Advantages and Disadvantages of a Corporation: Everything You Need to Know
The simple definition of a corporation is a legal business entity that exchanges ownership of a company, also known as stock, through shares. 3 min read
What Is a Corporation?
Before discussing the advantages and disadvantages of a corporation, we must first understand what makes up a corporation. The simple definition of a corporation is a legal business entity that exchanges ownership of a company, also known as stock, through shares.
Whether private or public, a corporation has investors and it must operate in the best interest of those investors at all times. Thus, a corporation is a group of people collectively serving as one legal entity and pursuing one goal: to generate the highest net return for its shareholders.
Advantages of Forming a Corporation
When it comes to deciding on a business entity, there are several benefits to choosing the corporation designation. One of the most important benefits to the corporation is that, in most cases, the owners are not personally liable for any debt or legal judgements associated with the corporation. In other words, if a company files bankruptcy and doesn’t have enough assets to fulfill the obligation, the shareholders will not be personally liable.
Another advantage to the corporation designation is the ease of funding. Corporations can transfer ownership by buying or selling its shares. Public corporations have a much easier time than private-companies to exchange shares, but regardless corporations offer its members the easiest means for transferring ownership.
Unlike other businesses, a corporation has no limit to its life. If owners die or want to dissolve their shares, they simply sell or transfer their ownership to someone else. The only way a corporation ends is if it deliberately ended through liquidation or other means.
Another benefit to the corporation is the tax liability separation. A corporation’s taxes are independent of your personal taxes. As an owner, you only pay taxes on the salary or dividends paid to you by the corporation. The corporation has separate corporate taxes which are taxed at a separate rate than your individual taxes.
Disadvantages of Forming a Corporation
Forming a corporation does have disadvantages. If you want to form a corporation, it will require investing more money and time than if you went with another business entity. You will need to file the appropriate registration, fulfill capital requirements, and formally list your corporate directors among other things.
Additionally, there are legal requirements and annual documentation that must be submitted. Because there are many government agencies that monitor corporations, fulfilling the paperwork necessary to meet all requirements can be cumbersome.
Another disadvantage to corporations is the double taxation that happens when dividends are paid to shareholders. Corporate taxes must be paid on profit at the corporate-level and again at the individual level. This double taxation can be avoided if your corporation is able to file as an S corporation. The S corporation files a Form 2553 to the IRS which eliminates the double taxation that C corporations are forced to pay.
Management Structure in a Corporation
An interesting note about corporations is that as ownership dilutes it can become difficult for owners to provide insight or direction. When there is no clear or definitive direction, the corporation’s management team can make executive decisions, as long as they act with the best interest of the owners or shareholders in mind.
As ownership spreads out and shareholders increase, a board of directors is often chosen to make decisions for the entire corporation. The board of directors are also tasked with selecting the management team. One of the difficulties with running a corporation is the dissemination of power and the loss of accountability as control spreads. This lack of accountability can lead to what is known as the “agency problem” which is when management makes decisions based on their self-interest instead of the interest of shareholders.
Public vs Private Corporation
Corporations can choose to be privately-held or publicly traded. A private corporation has a centralized group of investors that have limited options for transferring or selling their shares. Because it is privately-held, a shareholder cannot sell their shares in an open marketplace to the general public.
The other option for corporations is to be a public company which means the shares of the corporation can be bought and sold to the general public. To become a public company, one must register their shares for sale with the Securities and Exchange Commission (SEC). When a company does go public, they will issue an IPO or initial public offering.
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