C corporations are some of the most prevalent types of businesses there are. They are a particularly interesting option for those with SaaS (software as a service) businesses.
With the world moving towards a more digital landscape when it comes to industry, SaaS businesses have massive potential. That being said, the amount you stand to profit with any given business venture will be entirely dependent on how you go about building it.
Essentially, software as a service companies can trace their roots back to the advent of computers themselves. As technology rapidly evolved and advanced, it became clear that these services would become invaluable for collaboration at the business level.
Nowadays, we can see how true that sentiment is. With the global pandemic putting many brick and mortar businesses in a stranglehold, the move online was imminent. Cloud-based programs became the backbone of most of the country’s workforces. SaaS startups are so valuable these days because of the convenience they offer. You can pay for them on a subscription basis, and there isn’t a need for high-quality hardware.
By filing with the IRS (Internal Revenue Service), you can make your business a C Corporation. Below, we’ll detail the advantages and disadvantages of doing so, as well as comparing it to alternative options.
What is a C Corporation?
The type of corporation (B, C, S, etc.) will depend on the existing legal structure for that organization. The names themselves are determined by the part of the Internal Revenue Code they’re taxed under. For example, C corporations are taxed under Subchapter C.
For C corporations, more colloquially known as C-corps, the owners and shareholders are taxed separately from the business itself. Taxation comes at both the personal and corporate levels when it comes to profit in these cases. Because of this, there is a lower liability for investors as the most they stand to lose their initial investment.
There is also a lot of transparency when it comes to C corporations. Shareholders vote on the board of directors. The business itself is mandated to hold yearly meetings to update the shareholders.
Essentially, the corporation itself will pay taxes on profits before paying dividends to shareholders. Then, shareholders will need to pay taxes (personal income tax) on those dividends. Although taxation takes two steps in these instances, it results in a lower corporate tax rate for investors, which encourages reinvesting those profits.
Advantages & Disadvantages
If you’re considering filing for your business to become a C corporation, check out this handy list of advantages and disadvantages first.
Advantages
Although both C and S Corporations have access to limited liability, it is still a major draw to starting a C-corp in the first place. This limited liability extends to the directors, officers, employees, and even the shareholders. Essentially, when a company has this mantle, a corporate loss can’t exceed the amount someone invested into it.
When a limited liability company fails, the burden isn’t put directly on the shareholders and owners to dig themselves out of the hole. Given how volatile the market can be, filing to be a C corporation to ensure you won’t lose more than you can afford to is a smart choice.
Another clear advantage of this structure is that it builds a foundation for perpetuity. Even if the owner leaves the company, shareholders and directors will have joint control. This is a great asset because of the uncertainty of the future. The owner may need to step down to deal with personal matters for an extended period of time.
You don’t want these everyday occurrences to stifle the growth of a bustling business. In the realm of growth, C corporations also have virtually unlimited growth potential. The reason being that you have more flexible stock options, making it easier to have a larger pool of shareholders.
Additionally, there is no cap on the number of shareholders your business can have. The only catch to this process is that you’ll need to register with the SEC under the Securities Exchange Act of 1934 when reaching certain milestones. At the time of writing, these milestones are $10 million in assets and 500 shareholders.
The final advantage may seem obvious, but C-corps have a flexible tax structure that allows for business expenses to be tax-deductible. Depending on your company, this can save a lot of money which can then be reinvested in marketing and staffing.
Disadvantages
When it comes to disadvantages, although not as robust as the advantages, they still exist and must be considered when determining the right structure for your SaaS company.
The first and most obvious headache is the inevitability of double taxation. This happens because your business will be taxed both at the corporate level and the individual level with your shareholders’ dividends.
These types of companies are also relatively expensive to start up. You’ll be required to file Articles of Incorporation, among other paperwork which carry fees. Additionally, you'll need to pay fees to the state within which your business is operating.
Because of the filing and overseeing by the IRS, naturally, C corps are subject to higher government oversight as well. Finally, shareholders won’t be able to deduct corporate losses on their individual tax returns, which may be a selling point for some.
When it comes down to brass tax, however, you’re paying for unlimited growth potential. The value of that comes down to your business plan and prospective success.
C Corporation vs. S Corporation
One of the key distinctions you’ll need to make when determining the type of business that’s right for you is whether or not you’ll run a C corporation or S corporation.
C-corps are fairly standard when it comes to taxation from the IRS, whereas S corporations have a special tax status and some advantages. In order to declare S corporation status, you’ll need to file a 2553 Form to the IRS while also meeting all guidelines of an S corporation.
Although different, there are a few areas where these two types of businesses overlap. Both types will be eligible for limited liability protection, which helps to ensure shareholders don’t get stuck with the bill when it comes to business-related debt.
Both of these types of businesses are created by filing forms to the state and therefore are separate legal entities entirely. Both types must also adhere to corporate formalities and follow a similar structure. This structure includes shareholders electing a board of directors to oversee decision-making within the company.
The two main categories within which these types of corporations differ are taxation and corporate ownership. When it comes to taxation, C-corporations file tax at the corporate level (thanks to their 1120 Forms).
However, this opens the door for double taxation if dividends are released to shareholders. This is because those dividends are considered personal income and are subject to personal income tax. For S corporations, they don’t pay tax at the corporate level. Instead, the profits and losses are transferred to the owners’ personal tax returns. The tax is then paid at the individual level.
For corporate ownership, S corporations have a few extra restrictions. First, they can’t have more than 100 shareholders. These shareholders must also be US citizens or residents. S-Corps also can’t be owned by other S-corps, C-corps, LLCs, or trusts. Finally, S-corps can only have one class of stock, whereas C-corps can have multiple.
Those that do choose S corporations tend to do so because of its tax structure. They also feature a 20% qualified business income deduction thanks to the Tax Cuts and Jobs Act of 2017. The limitations on these types of businesses include the aforementioned corporate ownership restrictions.
Should Your SaaS Startup be a C Corporation?
Now you can choose which type of corporation you format your software as a service startup, as you now understand the advantages and disadvantages of the main kinds. The main question you need to ask yourself is whether or not the limitations and costs of a C corporation are worth what they bring to the table for your product.
If you’re someone who cares about your company’s intellectual property, a C-corp may be the right move. Within these businesses, all intellectual property is owned by the business itself.
This can save headaches down the road if you plan on growing your business to incorporate a more robust list of services. Given that property in this respect is protected, it often projects a positive image of the company to potential shareholders.
You also won’t be limited to a certain number of shareholders, making this an almost exclusively lucrative undertaking. You want to attract as many investors as possible. The hard but real answer to this question depends on who you are and how you see your business growing.
C-corps can be great for businesses that will outgrow themselves within a few years. There are financial roadblocks along the way, so including fees into your business plan and budget is a must. The final decision will be up to you.
Conclusion
If you’re sure now that starting a C corporation is the right thing to do for your business idea, here’s how to get started. First, you’ll want to reserve the legal name of your business. For the most part, you can achieve this by contacting your state’s respective Department of State.
You’ll also need to file Articles of Incorporation with the Department of State. Next, you’ll want to reach out to initial investors and issue stock certificates to make them feel like part of the official team. Depending on your industry, you’ll have to apply for various certifications and business licenses.
Finally, you’ll need to file an SS-4 form (or apply online) to the IRS to obtain an official Employer Identification Number for when it comes time for your employees to file their taxes. These are just the preliminary steps, but once you’ve completed them, you’ll be in the C-corp pool with both feet.
Now that you’re officially a C corporation, you’ll want to hit the ground running. The best course of action is to try and garner as many shareholders as you can. You won’t need to register with the SEC until this number surpasses 500, so you have plenty of time before then.
As your business will likely be under the watchful eye of both the state and federal government, you’re going to want to focus your energy on marketing and maintaining a positive public image.
SaaS companies are in incredibly high demand due to the ways in which they can connect us during these tough times. Incorporating your SaaS startup as a C corporation can be right for you if you see massive growth potential in your business.