Advantages and Disadvantages of Incorporation

Incorporation of a company is the legal process by which a business entity obtains recognition as a separate legal entity distinct from its owners. This involves filing the necessary documentation, such as articles of incorporation, with the relevant government authority. Once incorporated, the company assumes its own rights, liabilities and legal status, affording its owners or shareholders, limited liability protection.

This separation of personal and corporate identities allows the company to own property, enter contracts, sue or be sued and engage in business activities independently. The process of incorporation establishes the framework for the company’s existence, operations and legal standing.

The advantages and disadvantages of incorporation are:

Advantages of Incorporation of a Company

The advantages of incorporation are:

Establishment of a Separate Legal Entity

Incorporating a company creates a distinct and independent legal entity. Members of the company cannot be held personally responsible for the company’s actions, even if one member owns a majority of the shares. This principle was established in the case of Salomon v Salomon & Co. Ltd. (1897) AC 22. Solomon, a bootmaker, transferred his sole proprietorship business to a newly formed company (Salomon Ltd.).

Although Salomon and his family constituted the majority of the members, the company operated as a separate legal entity. When the company faced financial challenges and went into liquidation, Salomon’s personal liability was limited to his capital contribution and he was not held responsible for the company’s debts.

Perpetual Succession

Incorporated companies enjoy perpetual succession, meaning they continue to exist regardless of changes in membership. The company persists until legally wound up according to the provisions of the Companies Act, 2013.

As highlighted in Re Noel Tedman Holdings Pty Ltd (1967) Qd R 56, changes in company membership do not impact its legal standing, emphasising that the company remains unaffected by the comings and goings of its members.

Ownership of Separate Property

As a separate legal entity, a company can hold property in its own name and members do not have individual claims to the company’s assets. The Supreme Court, in Bacha F. Guzdar v CIT Bombay, affirmed that since the company is a distinct legal person, members cannot claim ownership of the company’s property in their individual capacity.

Additionally, the case of Macaura v. Northern Assurance Co. Ltd. illustrated that a shareholder cannot insure company-owned assets in their personal name, emphasising the separation of personal and company property.

Capacity to Sue and Be Sued

An incorporated company has the legal capacity to initiate legal actions or defend itself in its own name. However, for such legal proceedings, representation by a natural person is necessary. Failure to comply with this requirement may lead to the dismissal of a case, similar to the dismissal of an individual complaint in the absence of the complainant.

Enhanced Access to Capital

Incorporation facilitates easier access to capital for a business. Corporations can issue shares of stock, providing a convenient means to raise capital. This ease of capital raising becomes particularly advantageous when seeking bank loans, as banks generally prefer lending to incorporated businesses.

Therefore, incorporation not only fosters business growth but also increases the likelihood of securing financing from financial institutions.

Disadvantages of Incorporating a Company

The disadvantages of incorporation are:

Cost

Initial costs for incorporation involve filing fees, potential legal or accounting expenses and the option of using incorporation services. Ongoing fees for maintaining a corporation also contribute to the overall cost.

Double Taxation

Certain types of corporations, such as C Corporations, may face “double taxation.” This occurs when the company is taxed on its profits and again on the dividends distributed to shareholders.

Loss of Personal Control

In stock corporations, individuals may lose complete control of the entity. Governance shifts to a board of directors elected by shareholders, diminishing the singular ownership control.

Required Structure

Corporations must adhere to state regulations, encompassing corporate management, operational protocols and accounting practices. Strict compliance with these rules is mandatory.

Ongoing Paperwork

Corporations are obligated to file annual reports detailing the financial status of the company. Continuous paperwork includes tax returns, accounting records, meeting minutes and any necessary licenses and permits.

Difficulty in Dissolving

While perpetual existence is a positive aspect, the process of dissolution can be challenging, requiring significant time and financial resources to complete the necessary procedures.

Lifting of Corporate Veil

The legal principle of the “Lifting of Corporate Veil” posits that a company is a distinct legal person from its members. However, there are instances when the court may lift or ignore this corporate veil. This occurs to unveil the true nature of the company or when it is perceived that the corporate form is being misused or abused.

The court, in such cases, exposes the actual character and nature of the concerned company. This principle is evident in the landmark case of Salomon v. Salomon and Co. Ltd. (1897) A.C 22, where the court recognised the separate legal identity of the company but retained the authority to pierce the corporate veil when necessary to prevent misuse of the corporate structure.

Conclusion

The decision to incorporate a company involves weighing both advantages and disadvantages of incorporation. On the positive side, incorporation provides legal protection, perpetual existence, property ownership, enhanced legal capacity and improved access to capital. However, the drawbacks include initial and ongoing costs, the potential for double taxation, loss of individual control, strict structural requirements, continuous paperwork and challenges in the dissolution process.

Understanding the advantages and disadvantages of incorporation is crucial for entrepreneurs, as it enables informed decisions aligned with the specific needs and goals of the business. Ultimately, the benefits of incorporation must be balanced against the associated challenges to make a well-informed choice for long-term success.