Over 4.4 million businesses are started each year. This means, there are a lot of entities that need to be formed. While there are different types of entities and reasons for using each one (we describe more in this article), we want to focus on corporations in this article.
A corporation is a legal entity that exists separately from its owners, known as shareholders. It is a popular business structure that provides limited liability protection to its shareholders, offers opportunities to raise capital, and allows for perpetual existence. In this article, we will delve into what a corporation is, explore its limitations, and highlight situations in which a corporation should be considered as the preferred business entity.
What is a Corporation?
A corporation is a formal and legally recognized business entity that is created by individuals or groups of individuals to conduct commercial activities, generate profits, and shield shareholders from personal liability. The corporation operates independently from its owners, owning assets, entering into contracts, and engaging in business transactions in its own name.
The primary characteristics of a corporation include:
: Shareholders' personal assets are typically protected from the corporation's debts and legal liabilities, offering a safeguard against financial risks. (This excludes taking illegal actions)
Separate Legal Entity
: A corporation is treated as a distinct legal entity, which allows it to conduct business and own assets in its own right.
: Corporations have continuous existence, unaffected by changes in ownership or the departure of shareholders.
: A board of directors, elected by shareholders, oversees major decisions, appointing officers to manage daily operations.
: Corporations can raise capital by issuing shares of stock to investors in exchange for funding.
Limitations of a Corporation
Despite its advantages, corporations have certain limitations and considerations, including:
: One of the most significant drawbacks of corporations is double taxation. Corporate profits are taxed at the corporate level, and if dividends are distributed to shareholders, those dividends are taxed again at the individual level. (You should consult with a tax professional regarding on all matters involving tax)
: Corporations require more formalities, paperwork, and reporting obligations compared to other business structures.
Costly Setup and Maintenance
: The initial formation of a corporation and ongoing administrative requirements can be more costly compared to other business entities.
: The hierarchical nature of corporations may limit flexibility in management and decision-making compared to other structures like LLCs.
: Corporations with multiple shareholders may be more prone to internal disputes and conflicts. (Take the time to work with a professional and figure this out up front - most issues and most cost comes from the “break up” of a business)
When to Consider a Corporation
Choosing a corporation as the business structure should be considered under the following scenarios:
Limited Liability Protection
: If protecting personal assets from business debts and legal liabilities is a top priority, a corporation can provide strong liability protection for shareholders.
: If the business intends to raise capital through the sale of stock to outside investors, a corporation may be more attractive due to its ability to issue various classes of stock.
Going Public: For companies aspiring to go public and offer shares to the public through an initial public offering (IPO), a corporation is typically the preferred structure.
: Corporations are well-suited for larger businesses with a complex ownership structure and a need for centralized management.
: If the business plans to operate internationally or expand its reach across borders, the formal and recognized structure of a corporation can be beneficial.
A corporation is a distinct legal entity that offers limited liability protection and various opportunities for growth and investment. While it has certain limitations, its ability to raise capital and provide liability protection makes it an appealing choice for larger businesses, companies seeking outside investment, and those planning to go public. As with any important business decision, it's essential to carefully evaluate the specific needs and long-term goals of the business, seeking advice from legal, financial, and tax professionals to make an informed choice about the most suitable business structure.