Corporation Advantages and Disadvantages : A sole proprietorship is the simplest type of business because it is owned by a single owner. A sole proprietorship is generally smaller in size and relies on the provider of all the capital necessary to run the business. Once the business grows, owners may bring in other partners to the business.
Businesses with more than one owner are referred to as partnerships.
This refers to businesses that have at least two owners. The jurisdiction in which the partnership operates defines the maximum number of partners.
With a partnership, the business owners, called partners, share profits and losses equally. The share of profits or losses they receive is predetermined.
This is generally defined before the formation of the partnership in a partnership contract. Partnerships are more difficult to start and maintain than sole proprietorships.
These types of businesses do not have limited liability, which means if the business breaks down the creditors will be held fully responsible. Limited liability can exist in some types of partnerships, however.
Lastly, there is corporate business. Corporations are legal business entities that can have anywhere from 1 to unlimited owners. Ownership a corporation comes through shares, which are legal documents that give ownership a corporation to the shareholder.
The percentage of ownership is determined by the number of shares a shareholder possesses. The earnings the corporation pays to its shareholders is also a result of their shareholding.
Businesses can convert from one type to another. However, these changes may be subject to some rules and regulations. For instance, it may be easier to convert from a sole proprietorship to a partnership or a corporation than to downgrade.
Some of the advantages and disadvantages of general corporations or corporations as compared to the other types of businesses are summarized below.
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Benefits of Corporations
Companies as a type of business offer many advantages to both shareholders and the corporation itself. Some of these advantages are listed below.
1) Limited Liability
As previously discussed, corporations have limited liability for their shareholders. This means the shareholders are not fully liable for the debts of the corporation in case a corporation gets liquidated.
The shareholders of a corporation will only be liable for the debts of the corporation limited to the value of their capital investments in the corporation. Limited-liability companies are more profitable for investors because investing in corporations ensures you don’t have to pay any liabilities above your capital.
In contrast to sole proprietorships and some partnerships, in case a business fails its owners are held liable for all the business’s liabilities.
Therefore, people who have unlimited liability need to pay their personal liabilities to cover the liabilities of their business.
2) Separate Entity
One of the main reasons why corporations are limited liability is also because they are separate entities from their shareholders. Yet, this is not the only benefit of being a separate entity.
Corporations can sign contracts, lend and borrow funds, invest funds, buy and sell property, and deal with legal issues as a separate entity. Therefore, corporations do not need an owner for these things to happen.
3) Transfer of ownership
An advantage of corporations for their shareholders is that they allow transfers of ownership to share holders without requiring prior approval. Shareholders can easily purchase or sell shares on a stock market without obtaining approval beforehand.
Partnerships allow a new member only if all existing partners approve of the new member. If not, then the new member may not join the partnership.
Likewise, corporations can benefit as well because when shareholders transfer their shares, the operations of corporations are not affected by these transfers. On the other hand, partnerships become invalid when a new partner joins, or an existing partner leaves.
The partnership deed will be revised every time someone leaves, joins, or dies. Furthermore, corporations exist even when their shareholders leave, join, or even die, which isn’t possible for other types of businesses.
4) Management expertise
In general, the shareholders of corporations will typically have different management from the companies’ management. This can be advantageous for both the shareholders and the companies.
For the shareholders, this means that they do not have to possess any technical expertise or knowledge to become owners of a business.
The partnership is not similar to partnerships where the partners are in management roles. Some partnerships may not have partners involved in management, but most partners play management roles.
As a result, corporations do not have to be affected by the loss or purchase of shareholders. Likewise, corporations are free to hire experts in every management role to ensure the corporation has a smooth operation.
A corporation’s expert management can also benefit shareholders, as it helps the corporation generate the maximum amount of wealth for its shareholders.
5) Unlimited potential
A corporation can theoretically grow unlimited. This is mainly because corporations do not depend on a single owner for capital requirements. As discussed before, a corporation can have an unlimited number of shareholders.
A corporation is able to raise money on its own by issuing shares to new shareholders if the existing shareholders cannot. Other types of businesses, such as sole proprietorships and partnerships, are dependent on the capital that is invested by the existing owners.
6) Easy to invest in
In contrast, corporations are simpler to invest in than sole proprietorships and partnerships, since sole proprietorships require the owners to cover all the capital requirements for their operations, making them a risky and expensive form of investment.
The existing partners may refuse to allow new partners to join them, which makes partnerships difficult to invest in. For new partnerships, it may be difficult to find partners who share the same objectives and goals. For corporations, anyone can buy stock from the public market.
Disadvantages of Corporations
A corporation can also be a disadvantage. A corporation’s shareholders may or may not benefit from these disadvantages. Several of them are discussed below.
1) Agency problem
As was discussed above, corporations use separate management and shareholders. This separate management is not only an advantage for the company and shareholders, but it can also create problems.
In a corporation, the shareholders are represented by the management. Agency problems arise when the management’s objectives are in conflict with those of the shareholders.
It has been always the case for all corporations that their shareholders are unable to consistently monitor the operations of the company. This has led to the promotion of fraudulent activities by the management. However, there is still no definite solution to this problem.
Although the law may require corporations to conduct audits and follow certain rules and regulations, these solutions do not mean agency problems within corporations will cease to exist.
2) Difficult to form
It is often more difficult to form a corporation than to form an ordinary business. This is because corporations are subject to stricter rules than other businesses. Likewise, there are several stages that a corporation’s owners must attend to to form a corporation.
Corporations may require a lot of legal formalities to be completed. Furthermore, they have difficulty promoting themselves after forming a corporation. Overall, the formation of a corporation can be hard and time-consuming.
3) More compliance
Corporate shareholders are subject to stricter compliance standards due to a variety of reasons. These compliance standards safeguard shareholders’ investments and can benefit the corporation.
Corporations may face more administrative costs and administrative burdens. Likewise, they may be penalized for any non-compliance.
4) Double taxation
As discussed above, corporations are separate entities which can provide multiple benefits. However, they also need to pay taxes since they are now a separate entity. When this happens, they can distribute any profits to their shareholders as dividends.
Therefore, corporate dividends are taxed again for every shareholder, which has the effect of double taxation.
Companies and their the legal structures in which they operate are among the most advanced forms of business. They differ from companies that are smaller (solo proprietorships and partnerships) in a wide range of ways. Corporations as a type of business have many advantages and disadvantages.
Their advantages include their limited liability status, the fact they are a separate entity and readily transferable ownership. Furthermore, their management expertise is of great benefit, they have unlimited growth potential, and they are an easy investment to make.
It’s disadvantages are that they usually don’t pay dividends to shareholders, they’re usually hard to get incorporated, they’re more complex, and shareholders pay double taxation.