Choosing the right legal structure for your organisation requires a considerable deal of thought and research. Part of this is understanding what each option entails.
In some cases – particularly where sole proprietorships and partnerships are concerned – things are relatively straightforward. However, when it comes to incorporating your business, there are several directions you can take, depending on the needs of your organisation. This is important to consider, as the structure you choose will determine how your daily operations are carried out, the level of taxes you will pay, your ability to raise funds, and the form of personal liability involved. It can also impact on your ability to negotiate a good deal if, at some point, you decide to sell.
Therefore, if you have been leaning towards incorporation as a legal structure, then you must be aware of the different types of corporations that exist.
What Exactly Is a Corporation?
A corporation is a separate legal entity that is wholly separate from its owners. It is subject to compliance with greater regulations and tax laws; the liability protection afforded by a corporation is a significant benefit that also makes it more attractive to investors. These and other similar advantages of incorporation make it a lucrative choice for many.
Types of Corporation
Although slight variations exist, there are – generally speaking – five common and recognised types of corporations:
- Close Corporation
- Non-Profit Corporation
Here is a brief outline of each:
1. C Corporation
Also known as just a corporation, a C-corp is the most basic and common form of a corporate structure. Foremost, it must pay taxes (these can vary by jurisdiction, meaning that you should always carefully consider where to incorporate your business) and is permitted to make a profit.
The business entity itself can be held legally liable, although it affords the highest level of protection to owners from personal legal liability. C corporations need to maintain records diligently and call for extensive operational processes. They function independently of its shareholders, and business will continue as usual even if shareholders quit the organisation or sell their stake.
C corporations are at an advantage when it comes to raising funds because they can obtain the money through the sale of stocks. However, the costs involved in forming one tend to be higher than those for other types of corporations. They are generally seen as a good option for businesses that fall into one (or more) of the following categories:
- Seeking funding
- Carrying higher risk
- Likely to be sold
- Planning to go public
2. S Corporation
An S corporation is often used to circumvent the double taxation rule that comes with a C-corp. With an S-corp, you can directly pass on profits (as well as losses) to the owners' personal income without having to pay corporate tax on this amount. However, it's worth noting that the taxation rates on an S-corp will depend on the location.
Otherwise, this type of structure is similar to a C-corp in that it runs independently of its shareholders, and has to follow strict operational and filing processes. One crucial difference is that S-corps can only have a maximum of one hundred shareholders; as a result, it is a much better fit for a small business. Also, an S-corp can issue only one kind of stock, the ownership of which is restricted to estates, individuals, and certain types of trusts.
3. B Corporation
Also known as a benefit corporation, these usually place equal emphasis on profit and mission. Depending on your location, you might be required to submit an annual benefit report that illustrates your organisation's contributions to the public good. The taxation laws applicable to C-corps also apply to B-corps, although there is a difference in transparency and accountability – both of which are important to a B-corp. Under this structure, shareholders can go to court to ensure that the company adheres to its public benefit mission.
4. Close Corporation
Similar in many respects to B corporations, the key difference here is in the makeup of the corporate structure (the legal structures are mostly the same).
Indeed, the structure of a close corporation is not as traditional as that of a B-corp. Its shares cannot be publicly traded, and it cannot have a board of directors. However, a close corporation can be run by a small group of shareholders. This is ideal for family-run ventures and is also sometimes termed as an incorporated partnership or private company. It can prove highly beneficial if your business is dependent on closely guarded secrets, such as a critical piece of intellectual property.
Keeping the number of stakeholders to a minimum can enhance secrecy in this regard, while you will also have more flexibility in running your business as you will not have to meet quarterly profit targets. However, starting a close corporation can be more expensive than a traditional structure, and selling such a business is likely to be tougher in comparison.
5. Non-Profit Corporation
This type of legal structure is available only to organisations that work for the benefit of the public, usually under the guise of charity work or in areas of religion, education, literature, or science. They are generally eligible for tax exemption on any profits made, but their profits cannot be distributed to members or political campaigns. The organisational rules for a non-profit are similar to that of a C-corp.
Usually, you will have to decide on your business structure before you register your organisation with the relevant jurisdiction. While converting to a different business structure at a later stage is an option, it can involve various restrictions depending on where you are located.
There are also potential tax consequences, while it is essential to remember that the circumstances of your organisation (and external tax laws) are liable to change. If this happens, you may want to change your corporate structure to keep up with these changes. Therefore, it's important to understand the differences listed here and identify which is the best approach for your organisation in both the short and the long term.
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