Learn how stock corporations work through an example, along with the different types of stock corporations and their pros and cons to determine whether they're the right type of business entity for your venture.
Stock corporations are for-profit organizations that issue stock to shareholders to raise capital.
What Are Stock Corporations?
Stock corporations are for-profit organizations that issue shares of stock to shareholders (also known as stockholders) to raise capital, with each share representing partial ownership of the corporation and granting shareholders certain ownership rights that shape company policies. However, the corporation and its owners are generally treated as distinct legal entities.
How Stock Corporations Work
If you're considering the incorporation of your business (that is, forming a corporate business entity), you have several decisions to make. One is the broad type of corporation you want to form, with the two main types being stock and non-stock corporations.
Alternate name: corporation
If you want to organize for profit and sell shares of stock in the corporation to finance its efforts, you'll need to form a stock corporation. Whereas non-stock corporations aren't organized for profit and aren't authorized to issue company stock, stock corporations are typically organized for profit and can raise capital for the corporation's operations or expansion by issuing company stock to people willing to invest in the company.
Stock corporations have shareholders, directors, and officers, each with different responsibilities and rights:
- Shareholders: These are individuals with shares of stock in a corporation representing partial ownership of that corporation. Ownership rights include the right to vote at the corporation's annual meeting, to elect board members in order to have a say in the direction of the corporation, and the potential to receive stock dividends.
- Directors: These individuals oversee general business affairs and appoint officers.
- Officers: This group manages day-to-day business operations.
For example, let's say that ABCBiz is unincorporated but wants to incorporate as a stock corporation in order to raise money to finance a new product line. The board of directors sells stock to a group of investors who become shareholders. The shareholders help elect new board members and receive some of the earnings of ABCBiz as dividends. Thus, the corporation has traded the money received by shareholders for some decision-making power and a portion of the corporate earnings, but it has also gained the capital needed to expand its offerings and prosper as a business.
Non-stock corporations don't offer stock but may still have members with voting rights in the corporation.
Types of Stock Corporations
For-profit corporations generally fall into two categories:
- C corporations: These are stock corporations that are treated as separate taxpaying entities from their owners for federal income tax purposes. That is, the corporation pays taxes on its profits and the shareholders pay taxes on their dividends. The corporation cannot deduct the dividends it distributes to shareholders; nor can shareholders deduct the losses of the corporation.
- S corporations: These are stock corporations that have no more than 100 shareholders and employ "pass-through" taxation; that is, they pass the corporation's income, losses, deductions, and credits to each shareholder for income tax purposes.
Pros and Cons of Stock Corporations
Ability to raise money through stock
Ability to transfer ownership interest
Attract high-quality employees
Higher administrative burden
Double taxation of C corporations
The advantages of forming a stock corporation include:
- Ability to raise money through stock: Stock corporations are authorized to issue stock either at the time of the initial public offering or at a later time if permitted by the Articles of Incorporation, allowing them to finance initiatives that grow the business.
- Ability to transfer ownership interest: By transferring shares of stock, corporations can also shift ownership interest in the corporation from certain individuals to others when those individuals leave the company or changes in governance are desired.
- Attract high-quality employees: The opportunity to gain partial ownership in the corporation and receive dividends can serve as a recruitment tool for new employees or a motivating factor for existing employees. This can help a business attract the best and brightest.
- Limited liability: In general, corporations aren't liable for the obligations of their owners, which can significantly limit their losses and preserve business assets in the event that owners default on their debts, for example.
- Limited taxation: C Corporations file taxes separately from their owners. They're on the hook to pay taxes on income they receive, but not for the dividends shareholders receive.
The drawbacks of stock corporations are:
- Higher costs: Corporations (particularly C corporations) cost more to form and maintain than non-corporate business entity types, such as sole proprietorships, partnerships, and limited liability companies. For example, corporations must usually pay a one-time charter fee to the state (which may cost as little as $75 but can top $2,500) and an annual renewal fee ranging from $100 to $1,000.
- Higher administrative burden: Corporations are more regulated at the federal, state, and in some cases the local level, resulting in more paperwork, reporting requirements (an annual report, for example), and recordkeeping than simpler entity types.
- Double taxation of C corporations: These corporations are taxed at the corporate level when the company makes a profit and again at the shareholder level when shareholders receive dividends. However, S corporations avoid this pitfall.
How to Form Stock Corporations
The process and laws for forming a corporation vary by state. However, business owners can typically start by picking a name and filing Articles of Incorporation with their state's corporation commission. Required elements in this document may include the corporation's name and address, directors, business purpose, and the classes of stock and numbers of each that will be offered.
You can change certain elements of the corporation, be it the name or even the type of corporation (from stock to non-stock corporation, for example) by filing amended articles of incorporation.
Then, prepare bylaws detailing the rules for shareholders, directors, and officers, including how many votes must be received for an issue presented to the board to pass and the requirements that shareholders need to meet to sell shares.
Following this step, the corporation should hold a meeting where the incorporators appoint directors and officers, adopt the bylaws, authorize the issuing of stock, establish the accounting period, adopt a stock certificate form, and pick a bank and a corporate seal.
The corporation can then begin issuing stock certificates to initial owners, but it should obtain any required licenses to legally carry out business in the location.
- Stock corporations are for-profit organizations that issue stock (and potentially dividends) to shareholders in exchange for investment.
- They comprise shareholders who own shares and have voting rights relating to corporate governance, directors who oversee general business affairs, and officers who manage day-to-day business operations.
- Incorporators can opt to form either S or C corporations, with S corporations employing pass-through taxation and C corporations employing double taxation.
- To form a corporation, incorporators must typically file Articles of Incorporation, prepare bylaws, hold an organizational meeting, and issue share certificates.