Is a Corporation Right for Me?
The entity you use for your business should be chosen thoughtfully. Each entity type has its own positives and downsides, and nothing is a perfect fit for all goals. In this post we’ll focus on corporations.
What is a Corporation?
A corporation is a type of business entity that is legally (and taxably) separate from its owners. There are usually at least three levels of ownership and operation in a corporation, regardless of the number of owners. Shareholders are the owners of a corporation. The shareholders elect the directors (aka the “Board of Directors”), who set the vision for the corporation’s business goals and activities. The directors usually appoint the officers of the corporation (e.g. chief executive officer, chief operations officer, etc.), who are in charge of running a corporation. In most cases, these three distinct levels should exist regardless of whether the corporation is publicly owned by millions, or is a closely-held corporation with a single shareholder.
This distinct separation combined with the corporation’s various levels provides a number of benefits, but also come with certain obligations, costs, and complexities.
Benefits of Using a Corporation:
Limited Liability: In a corporation, shareholders' personal assets are generally protected from the company's debts and liabilities. This means, for example, that if the company goes bankrupt, creditors can't go after the shareholders' personal property.
Perpetual Existence: Unlike some other business types, corporations continue to exist even if a shareholder leaves, sells their shares, or passes away.
Raising Capital: If you plan on going public, you’ll need to have a corporation. Additionally many experienced investors (like venture capitalists) often require that the companies receiving their investment be corporations—corporations have long operating histories, case law around shareholder rights is usually deeply developed, and the separateness of the entity resolves potential short-term tax issues.
Downsides of Using a Corporation:
Double Taxation: Unlike LLCs or partnerships, corporations are subject to what's known as "double taxation." This means the corporation pays taxes on its profits as they come in, and when those profits are distributed to shareholders, the shareholders directly pay another round of taxes on those same profits.
More Regulation: Corporations have more regulatory and compliance requirements (and paperwork) than most other business types. This can include holding regular shareholder meetings, holding regular meetings of the board of directors, keeping detailed records, and filing complex tax returns. Corporations also need bylaws (the internal rule structure of the organization), and smaller corporations usually also have shareholder agreements.
Less Management Flexibility: Corporations have a set management structure, with a board of directors overseeing the company's direction and officers managing day-to-day operations. Shareholders have a say in major decisions, but they don't typically have rights to manage the business.
TL;DR
Corporations can offer easier path to raising capital than with other entities, but they also require more paperwork and regulatory compliance, have rigid management structures, and will usually require two levels of taxation on profits; formation and set-up costs can also be higher than with other entities.
Before getting too deep, it’s wise to consult with an experienced business attorney who can help guide you through the process. If only you knew where to find one…
As always, CapEx Legal is here to assist with your transactional and business law needs in California, New York, Virginia, Maryland, and Washington, DC.