Corporations are one option for start-ups that want to raise significant capital. Please keep reading to learn more about corporations and how they work.
What is a Corporation?
A corporation is a type of legal entity that forms a company. They have a board of directors and issue stocks to shareholders and investors to raise capital. Forming a corporation also affords them limited liability and asset protection, much like an LLC. Furthermore, LLCs also offer limited liability protection, so they are another option.
Here is an article that also defines corporations
How Corporations Work
A corporate business formation, or incorporation, is challenging to obtain due to the vast documentation requirements by many states. Board members and founders must create corporate bylaws to govern the corporation’s policies. Additionally, corporations must file articles of incorporation with the state in which they conduct business.
Other incorporation-related tasks include electing officers, drafting a shareholder agreement, and completing other general business start-up tasks. A board of directors sets policy and manages oversight. They ensure that the corporation adheres to the bylaws and stays legally compliant.
Types of Corporations
Numerous business entities are available to hopeful entrepreneurs. However, only a few, including S , C, and B corporations, offer attractive features to most start-up businesses.
Let’s take a closer look at the three different types of corporations below:
Type 1. S Corporations
S-corporations, or S Corps , are a type of corporate pass-through entity . Creating an S-Corp requires first registering as a C corporation or limited liability company with the state and then filing Form 2553 with the IRS. S-corps have similar advantages and disadvantages to LLCs . There are also significant differences between the two, such as ownership restrictions, tax treatment, and management structure.
You must meet the following requirements for S-corp taxation eligibility:
- Requirement 1. Qualify as a domestic corporation,
- Requirement 2. Possess allowable shareholders
- Requirement 3. Have a maximum of 100 shareholders
- Requirement 4. Offer a single type of stock
- Requirement 5. Not an ineligible corporation
S corporations and LLCs both have the option of having one or more owners who are personally liable for their debts and liabilities. Owners benefit from limited liability, with profits and losses taxed separately.
Type 2. C-Corporations
C corporations, or C Corps , are the most frequently used entity type for start-up businesses seeking funding from angel and venture capital groups. Yet, LLCs are also attractive to investors and may offer certain advantages for start-ups seeking funding. C-corps provide owners with limited liability and are comparable to LLCs and S-corps in formation and maintenance costs. A C-corps’ primary advantage is the preferred structure for outside investors and initial public offerings.
The primary disadvantage of C-corps is that their profits and losses are taxable to the corporation and do not flow through to their shareholders. As a result, shareholders cannot deduct start-up or other losses from other income in a C-corp, and revenue is subject to double taxation.
Type 3. B-Corporations
B-corporations, or B Corps , employ a management structure that strikes a balance between the financial interests of stockholders and the best interests of those impacted by the corporation’s actions. This structure enables a business to safeguard its mission over time. However, the specific requirements for a B-corp can vary by state and may not always require a supermajority vote.
A two-thirds supermajority vote of shareholders is required to alter the mission, indicating that a business can make decisions without jeopardizing its values. Not every state permits the formation of a B-corp, which means you should consult with corporate lawyers to determine if it’s right for you.
This article also discusses choosing a business structure.
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Corporations vs. LLCs
Forming the correct business entity is critical when considering an LLC vs. Corporation. It ensures that your business has the proper structure for its size and needs. Both types offer advantages and drawbacks that entrepreneurs and start-ups should consider carefully.
Below, we created a side-by-side look at corporations versus LLCs:
Ownership Structure
LLC owners are members, and each member owns a percentage of the business or membership interest. Individuals, corporations, other LLCs, and foreign entities may own membership interests in LLCs.
A corporation’s owners are shareholders, and their ownership percentages reflect the number of shares of company stock they own. It is relatively simple for a corporation to authorize the issuance of additional shares or for shareholders to transfer their shares.
Management Structure
Member-owners and silent investors generally manage LLCs. They do not have traditional roles or titles, such as CEO or President. They can, however, develop a management structure that meets their business needs.
Corporations have a much more rigid management structure. An elected board of directors oversees the strategic business efforts, while executive-level officers run operations. A corporation must hold annual shareholders’ meetings as well as provide proper financial reporting.
Taxation
LLCs can choose how they want to be taxed. They can elect to be taxed as a partnership, a sole proprietorship, an S-corp, or a C-corp. Single-member LLCs face taxation similar to sole proprietorships, while multi-member LLCs are more akin to partnerships. Business profits distribute to LLC members, who pay income and self-employment taxes on their share unless taxed as a C corporation or S corporation.
Corporations are by default C corporations, which require them to file a corporate tax return and pay corporate taxes. Shareholders must report company distributions on their personal tax returns. A corporation can avoid double taxation by electing S-corp taxation due to corporate income tax exemptions by acting as a pass-through entity.
How to Form a Corporation
Corporations are the most complex legal business entity to establish and maintain. However, they offer business owners the most significant protection against personal assets, the ability to raise capital, and more.
Here are ten steps to follow when forming a corporation:
Step 1. Choose a Business Name
Your state may require your corporate name to include an identifying term, such as incorporated, corporation, or an abbreviation.
Step 2. Search Business Name Availability
Along with looking for references to your corporation’s chosen business name, you should search for similar names. If your proposed name is too similar to an existing one, you may not register it.
Step 3. Register Your Corporation’s Name
Along with your legal business name, you should register any fictitious business names that you use to conduct business.
Step 4. Select a State for Incorporation
Even if your primary operations are in one state, you may incorporate them in another if the advantages outweigh the disadvantages.
Step 5. Appoint Your Corporation’s Directors
The board of directors is responsible for supervising the operation and safeguarding the investors’ and shareholders’ interests. Directors may be corporation officers, investors, or individuals with no other financial stake in the company whatsoever.
Step 6. Draft Your Articles of Incorporation
You file the Articles of Incorporation with your state’s secretary of state. They serve as the corporation’s official charter.
Step 7. Create Your Corporation’s Bylaws
Corporate bylaws define duties, such as the corporation’s purpose and who manages the business.
Step 8. Create a Shareholder Agreement
A shareholder or stockholder agreement is not always necessary. Nonetheless, it typically addresses shareholders’ rights and responsibilities and shares ownership terms and valuation.
Step 9. File Your Articles of Incorporation
File the articles of incorporation with your local secretary of state’s office and pay any applicable filing fees.
Step 10. Open a Corporate Bank Account
A corporation is a distinct legal entity from its owners. You should open a bank account in the corporation’s name rather than an individual’s.
That’s it! You will have officially formed a corporation by following the ten steps above.
Get Legal Help When Forming a Corporation
Incorporating your new business can provide long-term gains. By seeking professional assistance, you can ensure that your new company complies with relevant corporation laws. Speak with a lawyer who can assist you in establishing the most successful structure for your business, including corporations, limited partnerships, joint ventures, and general partnerships.
Post a project in ContractsCounsel’s marketplace to get free bids from lawyers that help with business formation. All lawyers in our network are vetted by our team and peer-reviewed by our customers for you to explore before hiring.
