Following fast on the heels of a decision to go into a particular kind of business is the decision about what kind of legal form it should take. The most common options are a sole proprietorship, a partnership, or a corporation. You may lean toward the corporate route because you like the sound of having “Inc.” after the company’s name, but there are some more practical, business‑like considerations to take into account.
More so than with some of the other structures for a business, starting a corporation means complying with formalities required by state laws. Once the shareholders (owners) of the business agree on some basic matters, such items are embodied in articles of incorporation that must be filed with the appropriate state agency. These essentials usually include:
- a corporate name;
-the number and type of shares that can be issued;
-the nature of the corporation’s business; and regulations pertaining to it;
-the agent for service of process ;
-the ability of the corporation to indemnify officers and directors; and
-the identity of the directors and officers of the corporation who will -handle day‑to‑day operations (optional).
The fledgling corporation will also need bylaws, which constitute a procedural rulebook for the company.
The bottom line here is that whoever holds a majority of the shares of a corporation has ultimate control over it. Usually it takes a majority of the shares to elect the board of directors, which is charged with making the “big picture” decisions. If a decision is momentous enough for the company’s future, such as a change in the articles of incorporation or whether or not to merge with another company, the shareholders usually have a more direct role in that they themselves must approve the decision by a certain margin of votes.
The board elects the officers of the corporation, typically including a president, vice‑president, secretary, and treasurer. The officers may or may not be salaried employees or shareholders, and in some cases one person may hold more than one office.
At or near the top of the list of characteristics favoring the corporate structure is the fact that, since the corporation is treated as a legal “person” separate from the people who own and run it, the shareholders as a rule are not personally liable for the corporation’s debts. Instead, their risk is confined to their investment in the company. To every rule there is an exception, however, and here the exception has the colorful legal name of “piercing the corporate veil.” If the owners do not comply with the statutory requirements for running a corporation, or if they blur the lines too much between corporate and personal finances, the legal fiction of the corporation as a separate entity is ignored and the owners are on the hook for the corporation’s losses.
As a separate entity in the eyes of the law, a corporation does not go out of existence if one or more of its owners dies. Instead, a corporation stays alive until its owners decide otherwise. Transfer of the ownership of the corporation is accomplished by selling its stock. New owners are added either when existing owners sell some of their stock or the corporation itself sells more shares of stock. The smaller the enterprise, the more likely it is that the owners, for whom the corporation may be both their property and their employer, may agree to restrict the sale of the stock in order to maintain control.
The particular circumstances of each new business and the differences in the governing laws of the states make generalities difficult. That said, the factors on the debit side of the ledger for corporations include the costs of setting up the corporate entity, the need for a separate tax return, and the potential burden of “double taxation.” Double taxation means that the corporation is taxed on its profits, and the shareholders are then taxed on their dividends. On the credit side are limited liability for the owners and easy transfer of ownership. Under the right circumstances, the corporation can avoid the double tax by making an S-corporation election with Internal Revenue Service and the Franchise Tax Board allowing the corporation to be taxed like a partnership.
Making the appropriate choice for a business form is one of the first, and one of the most important, decisions a new business will make. For more information about the various business structures, or to determine whether the corporate structure is right for you, contact our office, or sign up for our Business Law 101 Lunch.