Corporation

A legal entity created by individuals or shareholders with the purpose of operating for profit

Written by

CFI Team

Updated December 1, 2022

What is a Corporation?

A corporation is a legal entity created by individuals, stockholders, or shareholders, with the purpose of operating for profit. Corporations are allowed to enter into contracts, sue and be sued, own assets, remit federal and state taxes, and borrow money from financial institutions.

The creation of a corporation involves a legal process called incorporation where legal documents containing the primary purpose of the business, name and location, and the number of shares and types of stock issued, are drafted.

The process of incorporation gives the business entity a distinct feature that protects its owners from being personally liable in the event of a lawsuit or legal claim.

What are the Common Types of Corporations?

A corporation can be created by a single shareholder or by multiple shareholders who come together to pursue a common goal. A corporate can be formed as a for-profit or a not-for-profit entity.

For-profit entities form the majority of corporations, and they are formed to generate revenues and provide a return to their shareholders, according to their percentage of ownership in the corporation.

Not-for-profit entities operate under the category of charitable organizations, which are dedicated to a particular social cause such as educational, religious, scientific, or research purposes. Rather than distribute revenues to shareholders, not-for-profit organizations use their revenues to further their objectives.

The three main types of business incorporations are:

1. C Corporation

C Corporation is the most common form of incorporation among businesses and contains almost all of the attributes of a corporation. Owners receive profits and are taxed at the individual level, while the corporation itself is taxed as a business entity.

2. S Corporation

S Corporation is created in the same way as a C Corporation but is different in owner limitation and tax purposes. An S Corporation consists of up to 100 shareholders and is not taxed as separate – instead, the profits/losses are shouldered by the shareholders on their personal income tax returns.

3. Non-Profit Corporation

Commonly used by charitable, educational, and religious organizations to operate without generating profits. A non-profit is exempt from taxation. Any contributions, donations, or revenue received are retained in the entity to spend on operations, expansion, or future plans.

How Do Corporations Work?

A corporation is required to name a board of directors before it can commence operations, and the members of the board of directors are elected by shareholders during the annual general meeting. Each shareholder is entitled to one vote per share, and they are not required to take part in the day-to-day running of the corporation. However, shareholders are eligible to be elected as members of the board of directors or executive officers of the corporation.

The board of directors comprises a group of individuals who are elected to represent shareholders. They are tasked with making decisions on major issues affecting the shareholders, and they also create policies to guide the management and daily operations of the corporation.

The elected members to the board of directors owe a duty of care to the shareholders, and they must act in the best interests of the shareholders and the corporation.

What are the Advantages and Disadvantages of Incorporation?

Advantages

• Separate legal entity – Independent from its owners and considered a legal entity that may conduct business, own properties, enter into binding contracts, borrow money, sue and be sued, and pay taxes.
• Unlimited life – Stockholders, shareholders, or members are the owners of a corporation, and it is managed by a board of directors. Their death or inability to perform their duties does not affect the continuity of this legal entity; only changes in the company’s charter will enable it to either be extended or liquidated.
• Limited liability – Company owners are only liable for the amount they invested. Creditors and lenders have no claim to the owners’ personal assets for payments owed by the shareholders.
• Easy transfer of ownership shares – Publicly held corporations do not require approval from other stockholders to sell the stocks or shares of individual owners. Stocks or shares can be easily traded in the market, regardless of their volume.
• Competent management – Investors or owners may not directly handle day-to-day business operations. They vote for the board of directors who eventually hire a professional management team.
• Source of capital – Corporations can source funds from selling stocks and issuing bonds.

Disadvantages

• Incorporation costs – It is costlier to go through the process of incorporation than to form a sole proprietorship or partnership.
• Double taxation – Two taxes are remitted, from the corporate earnings and from payments of dividends to shareholders.
• Documentation – Aside from incorporation documents, companies must file annual reports and tax returns, as well as maintain accounting records, licenses, and other important documents.

How Does a Corporation Dissolve?

The life of a corporate entity lasts until there is a change in its charter or the purpose of its existence has reached its peak. A process called liquidation will serve the transition, facilitated by a liquidator.

The corporate assets will be sold and the proceeds will first go to creditors to pay off debt. Whatever remains will be given to shareholders. Involuntary liquidation is usually triggered by creditors of an insolvent or bankrupt company.

More Information

Thank you for reading CFI’s guide to Corporations. To keep learning and developing your knowledge base, please explore the additional relevant CFI resources below: