Business owners are often at crossroads when they want to decide the kind of business entity they want to establish. They are faced with several different options, and they primarily choose that on the basis of what suits them better amidst the several different options that they have. In this regard, corporations tend to be one of the foremost and primitive choices for entrepreneurs. Here’s a detailed breakdown of corporations, and all the advantages and disadvantages that are associated with corporations.
In technical terms, a corporation is created when it is incorporated by a group of shareholders who share ownership of a given corporation. This is represented by their holding of the stock shares, which further helps to pursue a common goal. Mostly, corporations are established with a common view of profit sharing. However, some corporations are also formed for other objectives, which might be important enough on a number of grounds.
Within corporations too, there are several types of corporations that are usually created by companies. The choice of corporation primarily depends on the objective, as well as the vision of the owners pertaining to the corporation itself.
What are corporations?
A corporation can be defined as a group of people that form a company, and are authorized (legally) to operate as a single entity. It is incorporated in the place where it is formed, and therefore, all applicable rules and regulations are levied in the locality too.
Hence, in simple terms, the corporation can be defined as a legal entity that separates the owners from the entity itself. This implies that the entity has its own identity. They possess the same legal rights and responsibilities as individual owners. The only difference is the fact that rather than a shared identity between a company and individuals, corporations have a separate identity of their own.
Advantages of Corporation
Establishing a corporation comes with its fair share of procedures and applications. However, when entities register themselves as corporations, they are able to enjoy numerous different benefits. They include the following:
- Limited Liability: Within business entities like sole proprietorship and partnerships, owners have unlimited liability. This is because in these business models, there is no difference between the legal identity of the owner, and the legal identity of the business entity. Therefore, the owner can be liable for all the transactions that are made by the owner, and this in itself tends to very risky for the owner of the business.
Corporations are limited liability companies. This implies that there is personal liability protection for the owners, and the affairs of the business are kept separate from the affairs of the individuals themselves.
- Business security and ownership: Ownerships in corporations functions with the mechanism of stocks. This means that all stockholders are technically the owners of the company. Since corporations deal with stocks, it is easier for owners to deal with stocks. This means that companies can sell ownership in terms of stock, relatively easily. On the contrary, with sole proprietorships, or partnerships, share of ownership is relatively difficult. This is because ownership in these kind of business entities is based on percentage terms.
- Access to capital: Corporations are normally listed on the public stock exchanges after cumbersome processes. This, in return, gives them access to capital. Publicly raising funds is relatively easier for corporations as compared to unincorporated companies. Additionally, investors, as well as lenders are more confident in investing in corporations, as compared to other unincorporated companies.
- Easier to scale operations: Since the access to capital and funds is of a considerable magnitude when it comes to corporations, it can be seen that scaling and expanding operations also gets easier for corporations. Hence, access to capital can further be leveraged to explore new business avenues, which in return can help fuel exponential growth. This option might not necessarily be available in the case of sole proprietorships, or limited companies.
- Perpetual life of corporations: Corporations do not have a fixed life. Factually, ownership can pass on to generations too. Since there are multiple owners (i.e. shareholders) involved, it is easy to pass on ownership from a deceased owner to the legal heir.
However, regardless of all these advantages that are associated with sole proprietorships, there are still a number of disadvantages that need to be accounted for.
Disadvantages of Corporations
There are certain disadvantages associated with corporations that need to be accounted for. These disadvantages are as follows:
- Establishing a corporation: Establishing a corporation (regardless of Private Ltd, or Public Limited, or S-Corp or C-Corp), is a cumbersome process. It involves several different objectives that need to be fulfilled in order for them to get a business license. In case of a public limited corporations, these processes are multiplied, since they involve preparations for IPO, as well as underwriting services. This is a time consuming process.
- Costs associated with corporations: In addition to the cumbersome processes of establishing corporations, added costs is another limitation of corporations. Underwriting services, as well as IPO is a considerably expensive task, and it cannot be afforded by all organizations. Therefore, this option is only exercisable by companies that have a significant volume of business. Hence, small and medium enterprises might not necessarily have the option to go public.
- Operational Changes: Corporations operate on the basis of a certain hierarchy present within the organization. For example, there should be strict internal control implemented within the company to prevent fraud or cash embezzlement.
- Costs associated with running and managing corporations: Once corporations are formed, they are also required to go forward with continual audits, so that the shareholders are informed about the internal affairs within the company. In the same manner, it is also gets important for companies to prepare their financial statements in accordance with the accepted accounting rules. These financial statements also need to be audited, so that there are no doubts about the authenticity of the issued financial statements.
- Taxation: Corporations are taxed at higher rates as compared to other unincorporated companies. They are subject to double taxation, since corporations are taxed on their profits first, and then the shared income is also taxed under the personal income tax law. Therefore, net income of owners might actually decline after forming a corporation.
- Divorce between ownership and control: This tends to be one of the most prominent shortcomings of corporations. As a matter of fact, the actual owners of the company might not be able to actively take a part in the operations of the company, primarily because of the fact that the decision making mandate rests with the Board Members of the company. Therefore, the actual owners might not be able to have a say on the actual affairs of the company, to say the least.
Therefore, it can be seen that there are both, advantages, as well as limitations that are associated with corporations. However, this does not eradicate the fact that corporations are still the number one choice for entrepreneurs because of the fact that they do not involve unlimited liability. Registering a business as a separate entity might be time-consuming to begin with, but in the longer run, it reaps multiple benefits for both, owners as well as investors. This is because the opportunities that can be availed once corporations are formed are endless.