If you’re interested in starting a business of your own, you may be tempted to organize it in the form of a corporation. Corporations, after all, carry a type of cache that other structures sometimes don’t.
There are actually multiple types of corporations available, including an S-corporation and a C-corporation; however, these are very similar. The biggest difference is the number of allowable shareholders and the requirements for those shareholders. S-corporations also don’t owe income taxes because they’re considered pass-through entities.
Is a corporation the right structure for your business? Examining the pros and cons of each can help you determine your best move.
Strengths of Corporations
Corporations offer many advantages over other business entities, including:
- Share issuing: Corporations have the ability to issue shares of ownership, publicly or privately. This makes it easy to distribute ownership of the company between multiple people, as well as distribute profits in the form of dividends between those people. In a publicly traded corporation, you can issue shares as a way to raise funds, giving you much more capital—which is incredibly useful if you’re interested in expanding.
- Ownership transference: If you need to transfer ownership on the fly, corporations make it easy. You can simply buy or sell shares as needed. It’s much more complicated if you own a partnership with one other person and need to arrange a deal to bring in a third.
- Liability protection: One of the biggest advantages of a corporation is its ability to shield owners from liability. In a business like a sole proprietorship, if the business is accused of wrongdoing, the owner will likely be held accountable for those damages. In a corporation, the business is treated as a separate legal entity; the business can take on debts and be held accountable for breaches of contract. This won’t protect you as an individual from all forms of accountability, but it will significantly shield you from liability issues.
- Extended lifespan: Corporations also exist in perpetuity, making them capable of many generations of existence. They’re ideal if you want to build a business that has the potential to outlive you.
Weaknesses of Corporations
However, there are some drawbacks to this entity type:
- Tax burdens: C-corporations face a corporate tax rate, which they pay on all income. In addition, shareholders of corporations are taxed on income they receive in the form of salary, profits from a sale, or dividends. Accordingly, owners of a corporation are often forced to face a “double tax” on all income. Compared to LLCs and other organizational structures, this usually means a higher tax burden.
- Tax and organizational complexity: Corporations are typically the most complicated type of business to start. They require the most paperwork and must comply with a litany of tax codes, operational rules, and regulations. You’ll likely need a legal team to help you navigate these complexities, which makes corporations intimidating to new entrepreneurs.
- Management and oversight problems: Corporations can also run into issues with management. If shareholders can’t agree on something or have no clear majority interest, the management team can make decisions for the company with practically no oversight.
If a corporation isn’t the right choice for your business, what other options are available? These are some of the most common:
- Limited liability companies (LLCs): A limited liability company (LLC) is kind of a scaled-down version of a corporation. Like a corporation, it’s treated as a separate legal entity, which means it can take on its own debts and shield you from liability issues. However, it’s treated as a pass-through entity; it doesn’t face an independent tax rate, but the money you collect as salary or profits will be considered taxable income. They’re more complex than some types of businesses, but still simpler than most corporations.
- Sole proprietorships: A sole proprietorship is the simplest type of business, but it only really works if you’re owning and operating the business by yourself. You won’t have to deal with any organizational complexity, but you’ll also be exposed to more liability issues. It’s a trade-off that’s often worth it for small-time operations, but not much else.
- Partnerships: Partnerships follow nearly all the same rules as sole proprietorships, with one main difference: They’re owned and operated by more than one person. You’ll need a partnership agreement in place to solidify and outline this type of business; however, this paperwork isn’t complex and is highly flexible.
There isn’t a “right” or “wrong” answer for which business type is best; it all depends on your organizational goals and what you hope to do with the business.
You can change the organizational structure of your business if you need to down the line. However, it’s easier to shift from low-complexity arrangements to high-complexity ones than vice versa. The key, at every point, is to not lose sight of what’s best for your company.