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Business Entity Formation 101: C-Corps

Brian Hall - March 24, 2020 - Business Law, Entity Formation

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The C-Corp is the most well-known business entity. Most every publicly traded company is a C-Corp. However, most C-Corps are still privately held businesses owned by a relatively small number of shareholders. It just might be right for you.

Like most other business entities, C-Corps limit the personal liability of its owners. This means that your personal assets—your home, automobile, savings, and so on—are not vulnerable if the company takes a downturn.

The most important aspects of the C-Corp include:

  • Limiting financial liability of its owners;
  • Enabling flexible equity structures;
  • Being subject to structural and formal requirements; and
  • Being subject to double taxation.

Equity for Employees and Investors

One of the most well-known features of the Corporation is stock, portions of which are represented by shares. Stock is ownership, or equity, in the company. For many small companies, equity is provided to employees as part of their compensation. Equity is also provided to investors in exchange for their investment of funds and other resources.

Small businesses must usually be especially efficient in how they spend money. In order to attract the best talent available, many offer shares of the company as part of their compensation package. The company provides value to the employee without dipping more deeply into its lean financial accounts. It also encourages employees to put in their best work: as the company does better, their shares become more valuable!

Investors, and especially sophisticated investors like venture capitalists, angels, and larger companies, very often seek equity in the company in exchange for their investment.

Shares of stock make meeting the needs of both employees and investors much easier. The C-Corp has a unique advantage here: only C-Corps can issue different classes of stock. Each class can have its own rights and privileges, like the ability to vote on vital matters, or preferential treatment when dividends are paid. Investors will require more privileged stock in exchange for their investment in small businesses, especially startups. After all, they’re providing a lot of money and will want to be able to ensure their investment’s health. This is part of why most professional and sophisticated investors restrict their investing activities to C-Corps.

Formalities Required

Whether C-Corp or S-Corp, corporations are subject to a variety of legal formalities. These include basic organizational requirements, the keeping of records, and various reporting requirements. For example, every corporation must have a Board of Directors (or its equivalent) with a minimum number of Directors. Every corporation must have certain officers, like a CEO, President, and Secretary. And every corporation must keep a record of the meetings of its Board.

Income, Taxed and Dividends, Taxed

Corporations are taxed in a unique fashion. The Corporation itself is taxed on its income. Additionally, if it pays dividends to its shareholders, that counts as income to the shareholder—so the shareholder is taxed on the dividend! This is often called “double taxation,” since the company’s earnings, which pay the dividends, are taxed; and the dividends themselves are also taxed.

Note, though, that dividends are optional. A Corporation isn’t required to pay dividends to its shareholders. This has a few consequences. Most obviously, a Corporation can choose to reinvest its profits, if any, and put that good quarter toward the future of the company.

It also means that if the Corporation doesn’t turn a profit, it doesn’t owe yet more money to the shareholders. Similarly, the Corporation can’t pass on losses to its shareholders (unlike other entity types like LLCs, where profits and losses are passed through automatically). As you can see, a Corporation is provided additional flexibility by this mechanism than is immediately apparent!

All that said . . .

As in any business decision, context is key. The attractiveness of a C-Corp will depend on your circumstances. Are you the sole owner, or one of several? Do you desire capital investments in exchange for equity? Are you equipped to handle the formal requirements, or would a simpler requirement be preferable? What state will your company be organized in?

If you are interested in forming a C-Corp, or not sure what kind of business entity is right for you, Traverse Legal has extensive experience advising clients on the entity that’s right for their goals. Our attorneys can advise you on the legal and business considerations that matter both at the outset of your new business journey and those down the road. We can help you make the best decision for your business, with certainty.

This blog post contributed, in part, by Traverse Legal Virtual Law Clerk Eric O’Neill.

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