Corporation: What It Is and How to Form One

When it comes to setting up the legal framework for their businesses, entrepreneurs have a few different alternatives. Choosing the best alternative is crucial to the business's long-term performance. Forming a corporation from the ground up is one of the more common choices made by entrepreneurs when it comes to setting up a small company. Even though there are numerous benefits to creating a corporation, it is essential for owners of businesses to understand both the benefits and the risks associated with this choice before moving forward. In this article, we'll take a look at what is corporation, how to form it and, the positives and potential drawbacks of forming a corporation.

What is a Corporation?

Individuals, investors, or shareholders may form a corporation as a separate legal organization with the intention of running a business for financial gain. Corporations are granted the legal authority to engage in contracts, sue and be sued, possess assets, pay federal and state taxes, and borrow money from financial institutions. One of the main advantages of forming a corporation is that shareholders are shielded from personal responsibility for the business's obligations. This indicates that shareholders are not personally accountable for the debts of the firm, even if they may partake in the earnings of the company via dividends and the appreciation of the stock.

Corporations make up the vast majority of the world's largest companies, with well-known examples being Microsoft Corporation, the Coca-Cola Corporation, and Toyota Motor Corporation. Some businesses operate both under their own names and under other trade names, such as Alphabet Inc., which is best known for operating as Google.

Types of Corporations

Numerous companies choose to use the corporate business form because of the numerous benefits it provides. Businesses have the option of selecting from among a variety of different kinds of corporations, each of which comes with its own particular set of advantages and disadvantages. The basic types of corporations that are available to businesses in the world today are the C corporation, the S corporation, the B corporation, the closed corporation, and the nonprofit corporation.

C Corporation

A C corporation is a kind of legal organization or structure that may be taxed independently from its owners by the federal government. It's a common organizational structure for bigger businesses and is gaining popularity among startups as well. A C corporation may have an infinite number of shareholders, and each shareholder's responsibility for the company's debts and liabilities is limited to the amount they invested.

A C corporation provides protection against personal liability, makes it easy to raise money via stock offerings, allows for tax-deductible healthcare plans and retirement plans, and, if desired, makes it easier to transfer ownership of the business to other individuals or organizations. However, this kind of organization does have a few drawbacks, such as the fact that profits are taxed twice (once when the company earns them and again when they are distributed to shareholders).

The most noteworthy distinction that can be made between a C Corporation and other types of company structures, such as an S Corporation or an LLC, is that C Corporations are subject to a double level of taxes on their earnings, one at the corporate level and one at the level of each individual shareholder.

S Corporation

S corporations, sometimes known as "S-corps," are a form of corporate structure that provides owners with the advantage of limited personal liability and enables them to avoid being taxed twice on the profits of their company. Although there are numerous similarities between an S company and a C corporation, there are also some key differences.

One significant distinction between an S corp and a C corp is that an S-corp is regarded as a pass-through corporation, which means that its earnings, losses, credits, and deductions may be passed on to the shareholders for reporting and taxation on their individual tax returns rather than the firm being taxed as a separate entity. One of the most important criteria for an S company is that every shareholder must be a citizen of the United States.

In order for a corporation to qualify as an S corporation, it is necessary for the corporation to satisfy a number of standards, including the following: the corporation may not have partnerships, nonresident aliens, or other companies as shareholders; the company may have no more than one hundred shareholders; and the corporation may only have one class of stock.

Limited Liability Company

LLCs are relatively new business structures that allow the pass-through taxes of partnerships with the limited liability of corporations. LLCs are recognized in every state and controlled by state-specific regulations. As with a partnership, the LLC's business earnings are not taxed separately since the IRS does not consider the corporation to be a distinct tax entity. Instead, the revenues from the firm are distributed directly to the members of the organization. When the members cash out their shares, the gains become part of their individual income, and they are subject to individual taxation on those profits.

Similar to other corporations, LLCs provide their members with limited personal liability. This ensures that members are completely protected from being held personally responsible for the debts and liabilities of the company. The maximum amount of financial responsibility that may be assigned to the corporation is equal to the value of its assets. Note, however, that members only have limited liability for their personal wrongdoings that produce business liabilities, such as court judgments. This indicates that a member may be held personally liable for corporate debts up to the amount of capital the member has contributed to the business.

Non-Profit Corporation

Nonprofit corporations are legal entities that may only engage in certain types of activity for the greater good, such as those related to politics, education, literature, science, social welfare, or similar causes. It does not create profits, and any money that it does earn must be spent to further the organization's mission. One of the most distinguishing features of a nonprofit corporation is that it is not permitted to distribute profits to its members, directors, or officers. Despite this restriction, nonprofit corporations are not prohibited from paying wages or other forms of reasonable compensation to individuals who have provided services to the organization.

Tax-wise, there are a number of benefits unique to nonprofit organizations, including There is no income tax imposed by the federal or state governments, the ability to take donations from individuals, the ability to apply for and receive grants, which are effectively free money to promote its cause, Board members are protected from personal accountability for the corporation's debts, and there is no need to pay real estate taxes when a building is acquired or sold. There is no charge for broadcasting public service announcements (PSAs) on television or radio stations.

B Corporation

These are the kind of companies that are expected to create a profit while simultaneously having a beneficial effect on both the local community and the natural environment. B corporations have just emerged onto the scene and have been steadily expanding their operations over the course of the previous ten years. According to the a Review, 2007 was the year in which the first wave of B corporations received their formal certification. And as of right now, there are over 3,500 businesses that have been granted the B Corporation certification and can be found in over 70 different countries, as stated by B Lab, which is the institution that grants the certification. There is a wide range in the size of B corporations; some are very small, while others are quite big. Patagonia, Ben & Jerry's, Cabot Cheese, and Seventh Generation are just a few examples of well-known B corporations.

There are strict requirements to become a B company, such as achieving a score of 80 or above on the B Impact Assessment, disclosing your scores on BCorporation.net, and signing a legal pledge to take into account your stakeholders. As a B-corp, you'll still be taxed as a C-corp or an S-corp.

Closed Corporations

A company that is not open to the general public for investment and has a small number of owners is known as a "closed corporation." These companies' shares are not publicly traded, making it harder for them to generate funds; nonetheless, their owners still enjoy limited personal liability.

Businesses that are typically held by a single family or by a small group of individuals are often structured as closed corporations. Rarely do they have more than thirty stockholders.

In most cases, closed companies are excluded from many of the requirements that are imposed on ordinary corporations. These requirements include the formation of a board of directors as well as the necessity that shareholders attend an annual meeting.

Mars Inc. and Beam Suntory are two companies that are good examples of closed corporations.

How to Form a Corporation

Choose a Corporation Name

The formation of a corporation is a significant accomplishment in the realm of business, and the selection of an appropriate name for the company is the first crucial choice that must be made. Your corporation will be known by the name you choose for your business; thus, it is essential to choose the best possible name. When choosing a good name for your corporation, you need to be sure that it won't be mistaken for other well-known businesses. You will be able to do this by investigating already established companies to ensure that no other corporation has already registered or gained the rights to a name that is identical to yours. Visit the website of your state's secretary of state or equivalent office handling company filings to see whether a desired name is already in use.

Advice and suggestions on selecting a corporation name

1. When choosing an acceptable corporation name, ensure that it is simple to pronounce and spell, as well as memorable and relevant for your target market.
2. Be sure that the name you choose for your corporation does not include any terms that might be taken the wrong way by prospective clients or investors and that it is not insulting.
3. Your corporation name must include identifiers for the kind of entity it represents, such as "Incorporated," "limited," "Corporation," or "Company," or an abbreviation like "Inc.," "Co.," or "Ltd."
4. In your company's name, you should avoid using terms like "trust," "bank," "credit union," or "trustee," as well as words that refer to governmental departments or agencies, such as "FBI," "State Department," or "treasury."

Appoint Initial Directors

Appointing the first board of directors is the next most significant stage since they will be responsible for making the policies and public statements that represent your company. An initial board is essential for a corporation since it contributes to the creation of a structure for the company and lends legitimacy to the organization in the eyes of prospective clients or investors. In order to ensure that no aspect of decision-making is overlooked, the board should consist of members who bring a wide range of experiences and opinions.

As soon as your company has been formally established, you may appoint a more permanent board of directors to take their position. This new board should be comprised of experienced industry specialists as well as folks who understand your company's needs and ambitions. Having such a competent staff in place will help you ensure your company's continued competitiveness and success in a constantly shifting market environment.

Articles of Incorporation

To start a new corporation, you have to file legal documents with the state agency that handles business filings. The document that is used for this purpose is called the Articles of Incorporation, and it specifies the fundamental organizational structure of your corporate entity as well as sets forth its authorities, rights, and obligations. The specific requirements for submitting this document will be different depending on the state in which you are located; however, it will typically contain a description of the company's purpose, its name, and location, information about the company's capital stock and directors, as well as other essential details.

Finding out what paperwork your state specifically requires for your articles of incorporation is the best course of action. Every state has its own set of regulations, terminology, paperwork, and fees to file, and they vary greatly from state to state. After the articles of incorporation have been reviewed and accepted, you will then be given a certificate of formation.

Draft Bylaws

In order to get legal recognition as a corporation, the bylaws of a corporation may be required in some states. Corporate bylaws are like a road map for how a corporation works. These rules and regulations outline the duties and responsibilities of each officeholder to guarantee that all activities are accomplished quickly and successfully. Draft Corporate Bylaws serve as a manual for board members and shareholders, laying forth standards like the required frequency of meetings and the subjects that must be covered. In addition, corporate bylaws include information on shareholder rights, the number of board directors and officer roles, voting criteria, and a variety of other essential specifics related to the processes of governance.

The goal of having these structured rules in place is to show how decisions should be made and to make sure that all shareholders or members are treated fairly.

Organize the First Meeting of the Board of Directors

When it comes to the effective management of a prosperous business, the significance of consistently convening board meetings and diligently recording the minutes of those sessions cannot be overstated. If the board of directors does not hold a first meeting, it is possible that they will not have a distinct sense of direction or a knowledge of the roles and responsibilities that they play. For this reason, it is essential that all companies conduct an initial meeting at which they establish bylaws, issue stock and share certificates, elect executives, appoint committees, and discuss the general objectives of the organization.

It is also essential to maintain accurate records in order to guarantee that any future decisions made by the board will be in agreement with the guidelines that have already been set. It is essential that minutes from each and every meeting be taken down in a precise manner in order to ensure that there is a well-organized record of events that can be accessed and reviewed at any time. This will make it possible for companies to show proof when asked about board decisions or company policies.

Issue Shares

After a corporation has been formed, one of the first official corporate actions that will take place will be the distribution of shares to the shareholders. In order for a corporate company to be considered legitimate in the eyes of the law, it is necessary for that crucial step to be performed first. The issuing of stock has a number of advantages, including the opportunity for owners to acquire more funding, an increase in liquidity ratios, and assistance with the development of new business enterprises.

When a corporation issues stock, it is very necessary for the rights of each shareholder to be set out in a clear and concise manner in a written document. This ensures that there will be no disagreements over ownership in the future. Creating documentation such as certificates of incorporation or shareholder agreements that specify the amount of stock owned by each individual as well as their voting rights is a simple and effective way to accomplish this goal.

Draft a Shareholders' Agreement

Every corporation needs a shareholder agreement, which is a very important document. This agreement specifies the rules of how ownership will be handled in the event that one of the business's shareholders passes away, retires, becomes handicapped, or quits the firm. A shareholder agreement that has been carefully prepared may be an effective tool for preventing possible disagreements amongst shareholders and ensuring that business operations continue forever, even when the firm is under challenging circumstances.

A shareholder agreement is particularly useful in situations when there is more than one owner of the corporation. This kind of agreement guarantees that everyone's interests are safeguarded in the event that anything unforeseen happens with any of the owners. The agreement also helps keep shareholders on the same page by making it clear what they can expect when decisions are made about their shares of ownership.

A shareholder agreement that has been carefully drafted may give clarity for all of the parties involved, ensuring that everyone is aware of their rights and responsibilities under the arrangement.

Obtain Permits and Licenses for Your Business

The majority of companies are required to get some kind of license or permission to operate legally, but the specific regulations that apply to your corporation will be determined by both the region in which it is situated and the industry in which it operates. All enterprises must obtain a general business license in accordance with the laws of certain states. The selling of alcoholic beverages and guns, as well as the operation of airplanes and restaurant facilities, all need special permits.

The United States Small Business Administration (SBA) maintains a chart that lists all of the sectors that need a license from the federal government. Get in touch with the relevant authorities in both your state and the municipality where you live to learn more about the extra licenses required in that area.

You will need to register a DBA name in addition to your company's official name if you want to do business using a name that is different from the name under which your corporation is legally recognized. The DBA name is sometimes referred to as a "fictitious business name" or "doing business as" name. It is possible that you may be required to register the DBA with the state, the city, and the county in which you now reside. You may skip this step if the only name you intend to use for your company is the one that is officially registered with the state.

Opening a Corporate Bank Account

Establishing a business bank account is a crucial step in the process of establishing a company. It gives you the ability to keep the money associated with your business distinct from your personal finances, which protects both the company and its owners. By establishing a separate financial entity, you provide yourself the opportunity to have access to more specialized services, such as loans or financing options with suppliers, that you otherwise would not be able to obtain as an individual.

The procedure of creating a bank account for a company is not too complicated, but it does need some advanced planning and organization. You'll have to provide information on the company's legal registration, as well as about its goals and upcoming activities. Your selected institution may also need additional papers, including articles of incorporation and partnership agreements, as well as identity documents for any owners and members who are actively participating in the firm.

Conclusion

Establishing a corporation is a crucial task that comes with a wide range of possible advantages as well as a few potential disadvantages. By taking the time to understand what a corporation is, the many types of corporations, and the formation process, you will be able to make an educated decision for your corporation. In the event that you make the decision to establish a corporation, consulting with an attorney or another expert who specializes in corporate law may be of great assistance in ensuring that everything is carried out in the appropriate manner.