Business Structures (continued…)

Corporations

To finish up the discussion on business structures, let’s discuss corporations. The type of corporations that we know about today such as Apple, Walmart, and GE, were not as common in the early history of the US. Corporations were originally designed to serve the state and the public, such as building bridges or roads for public utility. Early state corporation laws were restrictive with the intent of preventing corporations from gaining too much wealth and power. But over time, corporations have evolved into entities with certain rights/privileges that serve more than just our public needs today. Before I digress into a long discussion on the history of corporations, check out David Rothkopfs who gives a brief history on corporations in the US. Having a basic understanding on the evolution of corporations and their rights will allow an entrepreneur to understand whether or not a corporation is the right business structure for his or her venture.  

What is a corporation?

A corporation is a legal entity, distinct and separate from the individuals who create and operate it. As a legal entity the corporation can acquire, own, and dispose of property in its own name. It can also incur liabilities and enter into contracts like franchising and leasing. 

According to Mitt Romney, corporations are people. In many ways, he was correct. Through the use of the 14th Amendment, corporations have almost the same constitutional rights in which people do. 

How do you create a corporation?

To create a corporation, one must file a document called the articles of incorporation with the state, laying out basic info on the structure of the corporation. Any early stage investor who is investing in your venture is going to want to see this document in order to understand 

• name of the corporation, address of the corporation’s registered agent, name and address of the incorporators, number of share authorized to be issued.
• description of the capital structure and the rights/preferences/restrictions on the preferred and common shareholders 
• dividend policy related to the equity securities
• liquidation preference between the different classes of stock
• redemption rights
• voting rights 
• voting procedure for the election of the board of directors
• if the corporation wants to change the document (change the name of corp or issuance of additional securities), shareholders have to vote, once approved the amendments must be filed with the secretary of state for the company’s state of incorporation

What are the advantages and disadvantages of forming a corporation?

Advantages

• Limited Liability - owners of the business are only liable for their investment in the company. The corporation is liable for the debts of the business. 
• Continuation of the Business  - corporation is a separate entity apart from its owners and managers. So if the owners or managers resigns or dies, that corporation can continue.
• Transferability for Shareholders - owners are able to transfer their ownership in the business whenever they want, without the consent of other shareholders. 
• Attract Potential Employees - corporations can offer stock options and employe stock options plans to attract talent to their venture

Disadvantages 

• Double Taxation - corporations must pay income taxes on any profit and the owners pay tax on the profit when the corporation distributes the dividend 
• Corporations are able to elect to be taxed like an S corporation (e.g. have the ability to be taxed like a partnership)
• Sharing of Management Power - more governance oversight than other business structures. Shareholders elect the board of directors and the board directors appoint the management to run the organization. Take a look at the governance structure of Sony. 

• Costly/Paperwork/Formalities - corporations have to maintain more records than other business entities. As a result of being a separate entity, corporation must file annual tax returns and reports that are separate from personal accountings. need to maintain more records than other business entities. Corporations must file annual reports/tax returns and maintain bank accounts and records that are separate from personal accounts. Shareholder meetings, board of director meetings records, licenses and other corporate records also are necessary.

If a person wants to setup a business entity that protect their personal assets, doesn’t mind sharing management power, and would like the business to continue after the owner leaves, a corporation is not a bad fit. Also, if you are looking for funding from institutional investors you are going to want to be setup as a corporation for reasons discussed in my post about LLCs.

This concludes the posts on business structures, also I am not a lawyer or a tax advisor and if you are planning on incorporating, I would recommend consulting a lawyer and accountant before making any decisions.