Corporation: What It Is and How To Form One

What Is a Corporation?

A corporation is a legal entity that is separate and distinct from its owners. Under the law, corporations possess many of the same rights and responsibilities as individuals. They can enter contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.

A distinguishing characteristic of a corporation is limited liability. Its shareholders profit through dividends and stock appreciation but they are not personally liable for the company's debts.

Almost all large businesses are corporations, including Microsoft Corporation and the Coca-Cola Company.

Incorporation

A corporation is created when a business is incorporated by a group of shareholders with a common goal. Shareholders share ownership of a business, as represented by their holding of stock shares.

Corporations may return a profit to their shareholders. Some corporations, such as charities and fraternal organizations, are nonprofit or not-for-profit.

A private or closed corporation may have a single shareholder or several. Publicly traded corporations have many shareholders.

In the U.S., corporations are created and regulated by state laws. Public corporations are regulated by federal law through the Securities and Exchange Commission (SEC).

Legal Requirements

Each state has its own laws regarding incorporation. Most states require the owners to file articles of incorporation with the state and then issue stock to the company's shareholders. The shareholders elect a board of directors in an annual meeting.

Turning a private corporation into a public corporation is complex, as the company must comply with federal laws requiring full and public disclosure of financial information to potential shareholders and the government.

Operating a Corporation

The shareholders of a corporation typically receive one vote per share and may hold an annual meeting during which they elect a board of directors. The board hires and oversees the senior management responsible for the corporation's day-to-day activities.

The board of directors also executes the corporation's business plan. Although the members are not personally responsible for the corporation's debts, they owe a duty of care to the corporation and can incur personal liabilities if they neglect this duty. Some tax statutes also provide for the personal liabilities of the board of directors.

Liquidating a Corporation

Incorporation can be ended using the process called liquidation. This may result from a voluntary decision to cease operations or may be forced by the financial collapse of the business. A company appoints a liquidator who sells the corporation's assets. The company pays off its creditors and distributes any remaining money to the shareholders.

An involuntary liquidation is triggered by the creditors of a corporation that has failed to pay its bills. If the situation cannot be resolved, it is followed by a filing for bankruptcy.

The Bottom Line

A corporation may be formed by an individual or group with a shared goal and can be a for-profit or not-for-profit entity. Corporations possess many of the same legal rights and responsibilities as individuals. The limited liability nature of a corporation means that its shareholders are not personally responsible for the company's debts.