What Is a Corporation?
We’ve all interacted with corporations. Whether we’re using the Google search engine or shopping at Target, corporations are prevalent in our day-to-day lives. However, beyond seeing a corporation as a huge business employing hundreds of thousands of people and making lots of money, most of us don’t know much about them.
If you’re interested in starting your own business, then it’s a good idea to learn more about corporations. You may find that incorporating your business is the best option for you. On the other hand, you may find that a different business structure would be more suitable.
In this article, we’ll discuss what a corporation is, how it is formed and how it is run. We’ll also explain the different types of corporations and the differences between corporations and other business structures.
Understanding the Definition of Corporation
If you simply Google “corporation,” you get this definition: “a company or group of people authorized to act as a single entity (legally a person) and recognized as such in law.” Though the definition is helpful, it may leave you feeling a bit confused.
What a “single entity” means is that the corporation has the same freedoms and responsibilities as a person. That is, it must pay taxes, it can take out loans, it can sue others or be sued, and it possesses its own assets.
A corporation, though owned by a single person or a group of people, is separate from these people. This means that if the corporation ever sees financial trouble, the personal assets of those who own the corporation are not at risk. Instead, it is the corporation’s own assets that would be in jeopardy should the company owe money. This is known as limited liability.
How Are Corporations Formed?
Corporations are typically formed when a group of people called shareholders come together with a common goal. How much of the company each shareholder owns is represented by the amount of common stock they own. It is also possible for there to be a single owner of a corporation.
To become a corporation, the company must file something called articles of incorporation. This process is necessary for the company to legally be recognized as a corporation.
Exactly what is required to become incorporated will vary from state to state. However, there are some common requirements for forming a corporation, such as choosing an available business name and appointing a board of directors.
Upon formation, corporations also write bylaws. Bylaws detail certain aspects of how the corporation should be governed. For instance, they may outline the board of directors’ responsibilities, terms of office, and how often board and shareholder meetings should be held.
How Are Corporations Run?
The day-to-day operations of a corporation are managed by a board of directors. These directors are appointed annually and must be voted in by the shareholders. Each shareholder typically gets one vote per share, so the more shares they own, the more control they have over the company.
The board of directors manages the company. They determine dividend payouts, executive compensation, and they make decisions about the hiring and firing of senior executives. They also set broad goals for the company.
It’s up to the board of directors to elect officers to take care of the day-to-day operations of the corporation. The board of directors may elect a president, vice president, secretary, and treasurer to oversee the company.
How often the board of directors meets will depend on the bylaws the corporation put into place upon its formation. Some board of directors meet monthly, whereas others only require the board to meet once per year.
If the board of directors does not take its duties seriously, it can actually incur personal liabilities. This is because it is considered their responsibility to ensure that the company runs smoothly and has the resources it needs to operate and meet its goals.
Types of Corporations
There are a few different types of corporations. Though they’re all considered corporations because of how they were formed and how they are run, there are some minor differences between them, especially in terms of taxation.
C Corporations
A C Corporation is the most common type of corporation. Owners that receive the profits of the corporation are taxed at an individual level separate from the corporation. Basically, the owners pay income taxes just like the rest of us. The corporation itself is taxed as a business entity.
S Corporations
S Corporations are created in the same way as C Corporations but are taxed differently. Unlike with C Corporations, shareholders of S Corporations are not taxed separately from the company. The profits and losses of the company are shouldered by the shareholders and reflected in their income taxes.
B Corporations
B Corporations or benefit corporations are similar to C Corporations in the way that they are taxed. B Corps are also taxed as business entities separate from the shareholders. Though these corporations are for-profit, they’re different from C Corporations in terms of purpose, accountability, and transparency.
B Corporations have missions that are meant to benefit the public in some way. According to Business Insider, B Corporations “strive to reduce inequality, lower poverty levels, and create a healthier environment, stronger communities, and purposeful jobs.” Some examples of B Corps include Ben & Jerry’s, Prose, The Body Shop, Patagonia, and Leesa.
Close Corporations
Close corporations are small corporations that do not have to follow the strict formalities of larger corporations. This is a choice that small corporations can make if they do not want to follow the structure that we mentioned earlier, which involves electing a board of directors.
In fact, shareholders in close corporations can override the directors and act on their own, allowing them to usurp the authority that directors would typically have in a more formal, larger corporation like a C Corp.
We keep mentioning size here because it is important. Though the rules governing close corporations vary by state, a close corporation typically cannot have more than 30 to 35 shareholders. Therefore, it is impossible for larger corporations to choose to be close corporations.
Nonprofit Corporation
Most of us have heard of 501(c)(3) nonprofit organizations. There is also such a thing as a nonprofit corporation. These corporations put their profits toward charitable goals.
They are still considered corporations because they are founded and run the same way that for-profit corporations are. However, they are exempt from taxes because they are not for profit. An example of a nonprofit corporation would be Newman’s Own, Inc. which manufactures food and beverages for people and pets.
Public vs Private Corporations
Aside from being categorized as C, S, B, close, or nonprofit, corporations can also be public or private. The main difference between public and private corporations is that a public corporation’s shares are open to the public.
Corporations can be public upon their formation, or they can be made public later on. Once a corporation is made public, it must adhere to the rules of the U.S. Securities and Exchange Commission (SEC).
How Is a Corporation Different From Other Types of Businesses?
If you’re interested in business, then you likely already know that there are a number of different types of business structures, not just corporations. Other well-known business types include LLCs, sole proprietorships, partnerships, and cooperatives. Let’s look at how they are different from corporations.
>LLC
LLC stands for limited liability company. As you can guess, this means that the personal assets of the members of the LLC are protected. In this way, LLCs are similar to corporations. However, this is one of the only similarities.
Members of LLCs are considered to be self-employed rather than employees, so they have to pay self-employment taxes. LLCs tend to be governed by an operating agreement rather than a board of directors. The process for creating an LLC is also much shorter and more straightforward than that of forming a corporation.
Sole Proprietorship
Sole proprietorships are very different from corporations. In fact, any single person running their own business is automatically considered a sole proprietorship as long as they don’t register as any other business type.
Sole proprietorships do not have limited liability. Should the company incur debts or be sued, the assets of the business owner are at risk. The benefits of sole proprietorships are that they’re easy and inexpensive to start; there’s no legal action required to become a sole proprietorship. Sole proprietorships can also use trade names.
Partnership
There are a few different kinds of partnerships: general partnerships, limited partnerships, and limited liability partnerships. Partnerships include at least two business owners; however, they can also be a small group of owners.
The main difference between the types of partnerships is liability. In general partnerships, the personal assets of all partners are at stake should the company face debt or lawsuits.
In limited partnerships, there is one general partner and at least one limited partner. The general partner’s personal assets are not separate from the company, whereas the limited partner’s assets are. Because of this, the general partner typically has more control over the company since they have more at stake.
In a limited liability partnership, all partners’ assets are separate from the company. Should any partner be sued or incur debt, no one’s personal assets will be at stake.
Partnerships are also taxed differently from corporations. The partners are treated as employees on tax forms. While corporations have both their profits and dividends taxed, the profits of a partnership are not “double-taxed.”
Cooperative
Cooperatives, often called co-ops, provide services to the people who own and operate them. The business owners are often user-owners. The people who own the business work at the business. Unlike the owners of a corporation, you’ll see the owners of a grocery co-op stocking shelves or manning the cash register.
Cooperatives are also run quite differently from corporations. Every owner of the cooperative has an equal say in how it is run. Members will vote on different matters to determine the direction of the business.
Some cooperatives serve only those who are members. Others allow the public to shop their stores or use their services. Though cooperatives may sound like they are not for profit because of their goal to serve their members, this is not the case. Cooperatives do seek to make a profit.
As you can see, cooperatives are run quite differently from corporations, with one of the only similarities being that they both seek to make a profit. Some examples of cooperatives include Sunkist, Ocean Spray, Land O’Lakes, Best Western, and the Associated Press.
Corporations Are Common
A corporation is a business entity that owns its own assets, must pay taxes, can take out loans, and can sue and be sued. It’s typically owned by a group of people called shareholders. However, it’s also possible for corporations to be owned by a single shareholder.
Though there are a handful of different kinds of corporations, most of them are run in the same way — by a board of directors. The shareholders vote to elect a board of directors; the more shares a person has, the more votes they have.
Because the directors are meant to represent the desires of the shareholders, having more shares means having more power over the company. This is because it’s the board of directors that sets up broad goals for the company; they also elect executives such as company presidents, vice presidents, and treasurers.
Because corporations are their own entities, the shareholders’ personal assets are not at stake should the company ever run into financial trouble. This is known as limited liability.
When people use the term “big business”, they are usually referring to corporations, even if they don’t realize it. We’ve all shopped at or used services from corporations. Google, Apple, Walmart, and Amazon are just a few well-known, successful corporations. Corporations are so common that we interact with them almost every day.