How is a Corporation Defined?
When a company forms, it needs a structure to define it. Many times, that structure takes the form of a corporation. A corporation is an entity that meets certain legal requirements to be separate from its owners, who share in both losses and profits produced by the business’ operations. Almost every large company is a type of corporation, and every publicly traded company has a corporate structure.
There are several different types of corporate structure, and the nature of a corporation plays a role in how it operates. For everyday individuals, these differences are trivial; however, for the companies and owners themselves, they’re an important consideration. Corporate structure determines everything from taxation to share structure. And while corporate structures can change, the decision to operate as a certain type has major bearing on how they’re regulated.
Here’s a look at corporations: how they’re defined, the different types and the rules that govern them.
How to Form a Corporation
Forming a corporation is a complex process that requires forethought to everything from what you’ll call yourself, to the structure you want to incorporate as, to the state you want to incorporate in. Without going too deeply into the details, the formation of a corporation generally follows these steps:
- Choose a Business Name. The first step in creating a corporate entity is naming it.
- Register the Business. Registration processes and standards vary from state to state.
- Appoint Directors. Directors oversee the governance of the company and its direction.
- File Articles of Incorporation. This is the actual paperwork to incorporate the business.
- Write Corporate Bylaws. These standards govern the company’s purpose and mission.
- Draft a Shareholders’ Agreement. This is the share allocation and structure of equity.
- Convene the Board of Directors. The board meets to confirm the company’s formation.
This process is far, far more nuanced than these steps illustrate. Each step takes careful planning and precision, and generally involves filing paperwork, meeting with counsel and paying for services related to incorporation. All told, the process can take some time and costs no small amount.
Different Corporate Structures
One of the most important decisions any corporation needs to make is the structure of the entity. There are three types of corporate structures to consider.
- C-Corp. This is the “standard” corporation structure. C-Corps get all the freedom that comes with incorporation—and the burdens of its drawbacks, including double taxation.
- S-Corp. This structure means the company was incorporated under Sub-Chapter S of the tax code. They’re limited to 100 shareholders and have pass-through tax status.
- B-Corp. B-Corps are essentially C-Corps, but with a commitment to social responsibility and stewardship. B-Corps are held to higher standards of corporate governance.
Non-profit corporations also exist. These corporations enjoy all the benefits of for-profit corporations, yet do not exist to generate profit. Moreover, board members are also not allowed compensation to serve in the role—they’re effectively volunteer advisors.
The Advantages of Incorporating
There are significant benefits to incorporating. Businesses that incorporate unlock opportunities for growth, as well as certain protections not available to LLCs or other business entities.
- Legal status. A corporation is often referred to as a “legal person,” because it can engage in many of the same practices a person might. This includes entering agreements, signing contracts, borrowing money, suing, owning assets, hiring employees and much more.
- Liability protection. Alongside the legal status of an incorporated company comes liability protection for its owners. Owners aren’t liable for any more than they’ve invested in the company and don’t bear the weight of things like bankruptcy.
- Unlimited lifespan. Because corporations have management bodies (like a board of directors), they’re not tied to any one person. They live on for as long as the company is profitable and able to maintain its operations, regardless of ownership turnover.
- Capital raising capabilities. Corporations can issue shares and bonds, which means they have access to public and private markets. They’re able to sell debt and equity to raise capital.
Disadvantages of Incorporating
While there are plenty of reasons to incorporate, there are some drawbacks to consider. Keep in mind that entity structure can alleviate some of these headaches. Moreover, the benefits far outweigh the cons for companies that achieve success.
- Incorporation cost. There are significant costs that come with incorporating and for maintaining corporate structure—especially as the business grows and becomes more complex.
- Incorporation documentation. Corporations need to provide significantly more documentation about their activities than LLCs and other business types. For example, this includes annual reports, tax returns, accounting records, licensing paperwork and much more.
- Double taxation prospects. Corporate structures can face double taxation in one of two ways. Corporations must pay a tax on earnings. In addition, owners must pay tax on their income from the corporation. There is also a tax on shareholder dividend payments.
Corporations, in a Nutshell
Corporate structure unlocks a world of potential for businesses. It not only safeguards owners from liability, it also facilitates access to capital and opens the door to hiring employees. Simply put: incorporation is the path to growth and all the benefits that come with it. As businesses think about the future, their corporate structure needs to be a key point of understanding.
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Whether they incorporate as the entity they’ll grow into or change the structure over time, corporations need to understand how being a “legal person” affects them. Thankfully, it’s often as simple as following the example of successful corporations, from Amazon (NASDAQ: AMZN) to Zoom (NASDAQ: ZOOM).