The Advantages and Disadvantages of a Corporation

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The number of U.S. public corporations is shrinking from one year to the next. Privately owned corporations, sole proprietorships and partnerships, on the other hand, are becoming more and more popular; their number has tripled since the '80s. However, public corporations have distinct advantages that shouldn't be overlooked. This type of legal entity is more likely to attract investors and raise capital. As a business owner, it's important to understand the drawbacks and benefits of forming a company that falls under this category.

What Is a Corporation?

When it comes to starting your own business, you have several options. Depending on your goals, you can register a sole proprietorship, join forces with a friend or colleague and form a partnership or set up an LLC or limited liability company. Another option is to form a corporation.

This type of business structure is separate from its owners, which are called shareholders or stockholders. It has most of the legal rights of an individual, including the right to buy and sell assets, sue other companies and persons, enter contracts and more. Corporations are also responsible for paying taxes and complying with the law.

One of the main advantages of a corporation is that its shareholders are only liable to the extent of their investment in the company. If the corporation gets sued or has debt, it will be treated as an individual entity. This means that its owners won't be held liable for its losses or business debt.

To register a corporation, it's necessary to file articles of incorporation with your state. If you ever decide to do business in another state, you must file for qualification in that state as well. Also, you need to state how many shares you own and how many will be issued.

Those who purchase shares or stock receive a certificate of ownership in a corporation, which is issued by the municipal authorities of that state. In general, stockholders can purchase, sell or transfer their shares. For example, you may sell shares to raise capital and invest in new equipment or expand your business.

Types of Corporations

There are different types of corporations, and each has specific traits. These include C and S corporations and can be further divided into several other categories, including:

  • For-profit corporation.
  • Non-profit corporation.
  • Public or private corporation.
  • Professional corporation.
  • Public benefit corporation.
  • Quasi-closed or statutory-closed corporation.    

Each business structure comes with advantages and drawbacks. C corporations, for instance, pay taxes at the corporate level. Its owners also pay tax on dividends when they file their personal tax returns. This is known as double taxation and represents a major drawback for many entrepreneurs.

S corporations are not subject to double taxation, but they have limited rights. Unlike C corporations, which can have an unlimited number of domestic and foreign shareholders, S corporations cannot have more than 100 domestic stockholders.

The Advantages of a Corporation

Regardless of what type of corporation you choose to form, you'll enjoy various benefits. First of all, this legal entity offers liability protection for its owners. Secondly, tax on corporate profits is lower compared to personal income tax.

Furthermore, it's easier to secure funding as a corporation than as a sole proprietorship or LLC. You can reach out to investors, sell stock, apply for business loans and deduct the cost of benefits provided to your employees.

One of the most appealing advantages of a corporation is that it can live beyond the lifespan of its owners. If one or more of its owners die or sell their shares, the company will continue to exist.

Additionally, its ownership can be transferred. If you decide to cease operations, you may appoint a liquidator to sell the company's assets and then take the steps needed to close your business. Another way to end a corporation's legal life is to file for bankruptcy.

A potential benefit of forming a corporation is that you're more likely to attract top talent and establish credibility with suppliers, partners, customers and employees. This type of business also finds it easier to increase brand awareness and build customer loyalty.

Think of popular brands like Coca-Cola, General Motors, Macy's, AOL, Google and Amazon. All of them are corporations. Sure, your brand won't become popular overnight, but you'll have more opportunities to promote it and raise funds needed to expand your operations and reach your target market.

Are There Any Disadvantages?

At first sight, forming a corporation seems like the best option for aspiring entrepreneurs. However, this business structure has its drawbacks.

Corporations are expensive to set up and require extensive paperwork. Business owners who plan to form a corporation in Florida, for example, can expect to pay $87.50 for incorporation, $150-to-$550 on for-profit annual reports, $61.25 on nonprofit annual reports and fees ranging from $35.00-to-$600 for other services.

Delaware charges services fees of about $500 per year. Incorporation in this state may cost as much as $1,000.

Once established, this type of business must pay local, federal and state taxes. Additionally, its profits may be taxed twice as it happens with C corporations. Hiring accountants and lawyers is a must. They will be responsible for staying on top of the latest business regulations and filing annual reports and tax returns.

Even though S corporations pay less in tax, they can only issue stocks to individuals, trust and estates in the U.S. C corporations, by comparison, may issue shares to foreign investors, partnerships and other companies. With an S corporation, you can only provide one class of stock.

In addition to the drawbacks, a disadvantage of the corporate form of business entity is its strict management structure. Corporations are legally required to have a board of directors who will manage the company's operations, allocate resources and make decisions. Stockholders have limited rights despite being the company's owners.

This business structure is more likely to incur fines because of the strict legal requirements. For example, if a corporation fails to pay taxes on time, it may be charged up to a maximum of 25 percent of the unpaid tax. In case it doesn't report correct information, a penalty fee of $260-to-$560 may be imposed. The IRS may also charge additional fees for reportable transaction understatements, negligence and more.

Who Should Form a Corporation?

Forming and running an LLC, sole proprietorship or partnership is easier and requires less paperwork than setting up and managing a corporation. Additionally, there are fewer legal requirements in place, and the fines tend to be lower. An LLC, for example, doesn't have to appoint a board of directors and have regular management meetings.

Before starting your own business, research corporation pros and cons. This legal structure has its perks, but it's not for everyone. Once your company is incorporated, you'll have liability protection and gain more credibility. Plus, you can pass on your business to the next generation to ensure its continuity. The ability to sell stock will allow you to raise capital more easily.

However, the paperwork and costs involved are not always worth it. If you're just getting started or have a limited budget, you may not be able to keep up with the expenses. Consult a tax advisor or get in touch with a lawyer to discuss your options.

References

About the Author

Andra Picincu is a digital marketing consultant with over 10 years of experience. She works closely with small businesses and large organizations alike to help them grow and increase brand awareness. She holds a BA in Marketing and International Business and a BA in Psychology. Over the past decade, she has turned her passion for marketing and writing into a successful business with an international audience. Current and former clients include The HOTH, Bisnode Sverige, Nutracelle, CLICK - The Coffee Lover's Protein Drink, InstaCuppa, Marketgoo, GoHarvey, Internet Brands, and more. In her daily life, Ms. Picincu provides digital marketing consulting and copywriting services. Her goal is to help businesses understand and reach their target audience in new, creative ways.