Why are most large businesses organized as corporations?
Most large businesses are formed as corporations because of legal statutes that endow the incorporated form of business organization with full entity status. What this means is that corporations, having full entity status, have expanded powers of what can be exercise and limited range of liability.
A corporation is endowed as a separate, legal entity that has the rights of a "natural person." Corporations can buy and sell, enter into contracts, instigate law suits (or be sued), form associations with or own other corporations, own assets, pay taxes or be exempted from taxes, raise capital in the name of the corporation (as opposed in the name(s) of private individuals with limited credit-worthiness) (Sucha S. Ollek).
While these attributes of corporations benefit businesses of all sizes, large corporations benefit especially because these attributes allow for growth from a small, private corporation to a megalithic and even multinational corporation. In contrast, partnerships and sole proprietorships have more boundaries to growth and growth potential. Kinds of corporations are C corporations, S corporations and limited liability corporations.
The most significant attributes of corporations making them beneficial for and attractive to businesses that aspire to becoming large businesses are:
Limited liability: Corporations are liable, as separate legal entities, for their taxes, debts and other financial obligations. Thus owners and chief officers, who receive salaries and perquisites, are not liable to cover corporate financial obligations from their own wealth and income.
Capitalization: Corporations can more easily attain capitalization from banks than can sole proprietorships or partnerships since they have the force of independent entity status that is not complicated by personal credit history or family and personal finances. In addition, corporations can attract investors and stockholders; they can even attract venture capital for start-up or growth opportunities. Investors then share in the profits thus are willing to invest under the limited liability corporate umbrella. Sole proprietors cannot invite investors since, by definition, all profits must accrue to the owner or to the partners in a partnership.
Perpetuity: Corporations are formed for perpetuity. They do not end upon the death of the owner or partners as is the case with non-corporate businesses (though an unincorporated business can be transferred over to a family member through a sale of the business). Corporations, since they are not linked to any individual or individuals in partnership, have a perpetual life and continue with renewed chief officers and board of directors after the originator's death.
Taxes: Corporations are taxed differently from individual earners. Dividend income distribution from corporate earnings are taxed at a lower rate than employment income. In addition, corporation stakeholders pay fewer kinds of taxes than do owners of sole proprietorships.
A corporation has several advantages over a business:
- Limited owner liability: The owner of a business is liable for its failure and his property and other assets can be used by creditors to recover their capital. In comparison, the liability of any person in a corporation is equal to (or proportional to) his share in the corporation.
- Longevity: A corporation has practically infinite life as ownership can change when needed. A business, in comparison, is owned by an individual and thus has (potentially) limited life.
- Raising money: Its much easier for people and investors to trust a corporation as compared to a single person and thus it's easier for corporations to raise money from the market.
- Professional management: Corporations are more professionally organized as compared to businesses and inspire more confidence in both investors and clients.
- Credibility: Corporations are generally more credible than an individual and signal that they are here to stay.
The major reason for this is liability. It is much more sensible for a business to organize as a corporation than to remain as a sole proprietorship or a partnership.
When a business is organized as a corporation, its owners are protected from the debts incurred by the corporation. If the corporation goes bankrupt, only the money that the owners have invested in the corporation is lost.
By contrast, if a business is a proprietorship or partnership and goes bankrupt, the owners are liable for all the debts. Their personal fortunes (like whatever equity they have in their home or in their retirement accounts) is liable to be taken to pay of their creditors. This is an unacceptable amount of risk for most people.