Pros and Cons: Why Form a Corporation?
Deciding whether or not to incorporate is an important choice to make when starting your new business. Other types of business legal structures include sole proprietorships (which are very limited in scope), partnerships (which don't provide the same protections from personal liability), and limited liability companies (commonly called LLCs). As with any legal structure, corporations have certain advantages and disadvantages. Whether you decide to incorporate should be based on these factors and a careful analysis of the nature and needs of your business.
Following is a discussion of the main pros and cons of forming a corporation.
Owner Protection from Legal Liability:Once a new business's owner(s) successfully completes the incorporation process, the owner(s) have a limited amount of legal liability for the corporation's business activities and debts, because in the eyes of the law the corporation is a separate entity. In order to maintain this limited liability, the corporation's owners must follow a number of legally required corporate formalities.
Ability to Attract Investors:The corporation's ability to issue stock is a strong selling point to those willing to invest capital in a business venture.
Power Structure:The corporate business form has an established power and management structure: directors, officers, and shareholders. Each group has its own set of clearly-defined roles and responsibilities within the corporate framework. See "Corporate Structure: Directors to Shareholders" for more details.
Stock and Stock Options for Employees:Especially for larger businesses, the corporate business structure offers an appealing opportunity to potential employees -- stock benefits and stock options (the employee's right to buy stock at a locked-in price).
Time and Cost of Incorporation:The incorporation process can be expensive and time-consuming. A number of documents must be prepared (including the new corporation's articles of incorporation and bylaws), and filing fees must be paid to your state's Secretary of State office (or similar business filing agency).
Following Corporate Formalities:All corporations are required by law to observe a number of corporate formalities to ensure that the corporation is operating as a separate entity, independent of the business's owners. These steps include holding regular meetings of directors, keeping records of corporate activity, and maintaining the corporation's ongoing financial independence. See "The Basics of Small Business Incorporation" to learn more.
Potential Tax Liability:The profits from traditional corporations may be "double taxed." That is, the corporation itself is taxed for any profits earned, and any individual stockholder who earned profits from the corporation (in the form of paid "dividends") are also taxed. This occurs most often in larger corporations, and may not be an issue for stockholders and owners of smaller corporations, who often work for the business itself and are paid salaries (which are tax-deductible for the corporation) rather than dividends. One solution to the double-taxation problem is electing "S" corporation tax status.
Still Unsure About Whether to Incorporate? Talk to an Attorney
The type of legal structure you choose for your business will play a huge role in your success (or failure), so it pays to do your homework before deciding. Ultimately, you and any business associates will have to make that decision for yourselves, but a skilled business attorney can help you make an informed decision and make the process of starting your business as smooth as possible.