CORPORATIONS 101-
THE
BASICS BUSINESS PEOPLE HAVE TO KNOW
Running your own business? Confused about your
options when it comes to business structures? There
are certainly some features that you want. You
probably do
want the ability to share and transfer ownership. And you probably don’t
want to be personally liable for the company’s debts. A corporation may
be the answer for you and your business. This article will take a quick look
at some of the advantages and disadvantages of the corporate structure; you
should talk to your lawyer for advice tailored to your specific needs.
What Is a Corporation Anyway?
A corporation is simply a business structure that you can create by filing
articles of incorporation in your state. The equity ownership interest in
a corporation is called stock, and the owners of shares of stock are called
shareholders or stockholders.
The most important characteristic of a corporation
is that it is a separate legal entity. This means
that the corporation is treated as a legal person
in its own right, separate from its directors and
shareholders. A corporation can own property, and
sue or be sued in its own name. Pretty much all
of the advantages of incorporating a business—and
all the drawbacks too—stem from this characteristic.
Limited Liability
Limited liability is one of the greatest advantages of a corporation. It means
that shareholders can only lose as much money as they put into the corporation.
For example, imagine Alan and Bob are starting a small business, and each
put up $5,000 in return for stock in their company, AB, Inc. In theory, the
creditors of the company cannot come after them personally for payment because
a corporation is a separate legal entity. Even if the business is deader
than a three-day-old halibut, Alan and Bob can only lose their investment.
Of course, limited liability in the real world is a little more complex than
that. Banks and others who lend money to small new corporations know very well
that they can’t routinely get their money back if their claims are greater
than the assets of the corporation, and are unlikely to lend $100,000 to a
company whose coffers contain a measly $10,000. Therefore, creditors often
require investors to give personal guaranties, or to co-sign a note or other
obligation in their capacity as individuals.
“ Lifting the Corporate Veil”
Sometimes it is unfair for
the people behind a company to
escape liability for its debts.
Don’t worry—this happens
rarely, usually only in cases where
a company director has acted fraudulently,
or where the business fails to
follow the proper corporate formalities.
In such circumstances, courts will
sometimes allow creditors to “lift
the corporate veil”—a
rather Victorian expression meaning
that creditors can look behind
the edifice of the company and
seek compensation from the company
shareholders or directors.
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The Importance of Perpetual Existence
In certain partnerships, if one partner leaves,
the remaining partners may have to agree continue
the business, or the partnership will dissolve.
In
a corporation, on the other hand, shareholders can come and go with impunity—the
separate legal entity of the corporation means that it can survive even if
a shareholder or director leaves. The life of a corporation is indefinite—which
means that investment in a corporation may be somewhat safer than investments
in other, less permanent business organizations.
Transfer of Shares
Being able to freely transfer shares to anyone gives an investor the right
to liquidate his or her investment at any time. But this transferability
can be a disadvantage in a small corporation. Take the example of AB, Inc.,
a small company where it’s essential for the success of the company
that the two shareholders get along. If Alan wanted to sell his shares in
AB, Inc. to Zoran, but Bob dislikes Zoran intensely, it could be a disaster.
In most small corporations, shareholders enter into a share transfer restriction
agreement to limit the transferability of shares.
Taxation of Corporations
The fact that a corporation is a legal entity opens up the unwelcome possibility
of double taxation: a tax on the earnings of the corporation as an entity,
plus the tax paid by the shareholder on dividends paid by the corporation.
Small business owners can get around this if they meet the requirements of
subchapter S of the Internal Revenue Code. S corporations do not pay any
taxes—the income and deductions are passed through to the shareholders,
who report their share on their individual tax returns. Your lawyer can give
you more detailed advice on eligibility requirements.
Types of Corporations
Besides the distinction between S Corporations and those that file under Subchapter
C of the Internal Revenue Code, there are several types of corporations to
fit the needs of various enterprises. General business corporations are often
among the larger enterprises. Close corporations are often smaller enterprises
in which all or most of the shareholders are actively involved in the management
of the business. State law typically allows such corporations more flexibility
in management. Professional corporations are limited to licensed professionals
such as physicians or architects, and professionals licensed in the field
are the only shareholders.
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