There are many different forms or types of businesses. The simplest type of business is a sole proprietorship. It is a business that is owned by a single owner. Sole proprietorships are generally smaller in size and depend on a single owner to provide all the capital for their operations. Once these businesses grow, the owner may bring in other partners to join the business.
Businesses with more than one owner are known as partnerships. These are businesses that are formed by at least two owners. The jurisdiction in which a partnership operates will also define the maximum number of partners for a partnership.
In a partnership, the owners, or partners, share the profits and losses of the business. The percentage of their share of the profits or losses is predetermined. This is, generally, defined before the creation of the partnerships in the partnership contract or deed. Partnerships are bigger businesses as compared to sole proprietorships.
The problem with the above two types of businesses is that they are not limited liability businesses. This means that in case these businesses wind up, their owners will be fully liable to pay the obligations of the business. However, in some types of partnerships, the liabilities of one or all of the partners may be limited.
The final type of business is known as a corporation. Corporations are legal business entities that can have anywhere between 1 to unlimited owners. The ownership of corporations comes in the form of shares. Shares are legal documents that give the ownership of a corporation to the shareholder.
The percentage of ownership depends on the number of shares that the shareholder possesses. The earnings that corporations pay to their shareholders are also dependent on the number of their shareholdings.
Businesses can change from one type to another. However, these changes may be subject to some rules and regulations. For example, the owner of a sole proprietorship can easily convert it into a partnership or a corporation. However, it may be easier for businesses to upgrade rather than downgrade due to the different rules and regulations.
There are many advantages and disadvantages of corporations as a general or as compared to other types of businesses. Some of these advantages and disadvantages are discussed below.
Advantages of Corporations
There are many advantages of corporations, as a type of business, for both the shareholders and the corporation itself. Some of these advantages are listed below.
1) Limited Liability
As discussed above, corporations create limited liability for the shareholders. It means that in case a corporation gets liquidated, the shareholders will not be fully liable for the debts of the corporation.
Its shareholders will only be liable for the debts of the corporation limited to the value of their shareholding or their capital invested in the corporation. Limited liability businesses are more lucrative to investors as investing in corporations ensures they don’t have to pay for any liabilities above their capital.
This is different from other types of businesses such as sole proprietorships or some types of partnerships. In case these businesses wind up, the owners are held liable for all the liabilities of the business.
This means that the owners of an unlimited liability business will have to pay the liabilities of the business from their personal assets.
2) Separate Entity
Corporations are also considered separate entities from their shareholders. This is one of the main reasons why corporations are limited liability. However, that isn’t the only benefit of being a separate entity.
Corporations can enter into contracts and guarantees, lend and borrow money, invest funds, buy, own or sell property, and get into legal disputes as a separate entity. This means that a corporation does not need its owners for these things.
3) Transfer of ownership
An advantage of corporations for their shareholders is that corporations allow their shareholders to transfer their ownership without restrictions. Shareholders can easily buy and sell the shares of a corporation in a stock market without the need for prior approval.
In partnerships, all the partners must agree to admit a new partner. If any existing partner does not approve of a new partner, then the new partner cannot join the partnership.
Similarly, it can also be advantageous for the corporation. When shareholders buy or sell their shares, the operations of corporations are not affected by these transfers. On the contrary, for partnerships, if a new partner joins, or an existing partner leaves, the existing partnership deed becomes invalid.
A new partnership deed is made every time there is a change in the dynamics of the partnership. Furthermore, corporations exist even after a shareholder leaves, joins, or even dies, which may not be possible for other types of businesses.
4) Management expertise
In most cases, the shareholders of corporations will be different from their management. This can be advantageous for both the shareholders and the corporations. For shareholders, it means that they do not need to have any technical skill or knowledge to become owners of a business.
This is different from partnerships where the partners are involved in the management of the partnership. While some partnerships may have partners that do not manage the partnership, most of the partners are still involved in management roles.
For corporations, it means that they do not have to be affected by shareholders leaving or buying shares. Similarly, it means that the corporations can hire professionals for every management role to ensure the operations of the corporation run as smoothly as possible.
This can also be useful for shareholders as expert management means the corporation generates the maximum possible wealth for its shareholders.
5) Unlimited potential
Theoretically, corporations also have unlimited growth potential. This is mainly because corporations are not dependent on a single owner or a few owners for capital requirements. As discussed before, a corporation can have an unlimited number of shareholders.
Similarly, even if the existing shareholders cannot provide capital to a corporation, it can issue shares to new shareholders to generate finance. Other types of businesses such as sole proprietorships and partnerships are dependent on the capital that the existing owners invest in them.
6) Easy to invest in
Corporations are also easier to invest in as compared to sole proprietorships and partnerships. For a sole proprietorship, the single owner of the business needs to bear all the capital requirements of its operations which makes it an expensive and risky form of investment.
For partnerships, the existing partners may not allow new partners to enter, thus, making investing difficult in partnerships. For new partnerships, it may still be difficult to find agreeable partners that share the same objectives and goals. For corporations, anyone can buy shares from the market.
Disadvantages of Corporations
Corporations can also be disadvantageous as a form of business. These disadvantages may apply to both the shareholders and the corporations. Some of the disadvantages are as discussed below.
1) Agency problem
One of the problems of corporations is that their management is separate from their shareholders. While this can provide advantages for both the corporation and the shareholders, as discussed above, it can also be problematic.
The management of a corporation acts as an agent of the shareholders in the corporation. Agency problems arise when the objectives of the management do not align with those of the shareholders.
Since the shareholders of the company cannot continuously monitor the operations of corporations, it may promote fraudulent activities by the management. While this problem has existed for all corporations for a long time, there is no definite solution to it.
Corporations may be required by law to perform audits and comply with certain rules and regulations. However, these solutions still do not guarantee that agency problems within corporations will not exist.
2) Difficult to form
Corporations are more difficult to form as compared to other types of businesses. This is because corporations must comply with stricter rules as compared to other types of businesses. Similarly, there are several different stages that the initial owners of a corporation must go through to form a corporation.
These stages may require a lot of legal formalities to be performed. Furthermore, after forming a corporation, promoting it can be difficult and time-consuming. Overall, corporations are more difficult to establish and can result in more costs for the initial owners.
3) More compliance
As discussed above, due to various reasons, corporations are subject to stricter compliance standards as compared to other businesses. These compliances ensure the safety of shareholders’ investments in corporations and can also be beneficial for the corporation.
However, this may also create more administrative burdens and costs for corporations. Similarly, in case of any non-compliance, the corporations may face penalties or legal actions.
4) Double taxation
As discussed above, corporations are separate entities that may be advantageous for various reasons. However, this also means that a corporation, as a separate entity, will have to pay its taxes. Once a corporation is taxed, it can distribute any earnings to its shareholders in the form of dividends.
These dividends are then taxed again for each shareholder. This means earnings made by shareholders through corporations are subject to double taxation.
Corporations are one of the advanced forms of business. These are different from smaller types of businesses such as sole proprietorships and partnerships in many ways. There are many advantages and disadvantages of corporations as a type of business.
The advantages are that they are limited liability businesses, they are considered separate entities, and their ownership is easily transferrable. Furthermore, they can benefit from management expertise, they have unlimited potential to grow and they are easy to invest in.
Their disadvantages are that they may give rise to agency problems, they are difficult to form, they are subject to stricter rules and regulations, and shareholders are subject to double taxation.