Corporate Entity: Everything You Need to Know
A corporation is a type of corporate entity that is formed specifically to perform activities while being officially treated in many ways as an individual.8 min read
A corporation is a type of corporate entity that is formed specifically to perform activities, such as running a business, while being officially treated in many ways as an individual. Although it may consist of many different people, such as directors, officers, and shareholders, a corporation is a legal entity in and of itself.
Separate from all others, a corporation may, among many other things:
- Sue and be sued
- Buy property
- Open a bank account
- Participate in contracts
- Issue stock
Everyone who buys stock in a corporation owns a part of it. Directors and officers control the corporation and oversee its operations. Yet the corporation legally remains a completely distinct entity from all of them.
Additionally, the artificial form of the corporation allows for perpetual succession. So it may technically live forever unless it is dissolved.
Process of Forming a Corporation
Articles of Incorporation are filed with the Secretary of State in the state where the corporation wishes to be registered. That does not need to be the same state where the corporation will do business. There are some states which are noted for having very favorable implications for companies that register in them. However, that means the corporation will be required to register as a "foreign" corporation in the states where they actually conduct their business operations.
A Board of Directors is elected by the shareholders. Annual Meetings of the Board and the shareholders is required.
Stock Issuance methods are the main difference between closely held corporations and publicly traded companies. When there is public solicitation for the sale of shares, in an Initial Public Offering (IPO) for instance, there are a great many more regulations and the Security and Exchange Commission (SEC) may become involved.
Corporate Entities: C Corporation
C Corporations are the most sophisticated and complex organization of all the corporate entities. All of the major companies in the country, including those which are publicly traded on stock exchanges, are C corporations.
A C corporation truly is a separate legal entity. Shares may trade hands, upper management and board members may come and go. But C corporations last forever unless they are completely dissolved.
Advantages of a C Corporation
The biggest advantage of C corporations is protection from liability. It is harder to "pierce the corporate shield" of a C corporation than any other corporate entity. Shareholders may lose their entire investments if the business goes under, but they will not be liable to lose their homes or any other personal assets if the corporation goes bankrupt, or is subject to significant losses in litigation.
There are other advantages to forming a C corporation, as well.
- Venture Capitalists (VC) and other high-rolling investors will usually only put up funds for C corporations.
- Stock options can easily be granted to individuals for any number of reasons.
- The stock itself can be easily bought and sold, usually with little effect from change in percentage of ownership.
- No limit on the number of shareholders, who can be from anywhere in the world or be other corporate entities.
- C corporations exist in perpetuity, beyond the existence of its employees or shareholders.
- Many tax advantages, more deductions, and corporate tax rates are often lower than personal ones.
Disadvantages of a C Corporation
The most common complaint about C corporations is "double taxation." This refers to the fact that owners are not allowed to just take profits out of a C corporation. If company management decides that there are enough profits to share with those own stock, then the company will be issued dividends.
However, you will be taxed on those dividends. And the dividends were funded with profits that had already been taxed themselves. Thus, the concept of "double taxation."
Another disadvantage to choosing a C corporation as your corporate entity is the complexity of the organization. The paperwork involved in forming a C corporation and running one is considerable.
Corporate Entities: S Corporation
The S in S corporation is in reference to the Internal Revenue Code, where you must elect sub-chapter S in order to have this particular corporate entity.
S corporations are like lite versions of C corporations. They have very simple ownership and corporate structures. S corporations have only one class of stock and may not have more than a hundred shareholders.
Advantages of an S Corporation
S corporations have quite a few of the advantages of a C corporation and make a great choice for those who don't feel the need for a more complex corporate entity.
- S corporations provide very strong and effective corporate shields, similar to C corps, which offer a great deal of protection from liability to its owners.
- Profits and losses flow directly through to the owners of an S corporation, avoiding the problems of "double taxation."
- Shares are easily bought and sold.
- S corporations exist in perpetuity, with no expiration dates required.
Disadvantages of an S Corporation
The biggest problem with S corporation lies in its ownership restrictions. Shareholders are limited to:
- Individuals who are either US citizens or residents
- Certain types of eligible trusts
As stated above, no more than 100 shareholders are allowed, and there can only be one type of stock. S corporations may not issue convertible notes or stock options.
Corporate Entities: LLC
LLC stands for Limited Liability Company. An LLC is a sort of hybrid corporate entity, combining characteristics of a C corporation with that of a general partnership. While LLC members actively manage the business and control the company, the LLC is still its own legal entity, with its own privileges, powers, and liability.
When forming an LLC, there is a wide range of fees. Some ballpark figures would be:
- Filing fees - $250 to $600
- Tax/accounting fees - $1,000 to $2,500
- Legal fees - $$1,500 to $4,500
Advantages of an LLC
The biggest advantage of an LLC is that you get the liability protection of a corporation, but you aren't subject to "double taxation." The profits and losses flow through to the members and are included with other personal income.
Still, there are other advantages to using an LLC as your corporate entity.
- Flexibility – Members can choose how they want to distribute cash or other assets, and allocate profits and losses. Generally, this is all spelled out in the operating agreement.
- Simplicity – There is usually a lot less paperwork involved in forming an LLC compared to C and S corporations.
- Ownership – There are no citizenship restrictions with LLCs. They can have foreign ownership, and they can be owned by other entities, such as trusts, corporations or even other LLCs.
Disadvantages of an LLC
LLCs are an extremely popular form of corporate entity. Many startups choose to begin their official corporate lives this way. However, there can be some drawbacks.
- There have been cases when courts have held that a single owner LLC is not eligible for the personal liability protection usually available with this entity. And even with multiple owners, it can sometimes be somewhat easier to "pierce the corporate shield" of liability with an LLC than with a C or S corporation.
- Sometimes, though not often, LLC members might actually prefer being subject to lower corporate tax rates than having profits and losses flow through to their personal incomes.
- Some states do not allow LLCs to exist in perpetuity like a C or S corporation. They may require that the entity cease to exist if one of the members departs, or that the original articles state an expiration date.
- It is extremely difficult, if not impossible, to provide employees, consultants and others with stock options, issue convertible notes or any type preferred stock as you would find in C corporations.
Corporate Entities: General Partnership
A General Partnership is a corporate entity which allows multiple individuals or entities to own a business together. Many law and accounting firms choose this type of structure.
There aren't any onerous filing requirements; usually just a Doing Business As (DBA) certificate will suffice. However, there should be a very detailed partnership agreement. While the DBA may only be $50 to $75, legal costs for the partnership agreement could be $1,000 to $2,500 to very much more.
Advantages of a General Partnership
Basically, the advantage of a general partnership is that it can be a very simple and inexpensive corporate entity. Very little is required in the way of formalities, and the costs are usually low, not only to form a general partnership, but also to run one.
It is also an advantage that general partnerships do constitute a separate legal entity so that partnership interest can be transferred or issued to new partners.
Disadvantages of a General Partnership
There are a few significant disadvantages to choosing a general partnership as your corporate entity.
- Unlimited liability – This is the biggest problem. All partners are exposed to unlimited liability for all debts and liabilities of the partnership, including any actions of one of the partners during business activities.
- Fiduciary obligations – every partner has a fiduciary obligation to all of the other partners regarding anything that has to do with the business.
- No outside investors – General partnerships can't raise capital from others because it has no shares to sell.
Corporate Entities: Limited Partnership
A Limited Partnerships allow multiple individuals or entities to own a business together, just like General Partnerships. And the General Partners have unlimited liability, as well, but there the resemblance ends.
Limited Partnerships are allowed to have outside investors, which makes it perfect for a limited- term or one-time project, such as a film production or real estate deal. These are sometimes called labor-capital partnerships because the General Partners will do the work, but the outside investors provide the capital and share in the profits.
Advantages of a Limited Partnership
The two big advantages of a Limited Partnership are:
- It allows outside investors who have at least some liability protection.
- It has a flow-through tax structure, so partners are not subject to "double taxation."
Disadvantages of a Limited Partnership
The obvious problem is that liability is only somewhat limited. While the partners are protected from liability arising from any actions by each other, they can be held liable for any negligent acts by employees.
Corporate Entities: Sole Proprietorship
Basically, a sole proprietorship is a corporate entity with one owner. It is not a separate legal entity; there is no legal distinction between the owner and the business. This is the easiest and most common type of corporate entity.
It is particularly suitable for service providers, and the costs are low. Usually, only a DBA certificate is required, for about $50 to $75.
Advantages of a Sole Proprietorship
There are three main advantages to choosing a sole proprietorship as your corporate entity.
- No "double taxation." All profits and losses flow directly to the owner.
- Simple – there is very little in the way of paperwork to create a sole proprietorship or to run one.
- Inexpensive – There aren't a lot of legal or accounting fees.
Disadvantages of a Sole Proprietorship
There are four major disadvantages to a sole proprietorship.
- Unlimited liability – All of the owner's personal assets are at risk for all of the debts and liabilities of the business.
- Limited funding opportunities – Basically, the owner's personal assets, credit, and investment are the most likely sources of funding. It is very difficult to get loans for a sole proprietorship without some kind of collateral.
- No stock – You can't allow outside investors because you have no stock to offer.
- No continuity – As sole owner, the business ceases to exist when you do.
Corporate Entities: Non-Profit
Non-profits are organized by a group to further a common goal. These would be charitable, educational, public service, political, religious organizations and more.
Non-profits may actually make a profit. In fact, they hope to, so that they have funds to contribute toward their goals. What they don't do is distribute funds to the organizers.
Advantages of a Non-Profit
Non-profits are exempt from paying corporate income taxes on any profits generated from their activities. They are allowed to fundraise, take donations and accept grants tax-free.
Additionally, directors, officers, employees, and shareholders are all protected from personal liability.
Disadvantages of a Non-Profit
There are extensive regulations which require compliance, and a few restrictions, as well. Non-profits are not supposed to participate in any political campaigning. If the non-profit has to close down, all of its assets must be donated to another non-profit.
Choosing a corporate entity is of the utmost importance. Not making the right decision the first time could have significantly costly consequences. Seeking expert advice is highly recommended.
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