Key Takeaways

  • Incorporating a business provides limited liability, separating personal and business finances and protecting owners’ personal assets.
  • Corporations can raise substantial capital by issuing stock and attract investors more easily than other structures.
  • Additional benefits include perpetual existence, easier transfer of ownership, enhanced credibility, and potential tax advantages.
  • Drawbacks include more complex regulatory requirements, double taxation for C corporations, and higher formation and maintenance costs.
  • The decision of whether to incorporate should balance these advantages and disadvantages in light of the company’s goals and growth plans.

What are other advantages of organizing as a corporate entity? Some of the advantages include the option to sell shares of stock to raise capital, tax benefits, and reduced risk for the owner(s) of the business.

The Corporate Form of Organization

A corporation is a legal business entity that has been formed under the laws of the state in which it will operate. Corporations have investors who buy shares of stock to show their ownership in the business. This legal entity exists separately and distinctly from its owners, who are referred to as the stockholders or shareholders.

A corporation is an artificial being that only exists under the contemplation of the law. When one or more individuals go through the process of incorporation, the first step is filing the articles of incorporation with the secretary of state's office in the state where the business will operate. Upon filing the articles of incorporation, the corporation is created. This document will outline the specific aspects of the business entity, including how it will be governed and structured, as well as its purpose.

The Secretary of State will review the articles of incorporation. Upon approval, the business will receive a certificate of incorporation, also called a charter, that authorizes the legal existence of the corporation. Those who file the articles of incorporation will then be responsible for collecting the initial investments from the shareholders. After collecting the investment, the business owners can issue shares of stock to the shareholders, which is evidence of the ownership interest in the corporation.

After issuing the initial stock, the next step is meeting with the shareholders. During this meeting, the shareholders should choose the members of the board of directors and adopt corporation bylaws. The board of directors is responsible for appointing the officers who will take care of the daily business operations. In small companies or start-up ventures, the incorporators may be the only shareholders. These incorporators may also serve as the members of the board of directors and become the officers of the business.

Which Structure Is Best for Your Business?

When starting a business, you will need to decide which formation is best for the needs of the company. Business entity options include:

  • Corporation
  • LLC
  • Sole proprietorship

Choosing the right formation depends on your expectations, preferences, and situation, as well as how you want the business to grow.

There are two forms of corporations: S corporation and C corporation. Each has its own advantages and disadvantages. The most common form of incorporation is the C corporation, which is a separate entity that exits legally and is owned by its shareholders. Many of the publicly traded, larger corporations are formed as C corporations. Although C corporations are more common, S corporations offer several additional advantages, including an improved tax structure for the shareholders.

Advantages of a Corporate Structure

One of the advantages of structuring your business as a corporation is limited liability. The owners aren't personally liable for the business debts or legal action taken against the corporation. Instead, they are only liable for the amount they invested. Forming a corporation provides a shield against personal liability.

Corporations exist separately from their shareholders and owners. If a corporation is sued or has outstanding debts, A corporation is an entirely separate legal entity from its owners and shareholders. That means that in situations such as the company being sued or the corporation owing debts, neither the shareholders nor the owners will be personally held liable or responsible. However, some exceptions do exist. For example, a shareholder might have to sign a guaranty to take on corporate debt.

Shareholders in smaller companies may also be held responsible for corporate debt if their personal and business finances are mixed. If the owners of the business don't follow the legal requirements to keep the corporation in good standing, they could become liable for business debt or legal action as well.

A limited liability corporation, or LLC, is another option for business formation. This unique structure is legally authorized under state statutes. When you form an LLC, you must elect for treatment as a partnership, corporation, or individual for taxation. The option you choose may offer protection to the LLC owners, called members, from legal action or company debt.

Additional Benefits of Incorporating

Beyond limited liability, corporations offer several key benefits that make them a preferred structure for many businesses seeking growth and stability. Understanding these advantages is crucial when evaluating what are the main advantages and disadvantages of organizing a firm as a corporation:

  • Access to Capital: Corporations can issue shares of stock, making it easier to raise large amounts of capital from investors. This funding can support expansion, research, acquisitions, and other strategic initiatives.
  • Perpetual Existence: Unlike sole proprietorships or partnerships, a corporation continues to exist regardless of changes in ownership or the death of shareholders. This stability can reassure investors, creditors, and clients.
  • Ease of Ownership Transfer: Shares of stock can typically be bought and sold without disrupting the corporation’s operations, offering flexibility for shareholders and facilitating succession planning.
  • Enhanced Credibility and Prestige: Being incorporated often increases a company’s credibility with lenders, suppliers, customers, and potential partners. This perception can open doors to more significant opportunities and contracts.
  • Potential Tax Advantages: Certain expenses — such as health insurance, retirement contributions, and employee benefits — may be tax-deductible, and some corporations can take advantage of lower corporate tax rates or tax planning strategies.
  • Specialized Management Structure: Corporations benefit from a formal governance structure, including a board of directors and officers. This structure can lead to more strategic decision-making and professional management practices.

Disadvantages and Considerations

While incorporation offers substantial advantages, it also comes with notable drawbacks that should be carefully weighed before choosing this structure. Understanding these limitations is essential to fully grasp what are the main advantages and disadvantages of organizing a firm as a corporation:

  • Complex Formation and Ongoing Compliance: Corporations require more extensive paperwork, legal filings, and regulatory compliance than sole proprietorships or partnerships. Annual reports, shareholder meetings, and detailed recordkeeping are often mandatory.
  • Higher Costs: Incorporating typically involves higher upfront costs, including filing fees, legal fees, and ongoing administrative expenses to maintain corporate status.
  • Double Taxation (C Corporations): Profits earned by a C corporation are taxed at the corporate level, and dividends distributed to shareholders are taxed again as personal income. This “double taxation” can reduce net returns.
  • Reduced Control for Founders: Issuing shares and forming a board of directors can dilute control, meaning original founders may no longer have absolute authority over company decisions.
  • Extensive Regulatory Oversight: Corporations are subject to stricter state and federal regulations, including securities laws if they offer shares publicly. Compliance failures can result in significant penalties.

These potential disadvantages do not necessarily outweigh the benefits but highlight the importance of aligning your choice of structure with your business’s size, growth plans, and strategic objectives.

Frequently Asked Questions

  1. What is the biggest advantage of forming a corporation?
    The primary advantage is limited liability protection, which shields shareholders’ personal assets from the company’s debts and legal obligations.
  2. Why is perpetual existence important for a corporation?
    It ensures the business continues operating even if ownership changes, which adds stability and attracts investors.
  3. What are the tax disadvantages of a corporation?
    C corporations face double taxation: profits are taxed at the corporate level, and dividends are taxed again at the shareholder level.
  4. Can small businesses benefit from incorporating?
    Yes. Even small businesses can gain credibility, limited liability, and easier access to capital, though they must weigh these against added complexity and costs.
  5. What factors should I consider before incorporating?
    Consider your growth goals, financing needs, desired level of personal liability protection, tax implications, and willingness to manage additional legal requirements.

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