reasons many business owners opt for a corporation instead of a partnership.
Easier Transfer of Ownership
The ownership of a corporation is easy to transfer, and the shares are easily traded and sold. In case a corporation undergoes a change of ownership, its structure and operations would remain the same.
Generally speaking, corporations are deemed more credible than sole proprietorships. Potential customers, partners, and investors find incorporated businesses to be more stable in terms of capital, which leads to more success in the long run.
It’s easier for the owners of a corporation to get a retirement plan and qualify for a retirement fund.
The tax benefits corporations have access to depend on the type of corporation in question. For instance, C corporations are double-taxed, but S corporations aren’t subject to separate taxation. On the other hand, C corporations are able to deduct the losses on business operations from their corporate tax returns.
If your business qualifies for it, you can also deduct the cost of some of your assets and equipment, for instance, if you’re using your own vehicle for the purpose of the business.
Disadvantages of Forming a Corporation
On the flip side, there are also some disadvantages that come with forming a corporation which we’ll explore below.
C corporations undergo double taxation, which means that the owners are obliged to pay taxes both on a corporate and an individual level. This is the primary reason why so many entrepreneurs prefer S corporations over C corporations.
Hard to Set Up
The set-up process of corporations can take a while and be quite complicated. For instance, you need to file articles of corporation, which is a process that can take some time, up to four weeks in certain states.
Contrary to other business structures like sole proprietorships, corporations can be quite pricey to form and operate. You’ll have to have more capital at your disposal when you’re first starting the business, pay ongoing fees like articles of corporation, and pay higher taxes. Needless to say, these fees are higher for corporations than they are for sole proprietorships and partnerships, so keep that in mind when you’re deciding what business structure you should opt for.
Since it is a more complex structure, corporations automatically come with more paperwork and the need for extensive record keeping. You’ll need to file annual reports and tax returns, which can be quite time-consuming. Some businesses need to obtain additional licenses and permits. If you don’t like the thought of spending hours doing paperwork (or paying someone else to do it for you), you might be better off choosing another business structure.
Corporations require many ongoing formalities, such as selecting members for the board of directors, holding annual meetings, and filing annual reports. Plus, you’ll have to maintain separate bank accounts for all the owners and stay on top of the financial records.
Managing a corporation is naturally more time-consuming, so your work-life balance might suffer because of it.
How to Form a Corporation
Now that we looked at some of the advantages and disadvantages that come with forming a corporation, let’s elaborate on all the steps it takes to form one.
Choose a Name for Your Business
The first step to creating a corporation is choosing the name of your business. You can’t choose a name that’s taken by another corporation, so ensure that your name of choice is unique. You can skip the guesswork and save yourself a lot of time by executing a trademark search. While this is a costly service, it’s an amazing option for those who don’t have a lot of time to spare and are looking to speed up the process of forming a corporation.
The regulations in most states require you to add a corporate designation next to your business name. This could be simply Corporation (Co) or another designation of choice. It’s important to note that each state has a designated list of restricted words you can’t use in your name, so make sure you research that aspect.
File Articles of Corporation
The next step is filing articles of corporation. This includes all the necessary legal documents required by your state in order to start your business. Usually, they are the name and location of your business, the type and purpose of your business, and information regarding the stocks. If you want, you can always hire a legal advisor to help you with this step.
Appoint a Board of Directors
A board of directors is obligatory for every corporation, so, naturally, one of the first steps in forming a corporation is appointing the board’s directors by the shareholders. As we mentioned earlier, the role of the directors is to make decisions, manage the business, and choose corporate officers.
Write Corporate Bylaws
Composing your corporate bylaws is an important step in forming a corporation and it’s required in most states. Typically, these include general information about your corporation such as the name of your business, its location, and the name of the directors and owners.
Bylaws are important because they detail the rules and guidance about how you will conduct your business. They elucidate how the owners and directors will handle meetings, the duties of each person involved, and rules regarding how your business will operate.
Writing bylaws ensures that your business remains credible in case a lawsuit or a loan occurs.
Compose a Shareholder Agreement
A shareholder agreement is crucial in case you need to transfer the ownership of your corporation, or in case of an unfortunate event, like an owner’s death. If you want, you could ask for help and hire a consultant who could help you draft the agreement.
Issuing the shares of stock can happen after it’s been approved by the board of directors. Once approved, you can start distributing the initial stocks to the investors and increase the number of stocks over time.
Be Ready for Taxation
By this stage, you’ll need to have gotten acquainted with all the rules and regulations regarding taxation in your state. Next, you’ll want to obtain a specific tax ID number from either your state revenue agency or the Internal Revenue Service. Make sure you keep records of your taxation right from the get-go.
Start Your Business
Congratulations, now your corporation is ready to be up and running!
How to Dissolve a Corporation?
A common question among those looking to form a corporation is what happens if the owners decide to dissolve it. In order to dissolve a company, you need to liquidate it. This process entails the selling of the assets of the corporations and dividing the profits between the shareholders. Usually, liquidation is required in case of bankruptcy.
What Is the Difference Between a Corporation and a Company?
Distinguishing between a corporation and a company can be a hard task. Here’s how to tell the difference between these two business structures.
The main difference between a company and a corporation is that a single owner or multiple owners own a company, whereas a corporation is owned by its shareholders. Additionally, a corporation is usually bigger than a company. Corporations require a minimum amount of capital in order to be formed, whereas companies don’t. Many types of companies don’t have double taxation, whereas corporations are subjected to paying double taxes.
What Are the Characteristics of a Corporation?
Corporations have certain characteristics that make them distinct from other business structures. These characteristics include having a long lifespan, being appealing to investors, issuing dividends, having limited liability, and ownership based on the acquisition of shares.
Is Corporation the Same as a Business?
A corporation is a business structure that operates as a separate legal entity than its owners.
That brings us to the end of our article all about corporations and their advantages and disadvantages. We hope you found it informative and that it helped you get a better idea about whether your ambitions are compatible with this type of business structure.
There are several types of corporations you can choose from such as C corporation, S corporation, and a non-profit corporation. They all share some incredible benefits, like being more credible than other business structures, having a long lifespan, having more capital at the owners’ disposal, and having limited liability. Unfortunately, there are also some disadvantages you need to be aware of, such as more paperwork and being difficult and expensive to set up.