Corporations play a crucial role in the global economy, serving as a primary business structure for many enterprises. They provide a legal framework that enables businesses to operate, raise capital, and protect stakeholders’ interests. While corporations share common characteristics, such as limited liability and the ability to issue stock, they come in various forms to suit different business needs. In this article, we will explore the different types of corporations and their unique features.
What is a corporation?
A corporation, owned by shareholders or stockholders with the primary goal of making a profit, is a distinct legal entity separate from its owners. State regulations grant corporations the same rights and responsibilities as individuals.
Corporations facilitate collaboration among individuals, allowing them to invest varying amounts and share in the resulting profits. A corporation can have a single owner holding a 100% share.
The process of incorporating typically initiates at the state level, with specific requirements varying by jurisdiction. Corporations often receive special benefits from their state as long as they remain financially viable. The complete incorporation process involves the following steps:
1. Filing Articles of Incorporation: Prospective owners create and submit articles of incorporation to the government, outlining key aspects like the company’s name, physical address, and stock type.
2. Choosing a Name: Owners select a suitable name for their business, researching to ensure availability and alignment with their brand.
3. Creating an Operating Agreement: In most states, owners draft an operating agreement detailing financial decisions, voting processes, organizational structure, hiring criteria, and long-term goals.
4. Writing Corporate Bylaws: These rules, enforced by the board of directors, cover aspects such as voting procedures, shareholder meetings, and additional requirements.
5. Hiring or Appointing Directors: Depending on the business’s size and functions, owners may appoint directors to guide various departments or teams.
6. Appointing a Registered Agent: A registered agent manages legal notifications and serves as the contact point for legal matters.
7. Obtaining a Federal Employment Identification Number (FEIN): A unique identifier is required for business identification and financial transactions.
8. Opening Business Accounts: Separate accounts are opened to manage business funds distinct from personal assets.
9. Developing an Accounting Process: A consistent accounting process ensures compliance with local, state, and federal laws governing financial records.
10. Designing a Shareholder Agreement: This document outlines stock selling and transfer procedures and is a requirement for businesses issuing stock.
11. Issuing Stock: Corporations must issue and distribute shares among owners, and larger entities may register stock offerings with regulatory bodies such as the Securities and Exchange Commission.
Types of Corporations
1. C Corporations (C-corps)
A C corporation is a distinct legal entity that undergoes separate taxation by the government, independent of its owners. Numerous larger enterprises opt for the C corporation structure for federal income tax considerations, and they enjoy the flexibility of attracting an unlimited number of both domestic and foreign shareholders.
Government authorities treat the distribution of earnings and profits as dividends, subjecting them to income tax. The taxation process encompasses both the corporate level and the individual tax returns of shareholders. Exceptions to this taxation rule include distributions during the corporation’s liquidation and the termination of a shareholder’s interest.
2. S Corporations (S-corps)
S Corporations are generally small enterprises that offer the advantages of incorporation combined with the tax benefits similar to a partnership. Similar to an LLC, you can distribute income directly to shareholders without being subject to federal corporate taxes. However, there are certain constraints associated with S Corps, including:
. Limited to a maximum of 100 shareholders.
. Permitted to issue only one class of stock.
. Accessible exclusively to shareholders who are US citizens or residents, specific trusts and estates, or certain tax-exempt organizations.
3. Limited Liability Companies (LLCs)
Limited liability companies (LLCs) combine features of both partnerships and corporate structures, providing owners with limited liability protection against financial responsibility for any damages incurred by the company. Unlike C corporations, LLCs generally do not require a board of directors, and owners have the flexibility to structure the corporation as a partnership.
Additionally, LLCs benefit from pass-through taxation, wherein only the owners are subject to income taxes based on their shares of the business, rather than the entities making LLCs a favorable choice, especially for single owners.
An alternative organizational framework frequently utilized is the Limited Liability Company (LLC). Opting for an LLC offers several benefits:
. The associated costs are comparatively modest.
. The financial outcomes of the company are documented within your tax filing.
. Owners of an LLC bear no personal liability for the company’s debts and legal commitments.
Nonetheless, there are some downsides to consider when choosing an LLC:
. Expect to incur self-employment taxes.
. Attracting investors may prove more challenging.
. The LLC can dissolve in the event of a member’s departure.
4. Sole Proprietorship:
For small business owners initiating their venture without the backing of venture capital, the most straightforward choice is to establish a sole proprietorship. This type of business structure is an unincorporated entity owned and operated by a single individual. Sole proprietorship is also one of the best types of corporations. The process involves no formal registration or application, although obtaining a “doing business as” (DBA) certificate, usually requiring a nominal fee, is advisable to secure rights to a specific company name. It’s essential to note that changing the registered business name can be cumbersome once established.
While a sole proprietorship is an uncomplicated option, it does come with its drawbacks. Certain commercial banks, such as Silicon Valley Bank, may be unable to open accounts for sole proprietors. David Raynor, the founder of Accelerate Legal, a San Francisco law firm specializing in services for tech startups, suggests that this structure works well for solo endeavors like coding prototypes. However, as soon as multiple individuals are involved, complexities arise, such as determining ownership of intellectual property. Raynor cautions that at this juncture, it might be prudent to explore alternative legal entities. Additionally, if there is a plan to seek venture capital funding, incorporatimes are a necessity.
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5. Non-Profit Corporations
Non-profit corporations share a structural resemblance with traditional corporations, featuring a board of directors and financial supporters. Unlike their profit-driven counterparts, non-profits do not generate profits, as the name suggests. These organizations are established to champion a specific cause, often one of public interest, geared towards benefiting the non-profit’s members or specific groups of individuals.
A distinctive trait of non-profit corporations is their tax-exempt status, relieving them from corporate and federal taxes. They have the flexibility to secure funding from diverse sources, including grants, public and private donors, as well as corporations. Notably, donations made to non-profits are generally tax-deductible for the contributors, further distinguishing them from for-profit corporations.
For those driven by a passion for altruism and a desire to maximize positive impact rather than financial gain, opting for a non-profit structure is an ideal means to realize their mission.
6. General Partnerships
General partnerships resemble LLCs in that members can structure the business as they desire. However, in a general partnership, all profits, legal obligations, assets, and losses are collectively shared. Every member bears responsibility for any financial and legal liabilities, risking personal assets in case of forfeiture.
The key advantage of a general partnership lies in its simplicity to establish. General Partnerships is types of corporations. It involves less paperwork compared to setting up a corporation or LLC, providing a straightforward way to enhance professional appearance. Nonetheless, it’s crucial to note that all partnership members share equal responsibility for incurred damages, underscoring the importance of entering partnerships with trusted individuals.
How to Structure Your Startup
When deciding how to structure their startup, many businesses find it financially advantageous to incorporate in their home state or the state where they plan to operate. However, for startups seeking external funding, it is common for investors to prefer incorporation in Delaware due to its favorable corporate environment.
While Delaware is not classified as a “tax haven,” there are potential tax benefits associated with incorporating there. If your company doesn’t conduct business in Delaware, you are exempt from state corporate taxes. Additionally, the equity owned by individuals residing outside Delaware is not subjected to state taxes. Although companies are still responsible for taxes in their home state, these advantages help mitigate the risk of double-state taxation. Nonetheless, the Delaware-incorporate double-state is obligated to pay an annual franchise tax to the state. (Note that relocating your company to Delaware is not a requirement for incorporation there.)
Do You Need Legal Assistance to Register Your Startup?
Traditionally, establishing a C-corp necessitated the expertise of a seasoned lawyer, and some entrepreneurs still opt for legal guidance for various reasons. However, it is no longer a mandatory requirement. In the past decade, there has been a significant shift, allowing entrepreneurs to choose from a variety of online services that guide them through the paperwork at a lower cost.
If you prefer having a lawyer from the outset, consider consulting with your accountant, bank, or other connections. Some entities, like SVB, offer law firm referrals. Online platforms such as LawTrades and UpCounsel can also assist in finding an independent lawyer. For those seeking comprehensive services and guidance from an established law firm, negotiating a deferred fee arrangement is a potential option. In this arrangement, the firm may provide some hours of free service with the understanding that payment is contingent upon the startup reaching specific milestones, such as securing funding exceeding $1 million.
Conclusion
These are the few types of corporations we discussed. Choosing a legal designation and business structure for your small business might appear intricate due to the six available options. It is crucial to assess various aspects of your business objectives and current operations before making a final decision. This evaluation should encompass considerations such as annual tax responsibilities, growth projections, and even seemingly minor factors like employee benefits.