Corporation: What It Is and How to Form One

What Is a Corporation?

A corporation is a legal entity that is separate and distinct from its owners. Under the law, corporations possess many of the same rights and responsibilities as individuals. They can enter contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.

Some refer to a corporation as a “legal person.”

Key Takeaways

• A corporation is legally a separate and distinct entity from its owners. Corporations possess many of the same legal rights and responsibilities as individuals.
• An important element of a corporation is limited liability, which means that its shareholders are not personally responsible for the company’s debts.
• A corporation may be created by an individual or a group of people with a shared goal. That does not always involve making a profit.

1:46

Corporation

Understanding Corporations

Almost all large businesses are corporations, including Microsoft Corp., the Coca-Cola Co., and Toyota Motor Corp. Some corporations do business under their names and also under separate business names, such as Alphabet Inc., which famously does business as Google.

The precise legal definition of a corporation differs from jurisdiction to jurisdiction, but the corporation’s most important characteristic is always limited liability. This means that shareholders may take part in the profits through dividends and stock appreciation but are not personally liable for the company’s debts.

The Creation of a Corporation

A corporation is created when it is incorporated by a group of shareholders who share ownership of the corporation, represented by their holding of stock shares, and pursue a common goal.

The vast majority of corporations have a goal of returning a profit for their shareholders. However, some corporations, such as charities or fraternal organizations, are nonprofit or not-for-profit.

In any case, their shareholders, as owners of the corporation, do not accept responsibility for it beyond the potential loss of their investment in it.

A private or “closed corporation” may have a single shareholder or several. Publicly-traded corporations have thousands of shareholders.

In the U.S., corporations are created under the laws of the individual states and are regulated by state laws. Public corporations are regulated by federal law, primarily via the Securities and Exchange Commission.

Becoming a Corporation

Each state has its own laws regarding incorporation.

Most states require the owners to file articles of incorporation with the state and then issue stock to the company’s shareholders. The shareholders are required to elect the board of directors in an annual meeting.

The process of turning a private corporation into a public corporation is far more complex, as it falls under federal laws requiring full and public disclosure of financial information to potential shareholders and to the government.

The Day-to-Day Operations of a Corporation

The shareholders of a corporation typically receive one vote per share.

They hold an annual meeting during which they elect a board of directors. The board hires and oversees the senior management that is responsible for the corporation’s day-to-day activities.

The board of directors executes the corporation’s business plan. Although the members of the board are not personally responsible for the corporation’s debts, they owe a duty of care to the corporation and can incur personal liabilities if they neglect this duty.

Some tax statutes also provide for the personal liabilities of the board of directors.

Liquidating a Corporation

The legal existence of a corporation can be ended using the process called liquidation. This may be a voluntary decision to cease operations or may be forced by the financial collapse of the business.

Essentially, a company appoints a liquidator who sells the corporation’s assets. The company pays any creditors and distributes any remaining money to the shareholders.

An involuntary liquidation is usually triggered by the creditors of a corporation that has failed to pay its bills. If the situation cannot be resolved, it is followed by a filing for bankruptcy.

What Is a Corporation vs. a Business?

Many—but not all—businesses are corporations, and vice versa.

A business or any other enterprise may seek to incorporate. As a corporation, the enterprise exists as a legal entity separate from its owners. Most importantly, this means that the owners cannot be held responsible for the debts of the corporation. It also means that the corporation can own assets, sue or be sued, and borrow money.

How Is a Corporation Formed?

To form a corporation in the U.S., it is necessary to file articles of incorporation with the state in which it will be registered. The details vary from state to state. Usually, incorporation is immediately followed by the issuance of stock to the corporation’s shareholders. After this point, in an annual meeting, the shareholders will elect a board of directors.

Limited Liability Company vs. Corporation: What’s the Difference?

Both a limited liability company (LLC) and a corporation offer similar legal advantages to their owners: they cannot be held liable for the debts of either entity. But LLCs have a tax advantage in that they are “pass-through,” with profits and tax responsibility passed to the owners rather than paid by the LLC.

LLCs are governed by an operating agreement that sets out the roles and responsibilities of its members, and establishing an LLC is relatively straightforward. By comparison, a corporation elects a board of directors, conducts annual meetings, and adopts bylaws. The process can be complex and lengthy, depending on the state in which it incorporates.