Sole proprietor? Partnership? Corporation? LLC? The biggest challenge for many small businesses is finding the right choice of business entity. There are pros and cons to each type of business structure, so it’s critical to make sure you’re making the right choice.
This is the first article in our series The Many Shapes of Business where we discuss different types of business entities.
To help you figure out your best option, today we’ll cover what a corporation is and why forming one can be beneficial. We will also set you up for our next installment in this series, where we tackle LLCs.
What is a corporation?
A corporation is a business entity created by owners with a shared goal. This goal is often to generate a profit, but there is no requirement stating that this must be the goal. It is perfectly acceptable for a corporation’s purpose to be for the benefit of a separate stakeholder group like the environment. Corporations have many of the same rights and responsibilities as individuals, and the entities are legally distinct from their owners. A corporation is formed when an individual or group files Articles of Incorporation with a state. The state then charters the corporation and gives it certain rights and privileges. Limited liability is the most significant of these privileges.
Incorporating, or forming a corporation, is often an excellent decision for businesses. The primary benefits of forming a corporation include limited liability, perpetual life, transferability of ownership, and ease of raising capital through borrowing money or selling pieces of ownership. We discuss each of these here below.
Limited Liability
Limited liability is nothing short of being one of the great drivers of human progress. It refers to the concept where an investor’s maximum loss in a business is limited to their investment in the business. This encourages entrepreneurship and risk-taking because a failed business does not result in the loss of everything. In more relevant terms, a business failure does not mean that a lender can come after you personally. This is a crucial driver of progress since it frees innovators with great ideas from the fear that they and their families could lose everything if they fail. Instead, it limits the downside while the upside remains infinite. Limited liability drives greatness and innovation from neighborhood shops to multinational enterprises.
Perpetual Life
If all goes according to plan, a corporation may exist in perpetuity. In other words, it can live forever. This is possible because owners can sell their shares to new owners. Furthermore, directors and officers can be voted in and out. However, the corporate form remains. This perpetual existence is a real advantage of the corporate form since it allows owners and directors to plan long-term.
Transferability of Ownership
When hearing about buying and selling shares, many often think of large corporations which trade on stock exchanges in New York and London. However, it is possible to buy and sell shares in companies of all sizes. It is also possible for any corporation to issue new shares or buy back existing ones. This is a significant advantage of corporations since they can bring on new owners, pay high-performing employees in shares, and continue to operate if a current owner decides to retire. It reinforces and cements the perpetual life of the corporation.
Ease of Raising Capital
The corporate form is tried and true. It was initially designed with raising capital in mind (it’s true, see the Dutch East India Company). It is fundamentally a pot of money pooled and directed to solve a goal and achieve something great. This makes raising money through selling shares of the company straightforward. It is simple because owners generally can vote in proportion to their company ownership. As someone owns more of a company, they have more control. This is not necessarily the case in more complicated corporate (we know) structures and LLCs.
Furthermore, since corporations are distinct entities, it is also straightforward to lend to them. Overall, a key advantage of having a corporation is that it allows for a more natural process of raising capital. Although raising money is not always the goal, it is usually good to have the option.
Drawbacks
Since the corporation is so old, with roots dating back to at least 1602 with the Dutch East India Company, there are many seemingly antiquated corporate formalities. Each state has its rules which corporations chartered there must follow. Some essential rules include ensuring the separation of personal and corporate assets. If assets are commingled, the state may revoke the limited liability privilege. Other rules include holding board meetings and keeping accurate books and records.
A formality to briefly dive into is the requirement to keep a registered agent on file with your state’s Secretary of State. A simple paraphrase of the rule is that there must be someone at a location known to the state at all business hours who can accept a service of process or other legal notice on behalf of the corporation. This ensures that there is responsibility in the commerce system. An owner or employee of a corporation can be a registered agent. Still, it is critical to know the nuances of the rule within your state of operation. Third-party services can also serve as registered agents, and this is common practice.
Takeaways
This concludes our brief introduction to the corporate form. It is an excellent entity choice with many advantages, including limited liability and ease of raising capital. However, with its antiquity comes its rigidity. Maintaining the corporation is a serious process. As we will explore in our next installment, the LLC is much more flexible with its own set of advantages and drawbacks. We hope that this piece answers many of your initial questions. There is still so much for us to say on corporations, and have no fear, we will share these thoughts in future pieces. As for now, thank you so much for reading, and remember to Tread Boldly.
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