Definition of corporation
The corporation is a separate legal entity. It is considered a legal person who can hire employees, sue, be sued, pay taxes, own liabilities, borrow money, and enter into the contract etc. The best part of this legal business structure is that its life is not dependent on the members and there is a separate liability.
Advantages of Corporation
Following are some of the advantages of forming a corporation.
- Limited liability
- Separate legal entity
- Convenient Capital Generation
- Longevity and Transferrable Ownership
- Enhanced credibility
Unlike a general partnership and a sole proprietorship, where the business owners have unlimited liability, the owners of a corporation have a limited obligation to pay off the corporation’s debt. The credit-paying liability of the corporation is limited to assets owned. In other words, owners’ risk is limited to the amount invested in the business. So, it provides shareholders security against the loss of their personal assets and legal complications.
Separate Entity Benefits
Being a separate entity in the eyes of the law, a corporation can enter into legal obligations like a contract, guarantee, investment, legal disputes, sale and purchase of the property etc. It’s important to note that a corporation is a legal person and can do multiple statutory tasks and owners are not required to be part of it in personal capacity.
Convenient Capital Generation
For corporations, it’s comparatively easier to raise finance. It’s because they have multiple options including debt and capital investment which is gained through issuing stocks in the market. Initial Public Offerings (IPO) and other publicly traded stocks and bonds are effective means to raise capital from the general public.
Large number of Owners
A sole proprietor is a single owner and a partnership has a limited number of owners. Still, a corporation has a large number of owners as anyone who invests in the company takes a portion of its ownership. Here, a C-Corp can have an unlimited number of owners while an S-Corp can have a maximum of 100 owners. The benefit of larger number of owners is that it becomes much easier to raise finance.
Longevity and Transferrable Ownership
Another benefit of the separate status of a corporation is that it continues to exist even if its owners die or become bankrupt. The ownership can be easily transferred by selling those stocks. On the other hand, there are often problems with sole proprietorship and partnerships etc.
Most people would choose McDonald’s over a newly established fast food restaurant. This is because of the perpetual existence and credibility of McDonald’s. Similarly, any other well-established corporation would be preferred over startups or partnerships as corporations are formed in compliance with the state requirements after going through rigorous legal procedures.
Disadvantages of Forming a Corporation
Following are some of the disadvantages of forming a corporation.
- Formation can be problematic
- Less control over business
- Double taxation
Formation can be Problematic
The formation of a corporation is a difficult process that takes significant time, big fees like filing fees, attorney fees, and other expenses. At the same time, proprietorship and partnerships are relatively easy to form and dissolve.
Diluted control over the business
As a disadvantage, the business owners have lesser control over the separate entity of the corporation. The management or board of directors takes the important business decisions (although shareholders vote for the same but continuous monitoring is difficult).
So, this might give rise to the ‘agency problem’ where managers and owners might have a conflict of interest resulting in negative outcomes.
Excluding S Corp, the C-corporations are subjected to double taxation. It means earnings of C-Corp are taxed twice. First, the corporation has to pay taxes on the business profit. Secondly, shareholders have to pay taxes on receipt of dividend.
Corporation is considered to be a legal entity with the right and ability to do legal tasks the same as a real person. There are multiple advantages and disadvantages to forming a corporation as a business structure. The advantages include limited liability, separate legal entity, longevity, ownership transfer, credibility, etc. On the other hand, disadvantages include excess formalities information of the corporation, diluted control over the business, and double taxation etc.
What are the steps to form corporation?
Following are the main steps involved in the formation of a corporation:
- Choosing a corporation name that has to comply with the state regulations regarding business names.
- Creating articles of association, memorandum of association, corporate bylaws, founder’s agreement, and other important documents.
- Appointing an attorney, legal advisors, Board of directors, registered agent, and other staff.
- Obtaining business licenses and permits from regulatory bodies like local and state governments.
Also read, Accounting true up