Different Types of Corporations

One of the most pivotal choices an entrepreneur or business owner will make is determining the right type of corporation. The legal form of a corporation affects taxation as well as capital raising, liability exposure, and operational flexibility. Corporations as legal entities have several advantages including limited liability, perpetual existence, and the ability to issue stock to raise capital.

But there are different types of corporations and each comes with its own sets of unique requirements and benefits; some are ideal for big businesses looking to bring in venture capital while others are more suited to small and family-owned businesses. In this piece, we will analyze some of the available types of corporations, their advantages and disadvantages, along with real-life scenarios that will shed light on the best possible structure for your business.

What Is a Corporation?

A corporation is an entity separate from its owners or shareholders. It acts as its own legal entity, responsible for its own debts and liabilities, creating a corporate veil that acts as a protective barrier for the shareholders’ personal assets. In simpler words, a corporation can own property, enter business contracts, and execute other activities in its own name just like an individual.

Key Characteristics of Corporations

• Limited Liability: Most shareholders do not have personal responsibility for a corporation’s debts and legal obligations.
• Perpetual Existence: Corporations can exist forever even if there are changes in ownership or management.
• Separate Legal Entity: Corporations can independently initiate or defend actions in litigation, make contracts, and hold property.
• Centralized Management: Central focus resides with a board of directors who make important decisions that control the company’s concerns and manage other employees.
• Ability to Raise Capital: Incorporation makes it easy to sell stocks and bonds, thus reducing the chance of losing investors.

The Incorporation Process

The incorporation of a business model involves multiple stages such as the following:

1. Filing Articles of Incorporation: This is the stage where the document is prepared and filed to the respective state describing the name, reason, objective, and construction of the corporation.
2. Choosing a Corporate Name: The name must be distinctive and meet the requirements set out in the state rules.
3. Appointing a Registered Agent: A legal document can be received by a company or person on behalf of a corporation’s business affairs. 
4. Creating Corporate Bylaws:  Rules that govern the inner workings of a corporation, including the authority that directors and officers have on behalf of the corporation. 
5. Selecting a Board of Directors: A set of individuals with the authority to determine the corporation’s business objectives and strategies, as well as oversee the corporation’s operations.
6. Stock Issuance: Shares that indicate ownership of the corporation are given to the initial owners and investors.

Having covered these fundamentals, we will now focus on the six most important types of corporations and what differentiates them.

1. C Corporation (C Corp)

This is the most common structure in which most large businesses and startups target aggressive growth. A C corporation is treated as an independent taxable entity from its owners and therefore pays taxes on its earnings separately from its owners. The issuance of different types of stock makes it possible for C corps to have a variety of investors which is one of the distinguishing features of C corps. 

Key Features

• Separate Taxation: Corporate expenses are tax deductible for C as long as they are ordinary and necessary expenses associated with the corporation’s business.
• Unlimited Shareholders: There is no maximum number of shareholders, so shares may be sold publicly on stock exchanges, making this structure perfect for companies planning for an IPO. 
• Investor Attraction: The ability to issue more than one class of stock makes C Corps very popular among venture capitalists and other institutional investors.
• Perpetual Existence: The change of ownership or change in management does not affect the continuity of the corporation.

2. S Corporation (S Corp)

An S corporation offers many advantages of a C corp such as limited liability and corporate formalities, but most importantly, an S Corp includes the benefit of pass-through taxation. This means that the corporation does not pay income tax. Instead, all profits and losses are attributed to the shareholders’ returns. 

Key Features

• Pass-Through Taxation: C corporations face double taxation on their income, but S corporations only pay taxes at the individual level.
• Limitations on Shareholders: An S corp can never exceed the limit of having 100 shareholders and every one of them must be citizens or residents of the United States.
• Single Class of Stock: S corps are restricted to a single class of stock, which limits their ability to appeal to different investors.
• Liability Protection: Protection of shareholders’ assets is done in S corps just like in C corps, which allows them to have limited liability. 

3. Limited Liability Company (LLC) 

The term used for an LLC is ‘limited liability company’ and is one of the highly sought-after hybrid business structures as it brings the most important features of both corporations and partnerships into action. It allows having the limited liability protection of corporations as well as pass-through taxation of partnerships. 

Key Features 

• Flexibility in Taxation: Profits of an LLC are, by default, reported on the owners’ tax returns so they are taxed as pass-through entities which is the default.  But an LLC can also opt to be taxed as a C Corp or S Corp if advantageous. 
• Fewer Formalities: There are no requirements for LLCs to have a board of directors or hold annual meetings, which reduces the corporate governance burden. 
• Flexible Ownership Structure: LLCs can have an unlimited number of members and owners can be any individual, corporation, or LLC. 
• No Stock Issuance: Ownership in the LLC is defined by membership, rather than stock, as is the case with corporations.

4. Nonprofit Corporation 

Nonprofit corporations do not have stakeholders to answer for. Instead, they are formed with a religious, social, or educational purpose in mind. To further a charitable cause, these corporations are automatically eligible for tax-exempt status under IRS regulations 501 (c) (3) which usually means they are exempt from both federal and generally state income tax.

Key Features 

• Tax Exempt Status: Nonprofit corporations that have been granted 501 (c) (3) status, are exempt from federal and often states’ income taxes.
• Mission Driven: Unlike profitable corporations, nonprofits have a cause to serve and the profits generated must go back into serving that cause as opposed to being distributed as dividends.
• Public Accountability: Nonprofits are overseen by a board of directors and are held to strict compliance and reporting rules.
• Funding and Grants: One of the strongest points assisting nonprofits is the eligibility for grants and donations which further enables easier access to funds from the public and state agencies.

5. B Corporation (B Corp) 

B corporation is a much younger type of business entity that combines social and environmental impacts with for-profit motives. As legally recognized social enterprises, these corporations must account for their decisions concerning all stakeholders, not only shareholders, which guarantees that social and environmental returns are made alongside financial ones.

Key Features 

• Dual Mission: A B Corp is one type of business entity that is legally allowed to pursue a purpose in addition to generating profits as a positive social/environmental impact.
• Transparency and Accountability: A B Corps must adhere to strict accountability measures and publish annual benefit reports that evaluate their social and environmental impact. 
• Certification Process: Several companies approach B Lab claiming that they have had an impact, which then helps the companies build their brand and trust with consumers.

6. Closed Corporation

Closed marketing corporations operate as a unit privately. As per the law, closed marketing corporations have less than a specific number of shareholders which restricts trading. Normally, closed corporations are run and owned by small groups of investors or family members.

Key Features

Limited Shareholders: Specifically, a closed corporation can and normally does cap ownership at less than 35 shareholders which helps maintain stake concentration.

Reduced Regulatory Burden: Closed corporations do not have as many reporting regulations compared to public corporations, which makes it easier to manage.

Enhanced Control: The owners’ tight-knit relationships enable them to have greater control over business decisions as the shareholder group is small. 

Restricted Share Transfer: By nature, not freely offloaded. Transfers are subjected to board or shareholder approval.

Which Corporation Type is Right for Your Business?

Choosing the best corporate structure requires consideration of multiple factors. To ease your decision-making, below is a deep comparison between the factors: 

Taxation

• C Corporation: This structure is subject to double taxation which can be taxing for shareholders.
• S Corporation & LLC: Do not pay taxes at the corporate level, as profits or losses are recorded on personal tax returns.
• Nonprofit: Exemption from taxation is granted if certain requirements are fulfilled but come with significant restrictions on what they can do.
• B Corporation: They do not receive any special tax benefits but are taxed as a C corporation, which has no negative impact on the company’s ability to sell its goods or attract investments.
• Closed Corporation: Usually adheres to the taxation of the system selected, usually either C corp or S corp, which is associated with less cost in terms of operations.

Ownership and Capital

C Corporation: Most appropriate for companies who wish to have significant investment from venture capitalists or have plans to go for an IPO.

S Corporation: Suitable for family-owned businesses that have a small number of willing shareholders.

LLC: Owners can be individuals or companies and do not need to purchase shares, which is most beneficial for small businesses or partnerships.

Closed Corporation: Best suited for privately owned family businesses because there are very few owners.

Nonprofit: Emphasizes the need to get funds rather than selling shares or retaining earnings, thus is not corporated.

B Corporation: C corps that raise capital for the business through C corporation style with the difference that they cater to investors with specific social goals.

Management and Governance

• C and S Corporations: Have to maintain a minimum number of directors and comply with all business requirements such as meetings, reports, and business journals.
• LLCs: Possess increasing governance as compared to other business structures without any formal oversight.
• Nonprofit: Managed by a board of directors and is responsible for ensuring that the organization achieves its mission and complies with tax-exempt obligations.
• Closed Corporations: Have fewer owners and therefore, are more closely knit which leads to making business decisions faster.
• B Corporations: While still required to fulfill certain mandates of the corporation, they are also accountable for having policies that ensure social and environmental responsibility.

Regulatory Compliance

• C and S Corporations: Detailed business activities such as annual reports, audits, and state-supported reports create a stringent environment of compliance that leaves no room for error.
• LLCs: These organizations generally have greater flexibility and lower barriers to entry, although it will depend on the specific region.
• Nonprofits: Complying with the IRS thoroughly to maintain a tax ID requires disclosing extensive financial information and minutes of the board meetings.
• B Corporations: Have policies in place that ensure they have a positive social and environmental impact and must publish a report proving it every year.
• Closed Corporations: The small size and private nature of the business means having fewer policies and restrictions imposed on them.

Practical Considerations When Forming a Corporation

1. Legal and Financial Advice

Ensure that you acquire professional help before choosing the corporation structure. A legal practitioner can advise you on the possible consequences of each structure on your business, and your obligations regarding state-specific regulations, and assist you through the steps of incorporation. A professional can also assist in drafting by-laws, shareholder agreements, and other required documents that protect your business in case of unforeseen risks.

2. Growth Plans and Future Goals

Ask yourself about the long-term goals your business has set. While a C Corporation is less attractive due to taxes, it is possibly the best structure to enhance growth, draw in venture capital, and eventually sell the company stock to the public. An LLC or S Corporation would be more appropriate for small family-owned businesses or firms that do not wish to bring in outside investors due to its flexibility and ease when it comes to paying taxes. 

3. Operational Complexity

Think through your capacity to perform and deal with the administrative and regulatory burdens that come with every structure. C and S Corporations have stringent record keeping, board meetings, and compliance with an array of regulations which is a legal obligation for them. LLCs, on the other hand, have much fewer requirements, which may suit a single entrepreneur trying to run a small business.

4. Industry Considerations

Certain businesses have strong preferences when it comes to particular corporate structures. For instance, S Corporations are most often selected by professional service firms, while technology startups are C Corporations. Alongside them are companies intending to go public via IPO, which also favor the C Corporation format.

How to Get Started with Incorporation

1. Research and Evaluate

Start by looking into the different business structures available to you. Each type has specific tax obligations, liability risks, and regulations to adhere to. Bear in mind the potential goals of your business as well as the growth opportunities you may anticipate.

2. Engage Experts

Get in touch with corporate lawyers who have business experience, and accounting professionals. They will help you determine which structure is best for your business model, and make sure you understand the implications in a legal and financial sense.

3. Design Your Incorporation Outline

Outline the essential features of your corporate structure such as shareholder details, management structure, and stock ownership, if applicable to your business. If you are forming an LLC, determine the business structure for management and profit sharing.

4. File Necessary Documents

Complete and submit the Articles of Incorporation or Certificate of Formation for LLC to the relevant state body. Details about your business are required alongside the filing fee, which is typical at this stage.

5. Draft Internal Documents

Draft bylaws for a corporation or an operating agreement for an LLC. These documents explain how the business is run and are essential for dealing with internal disputes.

6. Obtain an EIN

You need to apply for an EIN to the IRS. An EIN is needed to open a business bank account, hire staff, and pay taxes.

7. Comply with Ongoing Requirements

After your corporation is set up, comply with state and federal laws. These include the submission of annual reports, routine board meetings, and detailed records of the corporation’s activities.

Conclusion

Selecting the appropriate variety of corporations is one of the most important decisions that can influence the growth of the business. Each option has distinctive benefits, including C Corporations, S Corporations, LLCs, nonprofit corporations, B Corporations, and closed corporations.

• If the business intends to expand aggressively, is willing to make significant capital investments, and wants to attract a wide range of investors, then C Corporations are the best fit. 
• For smaller companies that wish to benefit from incorporating while avoiding double taxation, S Corporations and LLCs offer significant advantages.
• Focused on public service, Nonprofit Corporations provide tax-exempt status making them ideal for such organizations. B Corporations enable companies to earn revenue while being socially and environmentally responsible, thus appealing to ethical consumers. 
• Closed Corporations are suitable for family-run businesses or companies with few shareholders who want to manage the business privately. 

Reference:
https://www.indeed.com/career-advice/career-development/types-of-corporations