2.4: Corporations

The stock corporation is more complex than the sole proprietorship or the partnership, but it has certain advantages that may make it worth considering as a business form. A corporation is considered a separate legal entity; because of this, the owners of the corporation (known as its shareholders or stockholders) are not personally responsible for the losses of the business. Although a corporation usually has more than one owner, it is possible for only one individual to create and own 100 percent of a corporation.

A stock corporation may elect Subchapter S status for tax purposes. Once such an election is made, the corporation is referred to as a Subchapter S corporation. This election is discussed in the section on taxes.

Getting Started

The Corporate Formalities

If you decide to do business as a corporate entity, you will have to comply with the formal requirements of law to create the corporation. Note that members of certain professions, such as doctors or lawyers, may be required to do business as a professional corporation.

The individual(s) who will own the business (i.e., the shareholders or stockholders) mustagree on the following to create a corporation:

• The name of the business.
• The total number of shares of stock the corporation can sell or issue (knownas “authorized shares”)
• The number of shares of stock each of the owners will buy.
• The amount of money or other property each owner will contribute to buy hisor her shares of stock.
• The business in which the corporation will engage.
• Who will manage the corporation (i.e., who will be the directors and officers of the corporation). Once the shareholders agree on these issues, they must prepare and file articles of incorporation or a certificate of incorporation with the corporate office in which they want to incorporate.

Fees Paid to the Local Government

You cannot form a corporation without filing with the appropriate government office. Most local governments charge an initial fee for filing the corporate documents and an annual fee for allowing the corporation to continue. These fees are sometimes based upon the number of shares of stock authorized and the par value of the stock. Because each local government has its own rules and schedule of fees, call your state’s corporate commission or secretary of state to determine what fees will apply to your business.

The corporation will also need bylaws, i.e., a set of rules of procedure by which the corporation is run. These include rules regarding stockholder meetings, director meetings, and the number of officers in the corporation and the responsibilities of each officer.

Keeping Account

The corporation is a legal entity separate from its owners; therefore, it will need a separate bank account and separate records. The money and property that the shareholders pay to buy their stock, and the assets and money that are earned by the corporation, are owned by the corporation and not by the shareholders.

A Word about the Corporation’s Name

When you send your corporate documents to the government, you must include the name of the corporation. If the name you have selected is already used by another company, your documents will be rejected. You can telephone the corporation commission and they will tell you whether the name you have selected is available as a corporate name. You also should take care to avoid using a name that is similar to that of an existing company or product.

Control

The Owners Have Ultimate Control

The shareholders of the corporation elect, at least once a year, a group of individuals to act as the board of directors. Usually, the directors must be elected by enough of the owners to represent a simple majority of the outstanding shares, although a higher vote requirement can be required. Thus, those who hold a majority of the shares have ultimate control over the corporation. Terms of directors often are for more than one year and are staggered to provide continuity. Shareholders can elect themselves to be on the board of directors.

Certain major decisions must be approved by the shareholders, such as amendments to the articles of incorporation, merger with another company and dissolving the corporation. In some states, certain of these decisions require more than a majority of the shareholders to agree; be sure to consult an attorney about your province’s voting requirements.

The Board of Directors Makes Major Decisions

The board of directors is responsible for the major decisions of the corporation. It must meet at least once a year. Each director on the board is given one vote; usually the vote of a majority of the directors is sufficient to approve a decision of the board. Directors may be paid for their services, although payment is not required. The board of directors elects the officers of the corporation. The officers usually consist of a president, vice president, secretary and treasure

Day-to-Day Decisions Are Made by the Officers

Officers of the corporation are responsible for running the day-to-day business of the corporation. Although they often are employees of the corporation and receive a salary, they can be non-employees and/or serve without pay. The shareholders can be elected as officers.

How Do the Owners Get Paid?

If you own stock in a small business corporation and also work as an employee in that corporation, there are two ways you may be paid:

(1) As an employee, you should receive wages or a salary for the work you perform and

(2) If the corporation’s business makes enough money, you may be paid a dividend or distribution on the stock you own.

The board of directors decides whether dividends shall be paid. If dividends are not allowed in any given period, a shareholder has no right to any of his money the corporation’s business has made (except as an employee receiving a salary or wages). This is because the corporation is a separate legal entity, and the money it makes belongs to the corporation.

Liability

The most important reason for you to consider incorporating your business is because a corporation is its own legal “person,” separate from its owners. This means, among other things, that creditor of the corporation may look only to the corporation and the business assets for payment. The individual shareholders are not personally liable for the losses of the business if the corporation is properly established and properly operated. The shareholders’ only risk is their investment in the corporation.

There are certain cases in which shareholders do incur some liability for the corporation. For example, if the shareholders do not observe the statutory requirements for running the corporation or do not keep the corporation’s money, accounts and assets separate from their personal accounts, then they may also be found to be personally liable for the business’s losses. Also, if the shareholders “guarantee” the obligations of the corporation in order to borrow money or to rent space, for example, then they are legally responsible for the obligations guaranteed. Finally, if shareholders make loans to the corporation and the business fails, their loans may be paid off only after the other loans of the corporation are paid.

Continuity and Transferability

The corporation, as a separate legal person, does not cease to exist if one or more of its owners die. Its corporate existence lasts as long as its shareholders decide it should; a corporation’s “life’ is usually perpetual. Ownership of a corporation can be transferred by sale of all or a portion of the stock.

Additional owners can be added either by selling stock directly from the corporation or by having the current owners sells some of their stock. (Before selling shares of stock tooutsiders, check to see whether securities laws permit the sale.)

Small businesses that are corporations are often owned by a small group of shareholders who all work in the business. Often these shareholders formally agree to certain restrictions on the sale of their shares, so they can control who owns the corporation.

Advantages

• Easier to raise funds through the sale of stock.
• The cost of benefits that are provided to officers and employees are tax deductible.
• Shareholders are not liable for judgments against the corporation and cannot be held liable for the corporation’s debts.
• S corporations offer some tax benefit

Disadvantages

• Forming a corporation requires more time, money, and paperwork than other business structures
• Tax laws that govern corporations can be complex, and accounting professionals will be needed in order to minimize tax liabilities
• Dividends paid to shareholders are not deductible from business income, which means they are taxed twice