Incorporating a company is an exciting step. When deciding whether to incorporate your business, you may weigh the pros and cons of running a corporation.
The first step to carry out the incorporation is the initial detailed business analysis, with audits and risk analysis.
It is a complex and strategic process where the main objective is to increase the presence of a given organization in the market, whether individuals or legal entities.
Like other types of business structures, an incorporated business has its pros and cons. Evaluate the elements of a corporate form of business to determine if it is the best option for your company.
Table of Contents
- Overview of Incorporation
- Pros of Incorporating yourself
- 1. Limited Personal Liabilities
- 2. Creation of subsidiaries and dependent companies
- 3. Democratic Management
- 4. More Money To Invest
- 5. Fiscal benefits
- 6. Tax treatment
- 7. Unique Structure
- 8. Eternal
- 9. Stock options
- 10. Administration entrusted to third parties
- 11. Incorporation Types
- 12. Raising capital
- 13. Change in structure
- 14. High degree of specialization
- 15. Separation of owners from management
- Cons of Incorporating Yourself
- At a Glance (Pros and Cons of Incorporating Yourself)
Overview of Incorporation
Do you know why apple company is called Apple Inc. or the reason behind the name Microsoft corporation? Both business assets are incorporations.
Incorporation is the type of business structure where the company is registered as a separate legal entity.
A legal entity means the organization or individual has its own legal obligations and rights.
The incorporation process allows the business property to be separate from the individual who owns or manages it, and it will have its own legal action and independent business life.
Pros of Incorporating yourself
There are several benefits to becoming a corporation, including limited personal liability, easy transfer of ownership, business continuity, better access to capital, and (depending on the corporation’s structure) occasional tax benefits.
The legal structure of your corporate business and the benefits you receive from it will depend on your specific business setup.
1. Limited Personal Liabilities
Corporations also have one clear advantage – limited liability. The owners of a corporation (i.e., the shareholders) risk only the amount they paid to buy the shares.
The owner’s personal properties are not at risk, even if the corporation is in danger of bankruptcy.
Creditors can sue the corporation as a legal entity but not the corporation’s owners as individuals. Limited liability makes it much easier for corporations to raise capital.
2. Creation of subsidiaries and dependent companies
The second advantage of corporations is the creation of subsidiaries and dependent companies that jointly serve a particular market segment.
It allows you to use purely market tools related to price and non-price competition and organizational and planning methods related to mesoeconomic marketing and management, innovative forecasting, intersectoral investment programs, and project management.
3. Democratic Management
The unincorporated business does not have a democratic division of power between legislative (general meeting of shareholders), executive (board of directors and management), and control and audit bodies (audit commission and mandatory external audit).
Representatives of personnel, scientific, consumer, independent directors, and environmental organizations are introduced to the board to implement this principle.
Legislation and the corporation’s charter should contribute to solving the agency problem, coordinating the interests of shareholders, investors, managers, employees, customers, local authorities, and the public.
4. More Money To Invest
The corporation is much more efficient than all other forms of business organization in coping with the task of raising capital.
Corporations have a unique way of financing – through the sale of stocks and bonds – which allows them to attract the savings of numerous households.
Through the securities market, corporations can pool the financial resources of a vast number of people into a common fund.
Financing through the sale of securities has certain advantages from the point of view of their buyers.
First of all, households, in this case, can participate in a business enterprise and expect some monetary reward; there is no need to take an active part in the management of the enterprise.
In addition, a person has the opportunity to distribute risks by acquiring securities from several corporations.
Finally, holders of corporate securities can usually quickly get rid of them by selling them to another owner.
Existing stock exchanges facilitate the movement of securities between buyers and sellers.
It increases the willingness of people with savings to buy corporate securities. Moreover, it is usually easier for corporations than other business forms to access bank credit.
Firstly, corporations are more reliable, and secondly, they are more likely than all others to provide banks with profitable deposits.
5. Fiscal benefits
Although some corporations, such as C corporations, are subject to double taxation, other corporate structures, such as S corporations, benefit from personal tax rates depending on how their business income is dispensed.
S corporations can divide their income between the company and shareholders, allowing them to be taxed at different rates.
Any income designated as owner wages will be subject to self-employment tax, while all other business dividends will be taxed at their level (no self-employment tax).
6. Tax treatment
The separate entity also separates tax obligations, which is another advantage. It means that corporation taxes are separate from your tax obligations.
As a business entity, you are answerable for paying taxes only on the money that the business structure pays you in the form of a salary, commission, or dividends.
The company is responsible for paying corporation tax (at the corporate income tax rate) on any company’s profits.
7. Unique Structure
A single owner does not own the corporation; a command chain exists within the model.
Many corporations have a chairman, CEO, and board of directors, while some may have a chairman and CEO the same.
All these personnel has specifically assigned tasks within the business framework that are unique to them with clear definitions.
A corporation survives independently of its owners and officers as a legal entity. Individual firms can die suddenly and unpredictably, but at least legally, corporations are eternal.
The transfer of ownership of a corporation through the sale of shares does not undermine its integrity and business continuity.
In other words, corporations have a certain permanence, lacking in other business forms, and open up opportunities for forwarding planning and growth.
9. Stock options
Incorporation also gives companies large and small the opportunity to offer stock options.
For a job well performed or as part of a bonus program, the employees have the right to buy shares at a fixed price can be a great incentive to help the company grow.
10. Administration entrusted to third parties
Among the advantages of an incorporated company, there is also the fact that it does not have to be administered directly and solely by the shareholders. Still, the administration can be entrusted to third parties.
It is an aspect to consider, especially if you simultaneously follow and invest in different business areas.
11. Incorporation Types
Mainly, there are two types of corporation: S corp corporation and C corp corporation.
S corp exists for one-person corporations, so they do not have to face double taxation.
You can file a tax report for the personal shareholders of the business instead of wages and profits being taxed separately.
However, this tax structure’s paperwork and qualifications are pretty complex and require a professional attorney. It might be an added financial burden.
12. Raising capital
Corporations can quickly raise additional funds by issuing more company shares and form of dividends.
The ability to increase stock is a feature exclusively enjoyed by incorporated businesses.
Additionally, an incorporated company may be able to raise capital by issuing more than one class of shares.
Issuing stock can provide a corporation with the capital it needs to meet obligations or expand a business.
An incorporated company can attract talented employees by offering employee stock incentives.
13. Change in structure
The C corporation can change its status to an S corporation if they operate in a standard calendar year with its budget.
As long as they meet the standard qualifications of an S corporation, such as not exceeding a maximum number of investors, there is a chance that this will happen every year. An S corporation can also change to a C corporation.
14. High degree of specialization
Due to its advantage in raising money capital, it is easier for a successful corporation to increase volume, expand the scale of operations and realize the benefits of growth.
In particular, the corporation can benefit from mass production technologies and deeper specialization in the use of human resources.
While the manager of a sole proprietorship is forced to divide his time between production, accounting, and marketing functions, a large corporation can attract specialized personnel in each area and achieve greater efficiency.
In addition, corporations may buy other corporations operating in other industries to diversify risk.
It means that a corporation can be engaged in various activities simultaneously, and if one direction fails, it can reduce the impact on the entire corporation.
15. Separation of owners from management
Corporations can raise funds from many different investors without involving them in management. The owners elect a board of directors.
The directors select the top management team. He, in turn, hires managers, workers, and employees.
The business owner thus has some influence over what runs the corporation but no control over business liabilities.
Cons of Incorporating Yourself
A corporation is not for everyone and could cost you more time and money than it is worth. Before incorporating yourself, you should be aware of these potential cons of incorporation:
1. Complexity of registration
Registration of a corporation’s charter involves bureaucratic procedures and costs for legal services.
2. Possibility of abuse
From a public point of view, the corporate form of business has the potential for some form of abuse.
Since the corporation is a legal entity, some unscrupulous business owners sometimes manage to avoid personal liability for questionable business transactions due to the opportunities the corporate business organization opens up for them.
The paperwork involved in forming a corporation is only the beginning. Tax laws require corporations to verify the legitimacy of all their expenses and deductions from taxable amounts.
In this regard, the corporation is forced to process many different documents. The owner of a sole proprietorship or partnership may maintain records in a reasonably accessible manner.
At the same time, a corporation is forced to keep detailed records, minutes of meetings, and much more.
4. Double taxation
The portion of corporate income paid out as dividends to shareholders is taxed twice: first as a portion of corporate profits and second as a portion of the shareholder’s income.
Scale can be one of the advantages of corporations but also a disadvantage. Large corporations sometimes become too inflexible and bureaucratic, making it impossible to respond to market changes quickly.
6. Separation of ownership and management functions
In sole proprietorships and partnerships, the owners of tangible and financial assets themselves directly manage and control these assets.
But in large corporations, whose ownership is widely dispersed among tens and even hundreds of thousands of shareholders, there is a separation of ownership and management functions (control).
The causes for this discrepancy lie in the inactivity of the typical shareholder.
The majority of shareholders do not take part in the voting. They indirectly transfer their votes to the corporation’s current officials if they participate in it.
Endowing the latter with practically unlimited powers and the ability allows determining their destiny independently.
The separation of ownership and control functions does not cause severe consequences if the group’s actions and management functions are in the interests of the group of owners of the corporation (that is, the shareholders). But the interests of these two groups do not always coincide.
7. Many Formalities
Incorporated companies have much more formalities and regulations than other companies.
Corporations must file paperwork to incorporate and pay the appropriate filing fees charged by the state of incorporation.
Additionally, corporations must hold at least one annual meeting, which may be required in the state where the company is incorporated.
Incorporated companies must keep an accurate account of the company’s minutes and banking information.
Corporations are expensive to form and operate. It can be easy for established corporations to raise capital by selling stock, but forming and maintaining a corporation can be costly.
You will likely need a large amount of start-up capital to get a corporation up and running and pay filing fees, ongoing fees, and higher taxes.
For franchises operating in their first year, an additional fee may be added to the costs of submitting the required documentation to incorporate.
That’s an advance tax payment on the first year’s expected income that has been budgeted.
Depending on the state where you have operated the business, incorporation would require paying a minimal 9% fee in addition to all other fees. That can quickly kill incorporation for some small business owners.
9. No Credibility
Incorporation can help a business protect its name within a specific region, but it doesn’t automatically convey the same respect as before.
In the past, an incorporated company commanded respect because you had to work hard to maintain that status.
Too many companies have scammed too many people over time, so it is challenging to build trust through recognition. You have to earn your credibility today; sometimes, that respect never comes.
10. A corporation can only change its status once a year
It would help if you made a business decision with significant consideration because status changes are only allowed once a year.
The most significant difference is in the amount of money and the type of shareholders each corporation can have.
Many formal requirements are the same, so there is a limitation on how you can operate the business.
At a Glance (Pros and Cons of Incorporating Yourself)
|Limited personal liabilities|
|Creation of subsidiaries and dependent companies|
|More money to invest|
|Admission entrusted to third parties|
|Change in structure|
|The high degree of specialization|
|Separation of owners of management|
|Complexity of registration|
|Possibility of abuse|
|Double taxation and higher initial investment|
|Ownership is divided among several shareholders|
|The corporation can only change status once a year|
Generally speaking, incorporating entrepreneurship is one of the most stable forms of management that are gaining unprecedented popularity today.
Many companies are switching to this method to save themselves from unnecessary problems.
But still, as in any situation, it is better to consider all the pros and cons of such a procedure and conclude the need to perform processes.
(Last Updated on August 24, 2022)