Business Formations & Incorporations: Corporations

Corporations are probably the most well-known of the business entities, as they provide limited liability to shareholders, easy access to raising capital through investors, are the only business entity that can go public through an IPO, and have a rigid management structure allowing shareholders to delegate the management of the corporation to directors and officers.

The Corporate Structure

Each corporation is governed by its bylaws.  The bylaws of the corporation contain the directions for the management and operations, and are agreed upon at the formation of the corporation.  Bylaws will include such things as procedures for calling meetings of either the board of directors or the shareholders, the annual meeting dates, voting procedures and regulations, the purpose of the company, quorum for meetings, proxies, the power of the directors and officers, and much more.

Corporations are generally run by a board of directors, which are elected by the shareholders via a majority vote of the outstanding shares. The board of directors then appoints officers to run the daily operations of the corporation.  This means that the shareholders of the corporation have no right to partake in the day-to-day management of the corporation.  Corporations can also have separate classes of shareholders, some with shares that hold no voting rights, leaving the business owners who started the corporation the only voting shareholders leaving the founders in control of the corporation.  Some corporations however, such as close corporations, have different management structures in which the shareholders are more heavily involved in the management of the corporation.

Another major advantage of having a corporation is the general ease of both raising and operating with capital received from investors, in which the investors then receive shares of that corporation’s stock.  However, all sales and issuances of stock (or any other securities), must be done in compliance with both federal and state securities regulations.   It is highly recommended to consult with an attorney when undergoing any rounds of financing to ensure that the corporation is complying with all pertinent statutes and regulations.

Corporate Requirements

Unlike partnerships and limited liability companies, California does impose certain requirements for corporations.   If the corporation does not uphold the requirements, there is the possibility that the corporation’s shareholders can lose their protection from personal liability.  This is called “piercing the corporate veil,” in which a creditor can go after the personal assets of certain shareholders due to failure to abide by the requirements laid out in the California Corporate Code.  Examples of these requirements include keeping a corporate book what contains the bylaws, minutes of the shareholder and director meetings, and records of any resolutions for decisions made by directors outside of the ordinary course of business for the corporation.

There are four sub-types of corporations for a business owner to choose from when forming and operating the corporation, each with its own separate requirements: (1) C-Corporation; (2) Statutory Close Corporation; (3) S-Corporation; and (4) Professional Corporations.

Liability Protection

Generally, corporations provide the shareholders of the corporation with protection from liability in regards to the debts and liabilities of the corporation.  This means that, generally, the most the shareholders of the corporation will lose was the amount of their investment.  Unless exigent circumstances arise, should the corporation be sued, the shareholders will not be held personally liable for the liabilities imposed on the corporation.

Another major component of the corporate structure is the corporation’s ability to limit the personal liability of the directors with respect to actions brought by or for the corporation with respect to breaches of the director’s fiduciary duties to the corporation and its shareholders.  This protects the directors from actions that may have harmed the corporation but were decisions they made in good faith that the directors honestly believed were in the best interest of the corporation.  However, this protection generally does not extend to intentional misconduct and bad faith acts contrary to the corporation’s best interests, transactions from which a director derives improper personal benefit, reckless disregard of a director’s duties, or unexcused patterns of inattention to one’s duties as a director.

Tax Implications

Unless the corporation is a S-corporation , the corporation will be taxed separately from the owners/shareholders.  This means that the profits/losses of the corporation will be reported on a separate tax return, and will be taxed at the corporate tax rate.  If the corporation decides to distribute profits via dividends to the shareholders, the shareholders will have to pay income tax on the monies received as dividends.  This method of “double-taxation” can be a positive or negative, depending on your individual circumstances and goals.

These are just a few of the considerations when forming, structuring, and operating your corporation, so it is always important to consult with an experienced attorney.  Contact Lee Shome & Kennedy, LLP, today to start the process of getting your corporation incorporated.