Is a Corporation the Best Type of Entity for Your Business?
Corporation as a Business Entity
Corporations offer many benefits as a business entity, and they are probably the most recognizable form. But that doesn’t mean that they are fully understood or appreciated. I’ve represented plenty of clients who chose a corporation without an attorneys’ input or guidance, incorporated, and then brushed their hands together and said, whelp, that’s that and thought everything was all good. All good until they got served with a lawsuit for not adhering to the corporate requirements and formalities and are potentially on the hook individually for the corporation’s liabilities. Yikes!
Don’t let me scare you, corporations are attractive entities for several reasons. A corporation has standing as a legal entity separate and apart from its owners. So what? Well that means a corporation can sue or be sued and can also hold title to property. Another plus, liability of shareholders is limited—in most cases. Shareholders of a corporation can be individuals, corporations, partnerships, or other types of legal entities. However, there are certain restrictions if you elect to be an S corporation.
Owners of a corporation are referred to as shareholders. Owners, or shareholders, have limited liability and can freely transfer their interest. Liability is limited in that only the assets contributed by a shareholder are at risk for any corporate obligations. That means that you only risk losing whatever money you spent purchasing the stock—nothing more. There are certain scenarios where the liability protection can be lost, such as failure to maintain corporate formalities or inadequate capitalization (happens way more than you would think). That’s why it’s so important to have your corporation set up correctly from the start. Another issue I’ve seen multiple times is a commingling of funds between the owner’s and the business’s accounts. Oops, you could unknowingly be exposing yourself to liability for ALL of the businesses obligations.
What’s required? A corporation must be incorporated in compliance with the laws of the state that you are incorporating in. In Illinois, that means you must be in compliance with the Business Corporation Act (“BCA”) of 1983, 805 ILCS 5/1.01, et seq. This is done by filing “articles of incorporation,” with the Secretary of State. The BCA requires written bylaws to be adopted. Then the owners or shareholder are issued stock certificates. Ta da, you’re in business!
One of the main differences between other entities and a corporation is that in a corporation the management and ownership are separate. There is typically a board of directors who are in charge of policies of the corporation, and they elect any corporate officers. Directors do not have to be shareholders. The officers are typically responsible for the day-to-day operations. The directors have what’s referred to as a fiduciary duty. This means that the directors must act in the best interests of the corporation and can be held responsible if they do not.
There are unique issues that can arise with the corporation entity given the separation of management and ownership. There are provisions under the BCA to protect minority shareholders’ rights. The corporate opportunity doctrine also serves as a protection.
A corporation also has a lot of flexibility in the types of investments it can offer—it can offer different types of stocks with different preference or voting rights attached. Typically, each shareholder is entitled to a vote, but that might not be the case depending on the voting rights attached to a specific class of stock. Compared to other entities, corporate ownership interests can be transferred easily and typically without restriction. This is helpful if you are looking to attract investors for your business or don’t want to jump through hoops to pass along your ownership interests to family, friends or loved ones.
The biggest advantage to this form of business entity is the protection against personal liability—your personal assets are not at risk for any obligations the business might have. But that is not bulletproof. There are many formalities to comply with. There are also tax considerations to think about. If you want limited liability, which is usually the number one consideration, then a corporation is likely the way to go. If you don’t have substantial risk or you can insure your business then you might want to consider another form to avoid the additional costs and expenses keeping a corporation up to date and in compliance compared to other entities. An attorney can guide you through this process and be a trusted advisor.