Characteristics of Corporations
Sole proprietorships, partnerships, and limited liability companies make up the majority of small businesses in the United States. However, corporations generate the majority of total business dollars annually. A corporation is organized and set up as a separate legal entity, which means that it's essentially a separate individual. As such, a corporation can own and dispose of property in its own name. It can also sell stock, a share of ownership of the corporation. Selling stocks allows the corporation to generate a great amount of capital.
Stockholders, or shareholders, are owners of a corporation's stock and are, therefore, owners of the corporation. These stockholders can buy and sell shares of stock with no effect on the operations or existence of the corporation. When a corporation trades stock in public markets, such as stock exchanges, it is referred to as a public corporation. Conversely, when a corporation does not trade stock in public markets, it is referred to as a nonpublic or closely held corporation. Stockholders have limited liability, which means that they're only liable to creditors for the amount they have invested in the corporation.
A corporation is governed by a group of elected officials known as the board of directors. The board of directors is responsible for establishing corporation policies, selecting the chief executive officer, and making decisions regarding the distribution of income to stockholders. Generally, the organizational hierarchy consists of the stockholders, or owners, who vote and elect the members of the board of directors. The board of directors then selects and hires the officers of the organization, and the officers run the day-to-day activities of the organization, including hiring other employees.
The formation of a corporation requires more steps than are required for the formation of a sole proprietorship or partnership. The first step in forming a corporation involves filing an application of incorporation with the state in which the corporation will operate. The laws of each state differ, and some states have more favorable laws. For example, many corporations incorporate in the state of Delaware because its laws are typically favorable to businesses. The Court of Chancery there, as court of equity, hears cases involving corporate law. For this reason, almost half of publicly traded companies in the United States are incorporated in Delaware, including Apple, Coca-Cola, Google, and Walmart.
Once the application has been approved, the corporation is granted a charter, or articles of incorporation, by the state, which formally creates the corporation. The management and board of directors of the newly formed corporation then create a set of bylaws, or rules and procedures, which the organization will follow when conducting business.
Advantages and Disadvantages of Corporations
Advantages and Disadvantages of Corporations
|Easily transferable ownership rights
Corporations sell shares of ownership through issuance of stock. Stockholders can transfer their shares of stock through the stock market to other stockholders.
|Double taxation of dividends
As a separate legal entity, the corporation is taxed on its earnings. Once the distributions pass to the stockholders, the earnings will be taxed again as dividend income.
The financial loss of a stockholder is limited to the amount of investment. The creditors of a corporation may not seize the individual assets of a stockholder to satisfy their claim against the corporation.
|Management separate from owners
While some owners have voting rights, the day-to-day management of the corporation lies with the board of directors and the officers. The board is designed to carry out the interests of stockholders (who appoint them) but often sides with officers of the organization.
|Raising large amounts of capital
Corporations are able to raise large amounts of money by issuing stock to their stockholders.
Because of the complexity involved in forming a corporation, there are higher costs of administration.
|Separate legal entity
The corporation exists separately from its owners.
The corporation is separate from its owners and therefore does not dissolve when the owners change.
One of the biggest risks of owning a business is personal liability in the event that the company fails. Therefore, one of the major benefits to forming a corporation is that the owners, or stockholders, are only liable up to what they have invested in the company. Because the corporation is its own separate legal entity, it exists separately from its owners. For example, if a stockholder owns $100,000 worth of stock from Company ABC and the company dissolves with $1 million in debt, the stockholder is only liable up to that $100,000. However, owners of a sole proprietorship or partnership would be liable for their company's entire debt, and their personal assets would be in jeopardy if the company dissolved.
The most commonly discussed disadvantage to the formation of a corporation is that the earnings are taxed twice. As a separate legal entity, the corporation pays taxes on its earnings, similar to how an individual must pay taxes on personal income at the end of the year. The difference is that when those earnings are distributed and passed on to its stockholders, the stockholders must then pay an additional tax in the form of dividend income tax on their individual tax returns.