Corporation
Ownership and Stock
Corporations are owned by shareholders
who invest money in the business by buying shares of stock.
The portion of the corporation they own depends on the percentage of stock they
hold. For example, if a corporation has issued 100 shares of stock, and you own
30 shares, you own 30 percent of the company. The shareholders elect a board of directors, a group of people
(primarily from outside the corporation) who are legally responsible for
governing the corporation. The board oversees the major policies and decisions
made by the corporation, sets goals and holds management accountable for
achieving them, and hires and evaluates the top executive, generally called the
CEO (chief executive officer). The board also approves the distribution of
income to shareholders in the form of cash payments called dividends.
Benefits of Incorporation
The corporate form of organization offers several advantages,
including limited liability for shareholders, greater access to financial
resources, specialized management, and continuity.
Limited Liability
The most important benefit of incorporation is the limited liability to which shareholders are
exposed: they are not responsible for the obligations of the corporation, and
they can lose no more than the amount that they have personally invested in
the company. Clearly, limited liability would have been a big plus for the
unfortunate individual whose business partner burned down their dry cleaning
establishment. Had they been incorporated, the corporation would have
been liable for the debts incurred by the fire. If the corporation didn’t have
enough money to pay the debt, the individual shareholders would not have been
obligated to pay anything. True, they would have lost all the money that they’d
invested in the business, but no more.
Financial Resources
Incorporation also makes it possible for businesses to raise
funds by selling stock. This is a big advantage as a company grows and needs
more funds to operate and compete. Depending on its size and financial
strength, the corporation also has an advantage over other forms of business in
getting bank loans. An established corporation can borrow its own funds, but
when a small business needs a loan, the bank usually requires that it be
guaranteed by its owners.
Specialized Management
Because of their size and ability to pay high sales commissions
and benefits, corporations are generally able to attract more skilled and
talented employees than are proprietorships and partnerships.
Continuity and Transferability
Another advantage of incorporation is continuity. Because the
corporation has a legal life separate from the lives of its owners, it can (at
least in theory) exist forever. Transferring ownership of a corporation is
easy: shareholders simply sell their stock to others. Some founders, however,
want to restrict the transferability of their stock and so choose to operate as
a private (or closely held) corporation.
The stock in these corporations is held by only a few individuals, who are not
allowed to sell it to the general public. Companies with no such restrictions
on stock sales are called public corporations;
stock is available for sale to the general public.
Drawbacks to Incorporation
Like sole proprietorships and partnerships, corporations have
both positive and negative properties. In sole proprietorships and
partnerships, for instance, the individuals who own and manage a business are
the same people. Corporate managers, however, don’t necessarily own stock, and
shareholders don’t necessarily work for the company. This situation can be
troublesome if the goals of the two groups differ significantly. Managers, for
example, might be more interested in career advancement than the overall
profitability of the company. Stockholders might care about profits without
regard for the well-being of employees.
Another drawback to incorporation—one that often discourages
small businesses from incorporating—is the fact that corporations are costly to
set up. Additionally, they’re all subject to levels of regulation and
governmental oversight that can place a burden on small businesses. Finally,
corporations are subject to what’s generally called “double taxation.”
Corporations are taxed by the federal and state governments on their earnings.
When these earnings are distributed as dividends, the shareholders pay taxes on
these dividends. Corporate profits are thus taxed twice—the corporation pays
the taxes the first time and the shareholders pay the taxes the second time.
Five years after starting their ice cream business, Ben Cohen and
Jerry Greenfield evaluated the pros and cons of the corporate form of
ownership, and the “pros” won. The primary motivator was the need to raise
funds to build a $2 million manufacturing facility. Not only did Ben and Jerry
decide to switch from a partnership to a corporation, but they also decided to
sell shares of stock to the public (and thus become a public corporation).
Their sale of stock to the public was a bit unusual: Ben and Jerry wanted the
community to own the company, so instead of offering the stock to anyone
interested in buying a share, they offered stock to residents of Vermont only.
Ben believed that “Business has a responsibility to give back to the community
from which it draws its support.” He wanted the company to be owned by those who lined
up in the gas station to buy cones. The stock was so popular that one in every
hundred Vermont families bought stock in the company. Eventually, as the company continued to expand, the
stock was sold on a national level.
Key Takeaways
- A corporation (sometimes called a regular or C-corporation) is a legal entity that’s separate from the parties who own it.
- Corporations are owned by shareholders who invest money in them by buying shares of stock.
- They elect a board of directors that’s legally responsible for governing the corporation.
·
A corporation has several advantages over a sole
proprietorship and partnership:
- An important advantage of incorporation is limited liability: Owners are not responsible for the obligations of the corporation and can lose no more than the amount that they have personally invested in the company.
- Incorporation also makes it easier to access financing.
- Because the corporation is a separate legal entity, it exists beyond the lives of its owners.
- Corporations are generally able to attract skilled and talented employees.
·
A corporation has several disadvantages over a
sole proprietorship and partnership:
- The goals of corporate managers, who don’t necessarily own stock, and shareholders, who don’t necessarily work for the company, can differ.
- It’s costly to set up and subject to burdensome regulations and government oversight.
- It’s subject to “double taxation.” Corporations are taxed on their earnings. When these earnings are distributed as dividends, the shareholders pay taxes on these dividends.
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