A corporation is a legal entity that is created as a separate entity from its owners via the filing of the appropriate documentation with the state in which the corporation is to be formed. This documentation is known as the “Articles of Incorporation,” and is where the term “corporation” originates. The creation of a separate business entity, or legal separation between the company and its owners (also known as “shareholders”), serves to limit the liability to the owners by empowering the corporation with the ability to establish credit, acquire assets, and enter into contractual engagements based on its own merits. Because these potential liabilities are incurred by the corporation, and not by the owners themselves, any liabilities that arise as a result of the operation of the corporation are the direct responsibility of the corporation; this serves to safeguard the personal assets of the shareholder’s or the officers of the corporation. This limited liability is among the primary reasons that owners choose to incorporate, as it serves to severely limit personal liability and the risk to personal assets by the owners.
Other important reasons corporations are formed are because of certain tax benefits, compensation and wage benefits, to increase the credibility of the company with potential investors, and in a very related manner, to attract investors. Because potential investors know that their liability and exposure is usually limited to the amount of their investment, investing in a corporation may be much less risky than directly investing in another sort of business venture.
Once the decision to form a corporation is reached, there are other important and necessary steps to take to ensure that the goals of a healthy corporation, and the minimized personal liability to its owners,’ are reached. Chief among these is the observance of the corporate formalities. You can search this site for a more thorough and in-depth explanation of these formalities, but in brief, these are the basic “rules of operation” that are necessary to ensure that the corporation maintains its separate legal entity status, and is treated as such by other entities (private and governmental). These formalities involve the appointment of a Registered Agent, the appointment of key officer positions within the corporation, election of a Board of directors, the maintaining of proper corporate documentation, holding important annual meetings, etc.
While filing for corporate status is not in and of itself a complicated task, care must be taken that the appropriate steps and measures, including the seeking and acceptance of sound advice, are taken when setting out to establish a corporation. Incorporating can be the best legal step to take when seeking to take your business to the next level.
Advantages of a Corporation
- Limited Liability for Shareholders
- Certain Tax Benefits
- Prestige for the Business and Corporate Officers
- Ability to raise capital and attract investors
A major disadvantage of the traditional corporation is the dreaded “double taxation” dilemma. A traditional C Corporation pays tax on all corporate (business) income, then once a distribution is made to the shareholders, the individual shareholders pay income tax again on these distributions (or dividends). One way to avoid the double taxation dilemma is to establish the corporation as a “pass through” entity like a partnership wherein all corporate profits pass through to the individual shareholders and they are then responsible for the tax burden. A corporation that has made the election to be treated in this manner (by making the appropriate filings and meeting the requirements) is known as an “S Corporation.”
Disadvantages of a C Corporation
- Double Taxation pitfall (can be avoided with proper accounting)
- Increased paperwork
- Necessity of exercising the corporate formalities
Incorporating is one of the first legal steps towards taking your business venture to the next level and important if raising capital is necessity. A Savvy investor would review business model and position, and see the “inc.” after your business as a sign that the business is a serious venture and worthy of his investment. This is a critical step towards making investors feel comfortable and give serious consideration towards investing capital in your enterprise!