Advantages and Disadvantages of Forming a Corporation

So you want to become a stockholder, CEO or Chairman of the Board of Directors rather than call yourself a proprietor, partner or a plain manager of your own business? A corporation promises a more prestigious form of business. In fact, the biggest, richest and most prominent companies in the world are corporations. Walmart, ExxonMobil, Royal Dutch Shell, Microsoft and Apple, they are all incorporated. But before you decide to incorporate your new business or existing proprietorship or partnership, it is wise to consider first the pros and cons of forming a corporation. So what are the advantages and disadvantages of incorporating a business? The following will give you answers to that question:

Advantages of forming a corporation

1. Owners have limited Liability. A corporation is considered by law as a separate and distinct legal entity. Thus, owners of corporation or shareholders are only indebted to the extent of their interest in the corporation. Corporations have limited liability. This means that their creditors can only run after the assets of the corporation and not the on the personal assets of the stockholders in the settlement of the corporation’s debts or liabilities.

2. It can exist with continuity. The power of succession gives a corporation continuous existence. Unlike a sole proprietorship, where the death of the owner proprietor ceases its existence, the death of a shareholder will not terminate the corporation. The shares of ownership or interest of a corporation can be transferred from one owner to another owner. A corporation continues to exist until the shareholders decide to dissolve it or merge with another business.

3. Shares of ownership are transferable. The shares of stock or interest of a publicly traded corporation can be traded easily though a stockbroker. Shares of corporations are freely transferable except when shareholders have “buy-sell” agreements restricting when and to whom share may be sold or transferred. Securities laws and regulations may also limit the transferability of certain shares. For non-publicly traded corporations, the stock certificate can be transferred or assigned to another owner by executing a deed of assignment of shares of stock.

4. It attracts more investors. Corporations attract investors because of its stock structure, perpetual existence, ownership transferability, and limited liability. Attracting more investors allows a corporation to raise more capital or equity to manage and expand their operations. Furthermore, because of a more regulated form of corporation and the fiduciary duties of its board of directors, it earns more trust and confidence not only from investors, but also from its employees, creditors, suppliers, customers and other outside stakeholders.

5. You can be an employee of your own corporation. Since the corporation is a distinct entity from its owners or shareholders, they can become the corporation’s employees or officers. Thus, they can receive salaries or compensation income aside from the dividends they may receive from the corporation. They can also be eligible for reimbursement or deduction of expenses they incurred related to their employment with the corporation.

6. The corporation pays its own tax. As a separate legal entity, a corporation is also a separate taxpayer from it owners. It has its own Taxpayer Identification Number, and it pays its own taxes, such as corporate income tax, business taxes and withholding taxes. The owners or stockholders pay their own taxes on the compensation and or dividend income they receive from the corporation.

Disadvantages of forming a corporation

1. Incorporation is costly. Incorporating a business needs to file with the Securities and Exchange Commission (SEC) and may involve a lot of formal and legal papers, such as by laws, articles of incorporation, affidavit and board resolutions. This is sometimes done by getting the service of a corporate attorney or firms which are specialized in incorporating a business. It may also require higher amount of initial or paid-up capital for other types of corporation like financing and lending corporations. Furthermore, the amount of subscribed capital is taxed with documentary stamp tax, which may result to additional expenses to be incurred by the incorporators.

2. Corporations are highly regulated. Ordinary corporations are regulated by the SEC. Special corporations may be required with secondary licenses and are further regulated by other government agencies, such as Bangko Sentral ng Pilipinas (BSP) for financing and lending companies, Commission on Higher Education (CHED) for companies operating secondary schools and Insurance Commission (IC) for insurance companies. Moreover, corporations also need to comply with the quarterly or annual reportorial requirements with the SEC and other agencies requiring those reports for certain types of corporations. This also means that the more compliance it requires, the more paper works and cost it involves. And when there are more to comply, bigger penalties are awaiting to be paid if they are not complied.

3. Limited liability may discourage creditors. The limited liability feature of the corporation can be an advantage for stockholders. However, it can also be a disadvantage when a corporation doesn’t have a good financial condition and performance. Because of the limited liability, a corporation with a low credit score may discourage creditors to lend their money to the corporation.

4. It may result to double taxation. Since the corporation is already taxed on its income, distributing this income to shareholders in the form of dividends may result to double taxation. This is because the dividend income received by the shareholders (natural persons) is also taxed on their personal income tax returns.

5. It is not easy to dissolve. Corporations are difficult to dissolve as it is also difficult to form. Everything is regulated from formation, to operation, and to dissolution. An application for dissolution must be filed with the S.E.C with complete requirements, including tax clearance with the Bureau of Internal Revenue. The liquidation process is also regulated to ensure that the rights of any creditor having a claim against it are not prejudiced.

Choosing the type and form of your business needs a lot of prudent considerations. It may involve assessing your financial resources, taking inherent risks and considering your preparedness. This article only aims to guide you on your way to the right formation of you company or organization. However, the final choice still lies in you. Whatever your decision is and whatever type of business you will form, always remember to do business at your best. To your success!

Victorino Abrugar is a retired CPA practitioner, a blogger, speaker, and an entrepreneur. He's the CEO of Optixor, Inc., a digital marketing company based in the Philippines. Follow him on Twitter at @viclogic.