When determining your foundation, the major concern seems to be whether the company is ever expected to go public. For General Partnerships and Limited Liability Company’s (“LLC”) this is an impossibility unless you plan to change your business structure. If your business is in its infancy, you may wonder whether forming a corporation is necessary. The most common reason to incorporate is to limit your personal liability for business obligations. However, it costs money to set up and dissolve a corporation, corporations have additional record keeping, an annual and biannual reporting requirements that you will not experience in other business structures. Be advised that, depending on your personal situation, a corporation may save you money on your taxes. However, it may cause you to pay more in taxes in the form of double taxation.
The summary that follows should not supplement the work of an experienced attorney, but rather, as a start up in addressing your blossoming business’s needs. Please keep in mind that this is not a comprehensive guide of how to form a Corporation, but rather, should be used to assist you in determining what is right for you. If you need advanced accounting or tax help, it is advised to find a knowledgeable tax attorney or accountant.
Legal Formalities
Corporations require two governing documents; a charter, and bylaws. You may also need corporate governing and shareholder’s agreements, which are recommended but are not required.
- Charter: Your charter specifies the Corporation’s name, the types of stock it is authorized to issue, the rights, and preference of any preferred stock, and an office and agent for the service of process in the state in which you incorporate.
- Bylaws: Bylaws specify rules regarding the governance of the Corporation (notice and quorum requirement for the board and shareholder meetings, number, and qualifications of directors, voting standards, proxy voting, appointment of officers and stock certificates).
- Corporation Governance Principals: Corporate governance principles are common for public Corporations (boards and committees, director responsibilities, content and frequency of board meetings, and director compensation).
- Shareholders Agreement: Shareholder’s agreements will address many issues, such as stock transfer restrictions, board representation, buy-sell rights with respect to the Corporation’s shares and employment of shareholders.
Advantages to the Corporate Form
Generally, there are hands full of distinct factors, which motivate owners of a business to conduct it as a Corporation. These factors include; Easy transferability of the ownership interests, perpetual existence of the Corporation, limited liability of shareholders and centralized management, and often times tax breaks. Look to the following for a brief description of Corporate Advantages:
- Transferability of Ownership Interest: Incorporation results in the use of transferable securities to represent the shareholder’s interest in the common business enterprise, therefore making the transfer of the ownership interest quite simple.
- Perpetual Existence of the Corporation: This offers great certainty to both creditors and investors, especially in circumstances where they must commit capital to the business for a prolonged or indeterminate period.
- Limited Liability of Shareholders: Investors risk only their purchase price paid for their shares and have no additional liability for debts incurred by the Corporation. When it comes to taking responsibility for business debts and actions of a Corporation, shareholders’ personal assets are protected. Shareholders can generally only be held accountable for their investment in stock of the company. However, in a small, new Corporation, regulations may require personal guarantees from the shareholders.
- Centralized Management: Corporations vest management authority in a Corporation’s board of directors. A Corporation’s shareholders have no statutory authority to manage the Corporation. Generally, a board of directors does not make the day-to-day decisions in regard to the Corporations business. Rather, the directors must appoint officers to run the business subject to the board’s oversight.
- Raising Capital: Generally, Venture Capitalists (“VC’s”) will be drawn to invest in your business when it is organized as a Corporation as opposed to a Partnership or LLC. Venture Capitalists are investors who provide capital to Start-Ups or support small companies that wish to expand but do not have access to equities market. High risk and great potential are a few of the factors that draw in VCs. VCs will raise money by selling interests in an investment funds formed and managed by the VCs.
- Planning for the Future: Generally, Corporations are more attractive to buyers than a partnership. The new buyer removes himself from liability for any wrongdoings on the part of the previous owners. When your business is a sole proprietorship, the new owner retains personal liability for any mistakes or illegalities on the part of the prior owner. The corporate form protects against this situation with limited liability of its shareholders.
Disadvantages of the Corporate Form
The following are disadvantages you should keep in mind:
- Forfeiting Personal Opportunities: Since a board of directors, rather than you, runs the Corporation, individually, you must forfeit your duties as sole decision maker and therefore, forfeit opportunities you wish to explore.
- Overhead and Compliance: Forming a corporation requires paperwork, including the documents listed above. Aside from these start up documents a Corporation is required to file annual reports that must be filed with state agencies. Therefore, Corporations are often more expensive to start up then other types of business structures. Depending on state law, a corporation must keep records of annual corporate formalities. Compared to other business entities, a corporation’s record keeping can take a lot of time and effort that a small business does not have at its disposal.
- Double Taxation: In some cases corporate earnings are double-taxed, meaning they are taxed at the corporate level when the business earns the income, and then taxed a second time at the individual level when profits are distributed. Avoiding double taxation is possible by forming an S corporation (“ Corp.”), which is a smaller form of corporation that are taxed differently than a C corporation. In an S corp., earnings flow through the tax returns of the individual shareholders rather than being taxed at the corporate level.
Forming a Corporation is an important legal step in developing your business. If you have any questions regarding forming a Corporation, or steps to take with your newly formed business, please contact Columbus, OH small business attorney Allison Harrison at (614)440-1395 or via e-mail at aharrison@alharrisonlaw.com
By Chad A. Hirschauer
