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What Is A Corporation
A corporation is a legal entity used to operate a business that is separate and apart from the business owners.
In essence, a corporation, just like an individual, can own assets, enter into contracts, hire people, incur debt, sue, and be sued.
In other words, a corporation enjoys many of the same rights and responsibilities as individuals allowing it to operate a business.
The main reason why many choose to operate a business by forming a corporation is that the business owner can take advantage of the limited liability afforded by corporations.
By forming a corporation, the business owner becomes a shareholder of the corporation.
In the course of running the business, it is the corporation that enters into contracts with lenders, landlords, and other creditors (not the shareholder).
Since the business owner (the shareholder) did not directly contract with the business creditors, they do not have the legal ability to pursue the corporation’s shareholders to recover a corporate debt.
For this reason, anyone looking to start a business and take on some business risk should consider forming a corporation.
How do you define a corporation?
According to The Corporate Finance Institute, a corporation is:
A legal entity created by individuals, stockholders, or shareholders, with the purpose of operating for profit. Corporations are allowed to enter into contracts, sue and be sued, own assets, remit federal and state taxes, and borrow money from financial institutions
This is a great definition of corporation.
You can consider a corporation as a “legal person” or an entity given the same legal rights as an individual to carry on a business.
Types of Corporation
There are different types of corporations that you can form to operate a business.
In the United States, you can have a C Corporation, S Corporation, B Corporation, or Nonprofit Corporation.
Although there may be other types of corporations, these are the most common ones out there.
Fundamentally, all these corporations are the same.
In essence, they are each separate legal entities offering limited liability protection to the corporation’s owners.
However, the tax regime or the corporation’s mission may vary.
In the United States, when you form a corporation, by default it will be a C Corporation.
The C Corporation is a business entity that is taxed under Subchapter C of the Internal Revenue Code meaning that the business revenues are taxed in the hands of the corporation and not the shareholders.
When you’re forming a corporation, you can choose to elect to be taxed under Subchapter S and become an S Corporation.
An S Corporation is a corporation where the shareholders are able to have the business revenues pass through or flow through to the shareholders and get taxed directly in the shareholder’s hands.
This allows the corporation to avoid double taxation (which is the same business revenue being taxed in the corporation’s hands the first time and in the shareholder’s hands when dividends are paid).
A B Corporation is a benefit corporation that is driven by both its mission and profits.
In other words, a benefit corporation is a for-profit entity that pursues a specific mission contributing to the public good.
A nonprofit corporation, as its name suggests, is a business entity that is organized to do charity, for educational, religious, scientific, or literary purposes.
These corporations generally do not pay state or federal income taxes on their earnings but are required to follow strict rules about the nature of business they can conduct to generate profits.
Nonprofit corporations are also called 501(c)(3) corporations.
Pros And Cons of A Corporation
Operating a business as a corporation can have advantages and disadvantages.
The main advantages of forming a corporation to run a business are:
- Your business will be operated as a separate legal entity
- The corporation can live an unlimited life
- The corporation offers the business owners limited liability protection
- Corporation’s shares are easy to issue and transfer
- Corporations offer flexible ways of raising capital
- Corporations can hire competent management to run the business
The main disadvantages of operating a business under a corporation are:
- Corporations are costly to form
- Profits paid out to business owners are subject to double taxation
- Corporations have more complex recordkeeping and compliance requirements
Forming a New Corporation
Every state and jurisdiction will have its own requirements and formalities to successfully create a new corporation.
In the United States, the process of forming a new corporation is generally called the incorporation process.
To form a new corporation, you’ll typically need to file the corporation’s articles of incorporation along with other incorporation papers with the Secretary of State or equivalent state agency.
Once you have complied with the corporation’s filing requirements and paid the necessary incorporation fees, the state will issue a certificate of incorporation legally recognizing your corporation as a business entity able to transact business in that state.
Following the formal incorporation of the corporation, the business owner will need to then adopt the company’s bylaws, issue shares, name its directors and officers, and prepare the necessary resolutions in a meeting called the organization meeting.
From then on, the corporation must observe its ongoing filing requirements to maintain its “good status” with the Secretary of State or state agency.
Corporations are managed by their board of directors.
Shortly after a corporation is formed, an initial organizational meeting must be held where the shareholders are named, the corporation’s board of directors is elected, and company officers appointed.
In a small corporation, the same person can wear the hat of a board member, officer, shareholder, and employee.
However, in larger corporations, a board member can be different from the officers, and shareholders.
A corporation’s shareholders have the responsibility of electing the members of the board.
The board of directors has a duty to make important and strategic decisions for the corporation so it can achieve its mission.
The board of directors will then appoint the company officers, like the CEO, CFO, CMO, CTO, CRO, and so on to have them manage the day-to-day operations of the business.
Ultimately, the board of directors has the duty to act in the best interest of the shareholders and are accountable to the shareholders.
If they do a good job, the shareholders will appoint the directors for a continued mandate.
Otherwise, the shareholders will appoint new board members to get the job done.
Technically, corporations can live perpetually.
In other words, to the extent a corporation is profitable and well-managed, it can survive forever.
As of 2021, the Japanese construction company Kongō Gumi is known to be the oldest existing company worldwide and has operated since 578 C.E. (more than 1443 years).
In the United States, The Fruit Basket is the oldest operating company that was formed in 1598.
In Canada, the Hudson’s Bay Company is the oldest existing company founded in 1670.
However, in some cases, a corporation can be dissolved, such as:
- When it has fulfilled its mission
- When it goes bankrupt
- When it is administratively dissolved by the authorities
Quite often, a corporation is dissolved by liquidating its assets and using the proceeds to pay off all the corporation’s debts and creditors.
Whenever money that may be left over will be distributed to the shareholders.
Ultimately, the corporation will file the necessary paperwork with the Secretary of State to have the corporate entity removed from the state business registry.
What Are Corporation Examples
Some of the most successful and most recognized companies in the world operate as corporations.
For example, Coca-Cola, Google, Microsoft, Amazon, Tesla, Apple, and many other companies are all corporations.
Corporations have the ability to issue shares to shareholders to raise capital to fund their ongoing business operations.
Since a corporation’s ownership is highly flexible and well understood by investors, corporations have the ability to become multi-billion dollar businesses with thousands, if not millions, of shareholders.
Depending on the company, corporations may reward their shareholders by issuing dividends to them (representing the distribution of business profits to the corporation’s owners).
So there you have it folks!
In a nutshell, a corporation is a business entity that is owned by its shareholders and is operated as a separate legal entity.
The corporation’s shareholders will elect a board of directors who will then oversee the corporation’s business operations.
The board of directors will appoint the corporation’s officers to run the business’s day-to-day activities.
Many entrepreneurs and business owners choose to operate their business as a corporation as they are able to protect their personal assets from business creditors.
Now that you know what is a corporation and how it works, good luck with your research!
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