Pros and Cons of a Corporation
The decision as to whether or not to incorporate is important to your business. Some of the key pros and cons are described below, but you may want to consult with an attorney to discuss how they affect your business.
Protection of personal assets
A properly formed and maintained corporation will shield the personal assets of the owners of the corporation from the corporation’s liabilities. This protection arises because, in the eyes of the law, a properly formed and maintained corporation is a separate, distinct entity.
To illustrate, Jennifer and Lilly decide to start a medical device manufacturing company. They both own homes and have savings accounts. To start the company they form a corporation and invest $10,000 each. They enter into a contract to purchase $120,000 of raw materials to build their devices; the materials are to be delivered and paid for on a monthly basis ($10,000 a month). Although the first half of the year went great, the only purchaser of their device goes bankrupt and stops buying their product. They still have 6 shipments of materials coming and will have to pay $60,000 for them. However, they decide to breach the agreement with their supplier and close down the corporation. The supplier will be able to recover damages for the breach of contract, however, it will not be able to obtain any of Jennifer or Lilly’s personal assets, such as their houses or savings accounts. Only the assets of the corporation will be on the hook to satisfy the supplier’s breach of contract claim. Jennifer and Lilly might lose their initial and any subsequent investments, and all the time they put into the company, but all their other assets are protected.
Well-defined power structure
A corporation has a defined power structure: Shareholders elect the board of directors, the board of directors directs and appoints officers, and officers run the corporation on a day-to-day level.
The sale of stock, options, or other securities is the classic way corporations raise money; this does not exist within a sole proprietorship. Additionally, the protection of personal assets applies to the investors, so they are only liable to lose their investment.
Corporations exist in perpetuity, this is an advantage over a partnership or sole proprietorship, which cease to exist on the death of the owner.
Cache of “Inc.”
There is a certain cache associated with having the word “Inc.” (or some similar designation) at the end of your business name.
Employee stock benefits
For medium to large businesses, the ability to offer stock options as part of a compensation package is a definite plus.
There are costs involved in starting a corporation, including incorporation costs, and the time and/or legal fees required in preparing the documents you need. There are also ongoing extra accounting costs associated with maintaining the corporation.
Unless you follow corporate formalities, the liability protection for which many people form corporations will be disregarded. The formalities include holding shareholder meetings, holding board meetings, keeping corporate records, and treating the corporation as a distinct and separate entity.
California $800 franchise tax
In California, regardless of type, all corporations must pay a minimum tax of $800 per year just for being a corporation.
The “it depends” category: Taxes
Sometimes the corporate structure can save on taxes, sometimes it can cost more. Taxation is a complicated issue, and depending on the amount of income, the type of corporation (whether is an “S” or “C” corporation, which refers to how it is taxed), and the other financial situations of the shareholders, the corporate structure can be beneficial or detrimental. You may want to read my article about title “S-Corporations – Avoiding Self Employment Tax” for more about tax ramifications of a corporation.