By Alex Montoya
In the fall issue of the AKC Law newsletter we took an in-depth look at partnerships, this quarter, let’s take a look at forming a corporation.
There are numerous legal entities to choose from when starting a business. Each entity comes with unique characteristics that should be carefully considered by company founders.
Entity selection plays an important role in many aspects of a business from personal liability exposure to capital raising implications.
Corporations, sometimes referred to as “C-Corps” due to the subchapter applicable to corporations in the Internal Review Code, are legal entities with characteristics starkly different than the characteristics of partnerships.
Namely, corporations are distinct legal entities that exist completely separate from their owners or founders. That comes with many benefits such as perpetual existence, protection from personal liability, greater transferability of corporate interests, and greater ability to raise capital. However, the benefits granted through corporations also come with greater expenses, record keeping requirements, and corporate formality adherence requirements.
Unlike general partnerships, corporations are distinct legal entities that require formal registration with a secretary of state or similar state entity. To bring a corporation into existence, the incorporators are required to file what are often referred to as “articles of incorporation.” Preparing the articles of incorporation and paying the state formation fees with the secretary of state or a similar entity requires much more time and money than would be required to form a general partnership. The articles of incorporation formally establish the basic information related to the corporation’s identity, location, agent for service, and stock to be issued.
2. Personal Liability Protection
As discussed in the previous newsletter, general partnerships can be unattractive to some business owners due to the personal liability exposure faced by partners. Unlike partners in a partnership, stock or shareholders in a corporation are not personally liable for any debts or obligations incurred by the corporation. Because a shareholder is only liable for up to the amount he or she originally invests, corporations are an attractive option for investors and others wishing to maintain ownership in the corporation.
3. Perpetual Existence
Once created, corporations offer many benefits. As mentioned above, because corporations exist separate from their owners and company ownership is based on stock ownership, corporations can exist long after the departure or death of the company founders or owners. Once an owner decides to depart from the company or dies, the company can continue to function, and the company’s ownership will transfer to another individual or back to the company. In fact, a corporation will exist until it is dissolved, wound-up, or liquidated by the board of directors and shareholders.
4. Double Taxation
One major disadvantage to the separate identity granted through the corporate form is that, in the absence of a special tax election, the corporation and the shareholders will both be liable for the payment of income tax, a scheme sometimes referred to as “double taxation.” The Internal Revenue Service views corporations as separate tax-paying entities, meaning the corporation itself will be liable for the payment of taxes on income received at the corporate level. Subsequently, the individuals operating the corporation will be liable for the payment of tax on the already taxed proceeds received through distributions made by the corporation.
5. Access to Capital
Another characteristic making corporations attractive for new founders is the ability to raise capital. Corporations have greater access to capital through the sale of equity in the company. Since ownership is represented through shares of freely transferable stock and the number of potential shareholders/owners is limitless, corporations have much more flexibility when it comes to raising capital as compared to sole proprietorships and partnerships. Since the transfer of ownership in other forms of entities is often restricted or much more burdensome to complete, the corporate form is much more attractive for founders hoping to raise large sums of capital.
Contact Alex at [email protected] to determine whether establishing a corporation is the right choice for you and your business.