Corporation Financing
We’ve addressed the major aspects of sole proprietorships, business partnerships, LLCs and the finance options available to those businesses, but what about the complexities of the corporate structure? While many well established businesses are excited at the thought of expanding and incorporating their business, it often comes with a variety of legal and financial intricacies – the corporate business structure is much more complex and expensive than any other business structure, with many more regulations and tax requirements involved. This is often daunting for many business owners looking to become incorporated, however there are also major benefits to setting up your business as a corporation. Essentially, a corporation is a separate, independent legal entity that is completely separate from its owners, oftentimes the shareholders. While establishing a business as a corporation is doable for any size business, it is generally recommended for larger, more established businesses due to the high fees and legal regulations associated with incorporating a business.
To form a corporation, a business owner must establish a business name and register with their state government. There are also quite a few different documents that must be filled out and returned to the state’s Secretary of State office. The most important step in setting up a corporation is to file the articles of incorporation; the articles of incorporation are a set of documents filed with the government to legally create a corporation. The articles of incorporation contain general information regarding the business, such as the business name, location, and so forth. Unfortunately, the articles of incorporation are often confused with bylaws – bylaws simply explain the rules and regulations for a specific type of corporation, as well as helping to establish the duties of the business’s directors and employees. Bylaws work in conjunction with the articles of incorporation.
Types of Corporations
Now comes the complicated aspect of corporations – deciding what type of corporation your business will be. All types of corporations have various advantages and disadvantages, so remembering that consulting with legal help before making any decisions can help.
Professional Corporation vs. Personal Services Corporation:
A professional corporation (PC) is a corporation of professionals who are incorporated under the laws of a specific state. This seems obvious, but in a professional corporation, there is the issue of malpractice or other professional actions. Typically, a corporation absolves the shareholders from personal liability, but with a professional corporation, the individual who committed the malpractice action would still be liable without putting the other shareholder’s personal assets in jeopardy. This type of corporation is limited to certain types of businesses (i.e. doctors, etc). Alternatively, a personal service corporation (PSC) is a considered a taxing entity. According to the Internal Revenue Service, there are two major requirements for a personal service corporation: principal activity, which is providing personal services in specific fields, and employee ownership of more than 10 percent of the fair marketing value of its outstanding stock.
General Corporation (C Corporation):
According to the Small Business Administration, a corporation, or C-Corp, is an independent legal entity from owned by shareholders, allowing shareholders to not be legally liable for the actions and debts created by the corporation. Most general corporations have shareholders, with a majority of the shares being closely held by only a few individuals; however, there is also a non-stock corporation that does not issues shares of stock. A non-stock corporation may be non-profit or for profit. In place of one person making every decision, there is often a board of directors that works together to set policies and management oversight throughout the corporation; the board of directors often put the next level executives into place who run the day to day operations as paid employees. The biggest issue for corporations is the way they are taxed. The corporation itself is taxed on its profits (at the federal corporate tax rate of 35 percent), but the shareholders (or owners) of the corporation are also taxed on their dividends they receive through the corporation on their personal tax returns. This is often referred to as “double taxation”.
- Advantages: Corporations get to enjoy the major benefits of limited liability amongst shareholders, the perpetual existence of the corporation (as opposed to the business ending after the death or resignation of the owner), no limit on shareholders which allows a corporation to raise more funding, and the ability to enjoy tax deductible business expenses.
- Disadvantages: While there are many benefits to become a corporation, this business structure tends to have expensive administrative and filing fees, complex legal requirements, and complicated tax requirements. Double taxation is a downside for corporations, however some corporations try to alleviate this pressure by paying some of the money out as salary to corporate shareholders – but there are requirements by the IRS for reasonable compensation. Another issue with a c corporation is that it is unable to deduct corporate losses from personal tax returns.
Close Corporations:
Generally, a close corporation is a smaller version of a general corporation, with a few caveats; the biggest reason businesses choose to operate as a close corporation is the ability to operate their business without the strict formal requirements associated with a general corporation. This basically allows a corporation to operate like a partnership were shareholders and directors are entitled to a larger role in the company. However, there are strict requirements that a business must meet in order to qualify as a close corporation; particularly, all shareholders must unanimously agree to the close corporation status.
- Advantages: Close corporations often have fewer formalities than general c corporations; close corporations are also have more control over sales of shares. Corporate liability protection is also a major advantage to a close corporation.
- Disadvantages: Not every state offers a business the ability to become a close corporation, and they tend to have higher costs associated with them. There are also more responsibilities and expected participation requirements for shareholders, which can be seen as a disadvantage for some shareholders. A close corporation is not allowed to publicly offer its stock.
S Corporation:
When debating between what type of corporation to register under, a common misconception is that S corporations are a different type of corporation. Really, an S corporation is different than a C corporation because of the special tax designation applied for and granted by the IRS – but an S corporation still has the same basic advantages as a C corporation. Essentially, an S Corporation allows a corporation to avoid double taxation so income and losses are “passed through” to shareholders to be included on their personal tax returns. Other differences associated with S corporations include the limit of shareholders that a corporation can have (up to 100) and the ability to only issue one class of stock. For S corporations, there are also limits on who can own shares in the corporation.
- Advantages: S corporations that have inventory can use the cash method of accounting (which is much simpler than the accrual method). However, the biggest advantage associated with S corporations are the tax savings for the business owners, as well as the business expenses that can be written off. S corporations are also able to be independent from its shareholders, similar to a partnership.
- Disadvantages: While an S corporation is very appealing to many business owners, especially smaller businesses that would like to incorporate, there are many more legal complexities associated with this corporation structure. There are also stricter operational processes for S corporations, such as being required to have regular director and shareholder meetings, strict records maintenance, and shareholder compensation requirements.
When Would a Need a Loan?
No matter the size or type of your corporation, there will always be a time when finance options may be a consideration – or better yet, if your business is looking to become incorporated. This can be a huge step for many business owners, especially after seeing the fees associated with becoming a corporation. Some of the other major reasons an established corporation would need a loan include needing more working capital to expand, renovate, or incorporate new things into your business. There is also the unavoidable expense of payroll, as well as hiring new employees. A loan for a corporation can also be utilized for a variety of other things such as inventory, new equipment, marketing campaigns, implementing omnichannel platforms, and so much more.
Types of Loans For Corporations
| Types | Rates | Terms | Funding |
|---|---|---|---|
| Bank | 6-10% | 3-7 years | 14-30 days |
| SBA | 6-10% | 3-7 years | 10-30 days |
| Line of Credit | 5-15% | 1 – 3 years | 7-30 days |
| Alternative | 6-25% | 1-5 years | 5-7 days |
| Cash Advance | 1.16-1.55 | 3-24 months | 1-3 days |
Corporate Bank Loans
The most desired route for corporate financing is always traditional financing through a bank (large banks, small banks, community banks and credit unions). The reason why is quite obvious: best rates and terms available. But it usually requires established profitability and collateral to get approved.
- Rates: 5-10%
- Terms: 1-25 years
SBA Loans For Corporations
The next best choice after bank financing would be SBA financing. SBA loans are traditional loans originated by banks, community lenders and credit unions in which the SBA agrees to cover the lender’s losses should the corporation fail to repay their loan.
- Rates: 6-8%
- Terms: 3-25 years
Alternative Corporation Loans
Obtaining traditional financing is not easy, and sometimes its impossible. The next best financing option for corporations would be an alternative loan. Alternative corporate financing allows companies with good cash-flow to obtain needed funding without the long waits associated with a bank.
- Rates: 9-25%
- Terms: 1-5 years
Asset Based Loans For Corporations
Asset based loans are a way for a company to leverage their company’s balance sheet (and even personal assets) to obtain business financing. Collalteral used for an ABL include AR, inventory, commercial real estate and personal real estate.
- Rates: 8-25%
- Terms: 1-3 years
Corporation Cash Advance
Corporate cash advances are the sale of the company’s future revenue in exchange for immediate funding. A cash advance lender will examine a company’s cash-flow through the company’s bank statements (or even credit card processing if used) and then provide financing based on expected future revenue. After an cash advance amount has been agreed upon, the lender will fund the company, and then collect repayment through a daily remittance via ACH.
- Factor Rates: 1.16-1.50%
- Terms: 4 months – 2 years
