Chapter 39 - Corporate Formation and Financing

S corporation

A close business corporation that has most of the attributes of a corporation, including limited liability, but qualifies under the Internal Revenue Code to be taxed as a partnership.

holding company

A company whose business activity is holding shares in another company.

Crowdfunding

A cooperative activity in which people network and pool funds and other resources via the Internet to assist a cause (such as disaster relief) or invest in a business venture (such as a startup).

alien corporation

A corporation formed in another country but doing business in the United States.

Tort Liability

A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment.

public corporation

A corporation owned by a federal, state, or municipal government—not to be confused with a publicly held corporation.

close corporation

A corporation whose shareholders are limited to a small group of persons, often family members. Close corporations are also referred to as closely held, family, or privately held corporations.

publicly held corporation

A corporation whose shares are publicly traded in securities markets, such as the New York Stock Exchange or the NASDAQ.

dividends

A distribution of corporate profits to the corporation's shareholders in proportion to the number of shares held.

Preferred Stock

A security that entitles the holder to payment of fixed dividends and that has priority over common stock in the distribution of assets on the corporation's dissolution.

Bonds

A security that evidences a corporate (or government) debt.

Common Stock

A security that evidences ownership in a corporation. A share of common stock gives the owner a proportionate interest in the corporation with regard to control, earnings, and net assets. Common stock is lowest in priority with respect to payment of dividends and distribution of the corporation's assets on dissolution.

benefit corporation

A type of for-profit corporation, available by statute in a number of states, that seeks to have a material positive impact on society and the environment.

shareholder agreement

An agreement between shareholders that restricts the transferability of shares, often entered into for the purpose of maintaining proportionate control of a close corporation.

Stocks

An ownership (equity) interest in a corporation, measured in units of shares.

Venture Capital

Financing provided by professional, outside investors—that is, venture capitalists, usually groups of wealthy investors and securities firms—to new business ventures.

Securities

Generally, stocks, bonds, or other items that represent an ownership interest in a corporation or a promise of repayment of debt by a corporation.

Criminal Acts

Under modern criminal law, a corporation may be held liable for the criminal acts of its agents and employees. Although corporations cannot be imprisoned, they can be fined.

Corporate Taxation

Whether a corporation retains its profits or passes them on to the shareholders as dividends, those profits are subject to income taxation by various levels of government. Another important aspect of corporate taxation is that corporate profits can be subject to double taxation. The company pays tax on its profits. Then, if the profits are passed on to the shareholders as dividends, the shareholders must also pay income tax on them.

The following are some of the factors that frequently cause the courts to pierce the corporate veil:

1. A party is tricked or misled into dealing with the corporation rather than the individual. 2. The corporation is set up never to make a profit or always to be insolvent. Alternatively, it is too thinly capitalized—that is, it has insufficient capital at the time it is formed to meet its prospective debts or potential liabilities. 3. The corporation is formed to evade an existing legal obligation. 4. Statutory corporate formalities, such as holding required corporation meetings, are not followed. 5. Personal and corporate interests are mixed together, or commingled, to such an extent that the corporation has no separate identity.

Benefit corporations differ from traditional corporations in the following ways:

1. Purpose. Although the corporation is designed to make a profit, its purpose is to benefit the public as a whole. 2. Accountability. Shareholders of a benefit corporation determine whether the company has achieved a material positive impact. Shareholders also have a right of private action, called a benefit enforcement proceeding, enabling them to sue the corporation if it fails to pursue or create public benefit. 3. Transparency. A benefit corporation must issue an annual benefit report on its overall social and environmental performance that uses a recognized third-party standard to assess its performance.

The following order of priority is used if a conflict arises among the various documents involving a corporation:

1. The U.S. Constitution. 2. State constitutions. 3. State statutes. 4. The articles of incorporation. 5. Bylaws. 6. Resolutions of the board of directors.

Among the numerous requirements for S corporation status, the following are the most important:

1. The corporation must be a domestic corporation. 2. The corporation must not be a member of an affiliated group of corporations. 3. The shareholders must be individuals, estates, or certain trusts and tax-exempt organizations. 4. Partnerships and nonqualifying trusts cannot be shareholders. Corporations can be shareholders under certain circumstances. 4. The corporation must have no more than one hundred shareholders. 5. The corporation must have only one class of stock, although it is not necessary that all shareholders have the same voting rights. 6. No shareholder of the corporation may be a nonresident alien.

ultra vires

Acts of a corporation that are beyond its express and implied powers to undertake (the Latin phrase means "beyond the powers").

Effect of S Election

An S corporation is treated differently than a regular corporation for tax purposes. An S corporation is taxed like a partnership, so the corporate income passes through to the shareholders, who pay personal income tax on it. In addition, the shareholders' tax brackets may be lower than the tax bracket that the corporation would have been in if the tax had been imposed at the corporate level. In spite of these benefits, the S corporation has lost much of its appeal. The newer limited liability business forms (such as LLCs, LPs, and LLPs) offer similar tax advantages and greater flexibility.

Private Equity Capital

Capital funds invested by a private equity firm in an existing corporation, usually to purchase and reorganize it.

articles of incorporation

The document that is filed with the appropriate state official, usually the secretary of state, when a business is incorporated and that contains basic information about the corporation.

Nonprofit Corporations

Corporations formed for purposes other than making a profit are called nonprofit or not-for-profit corporations. Private hospitals, educational institutions, charities, and religious organizations, for instance, are frequently organized as nonprofit corporations.

foreign corporation

In a given state, a corporation that does business in that state but is not incorporated there.

domestic corporation

In a given state, a corporation that is organized under the law of that state.

The Limited Liability of Shareholders

One of the key advantages of the corporate form is the limited liability of its owners. Normally, corporate shareholders are not personally liable for the obligations of the corporation beyond the extent of their investments.

Professional Corporation

Professionals such as physicians, lawyers, dentists, and accountants can incorporate. A professional corporation is typically identified by the letters P.C. (professional corporation), S.C. (service corporation), or P.A. (professional association).

Piercing the Corporate Veil

The action of a court to disregard the corporate entity and hold the shareholders personally liable for corporate debts and obligations.

bylaws

The internal rules of management adopted by a corporation at its first organizational meeting.

retained earnings

The portion of a corporation's profits that has not been paid out as dividends to shareholders.