When establishing a business, owners have a few different options as far as what type of business structure they want to create—one such structure is a corporation. Corporations generally have shareholders and operate on a for-profit basis. When forming a corporation, the owner(s/) will have to file legal documents; these are called Articles of Incorporation. These will include the basic information regarding the business as well as the company's legal name and the number/type of stock sold. In establishing the corporation and filing the articles, the business owners are thereby protected from any liability with which the company itself might have to deal. In this article, we look closer at what exactly a corporation involves.
Different Types of Corporations
A corporation can be founded by an individual or by multiple shareholders. Most often established as a for-profit organization, some can be set up as not-for-profit companies. In the for-profit scenario, the company is designed to earn revenue and thus provide dividends to its shareholders. The shareholders will receive an amount as reflected by the percent ownership they have in the business.
Not-for-profits are generally seen as charitable organizations. Instead of distributing dividends from any money earned, the funds go back into the corporation to further the cause(s/) on which the entity is focused.
There are essentially three kinds of corporations that can be set up. They are as follows:
C Corporation
A-C Corporation is usually the most common among the three options. It has all of the benefits and attributes of a corporation but it also has a double taxation component. In other words, the company itself gets taxed and then the profits distributed to shareholders also get taxed at the personal level as income.
S Corporation
With an S Corporation, you do not have a double taxation factor. Instead, the profits/losses are only taxed as a shareholder's income. Also with an S Corp, there are some limitations as far as ownership goes. An S Corp can only have up to 100 owners.
Non-Profit Corporation
This again is a structure that you will find most often with charitable organizations. Non-profits are usually tax-exempt and any money received by the organization is used to further the charitable cause on which they are working.
Understanding How a Corporation Works
Before launching the business, a corporation must have a board of directors in place. The board members are elected by the shareholders. Shareholders' votes on such matters are generally determined by the number of shares they hold. They usually though are not part of managing the business itself. A shareholder can however be a board member or also an executive officer of the company as well.
As far as the board of directors goes, this is a group that in effect represents the shareholders and to that end, makes major decisions regarding the company. A board of directors will also be tasked with establishing the policies that will be used in the context of company management. In setting up the policies and voting on company decisions, the board of directors needs to act in the best interests of the shareholders who elected them.
The Advantages of Incorporating
- Separate entity – This is perhaps the biggest advantage of establishing a corporation versus say a sole proprietorship or partnership. The business is a separate legal entity and has no connection with the owners since the owners cannot be personally sued for any action against the business. Additionally, if the company accrues major debts, creditors cannot go after the business owners' personal assets to try and recoup their losses.
- Extends beyond the life of the owner – The owners of the company are the stockholders; the decisions of the company and management is in the hands of the board of directors. So the business itself does not hinge on one individual. When people pass away, the company will not necessarily come to an end as is the case with a sole proprietor in most instances.
- Limited liability – As noted above, creditors and lenders cannot come after the owners of the company to recover any losses experienced. The shareholders are only liable for however much they invested in the business.
- Easily sell shares – If the corporation is publicly held, they can easily trade stocks on the market. So this way, if they do need to raise additional capital, they have the option of selling off more shares of the company to get the money needed.
- Solid management team – The owners of the company don't necessarily handle the day to day operations and management thereof; rather, with a corporation, the board of directors is usually tasked with hiring a high-level managing team for the firm.
Few of the Disadvantages of Incorporating
- Initial costs – Starting a sole proprietorship is going to be the cheapest way to go when launching a business. That said, incorporating can be a costly process as you will likely need to enlist an attorney's help.
- Double taxation – As mentioned, with a C Corp there is the double taxation element. Taxes are paid on both corporate earnings as well as on dividends paid out to stockholders.
- A lot of documentation – With a corporate structure versus a sole proprietorship, there is going to be a lot more paperwork involved. Corporations must file annual reports; they have to maintain more detailed records and the bookkeeping end of things is going to be quite a bit more involved as well.
When Does a Corporation End?
When the relevant stakeholders agree that it is time to dissolve the corporation, they will undertake the process of liquidating. So all assets will be sold off and any creditors paid. Anything that's left is divided among shareholders of the corporation.
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