Third form of Business Ownership

How does it work?

A corporation is a business owned by a group of people & authorized by the state in which it is located to act as though it were a single person, separate from its owners. To get permission to form a corporation, organizers must obtain a charter. A charter is the official document through which a state grants the power to operate as a corporation.

What does all that mean?

Think of a corporation as a person that only exists on paper. This person can make contracts, borrow money, own property, and sue or be sued in its own name. The actual owners of the company are considered a separate entity from the business.

Three Key Categories of People in a Corporation

Categories Explained

Stockholders - When you own stock in a company you receive a certificate showing the number of shares you own. Stockholders are only liable for the amount of money they invested in the corporation. They can make money on top of what they invest, but they cannot lose more than what they invested. Stockholders have right to transfer ownership of their stock to others, vote for board members, receive dividends, buy additional shares when they exist and share in the net proceeds if the business goes under.

Directors - This group of people have the responsibility to develop plans & policies to guide the corporation as well as appoint officers to carry out the plans. If the corporation operating effectively the board is only there for policy issues and review the progress of the company. If the corporation is doing poorly, the board will take more of an active role in the day-to-day operations.

Officers - This group usually consists of a president (CEO), a secretary, and a treasurer. However, a vice presidents (VP) can be appointed to help in specific operating areas, such as a marketing VP, finance VP or chief financial officer (CFO) and manufacturing VP.

Types of Corporations

Closed Corporations (Privately Held)

This type of corporation does permit the public to purchase shares of its stock. The owners do not have to disclose their financial activities to the public since they are not asking the public to invest.

Open Corporations (Publicly Owned)

When a corporation is publicly owned, which means it offers shares of stock for the public to purchase. Public corporations must prepare a prospectus that explains the business to the public and helps them decide if they want to buy stock.

Certificate of Incorporation

Every business that wants to form a corporation must first obtain a certificate of incorporation. The certificate requires that the following information be included.

1. Name the business - Must use the word Corporation, Corp., Incorporated, or Inc. somewhere in the title.

2. State the purpose of the business - Describe it clearly. Afterwards any expansion will require more paperwork.

3. Invest in the business - Owners must decide how many share each person will own & how many shares could sold later to raise funds for the business.

Lastly, you must pay incorporation costs - This amount taxed by the government and is based on the amount of its capital stock.

Getting Started

After the business receives its Certificate of Incorporation they must then begin organizing how the business will run. That process begins by preparing a balance sheet that reveals the company's current financial position. Next, they must decide how the lines of authority for the business. This establishes the hierarchy of power and job titles for each person of authority in the business. Lastly, the owners must decide how to handle voting rights for those that own stock.

Advantages of Corporate Ownership

1. Borrowing money and finding people to purchase stock in a corporation is much easier.

2. Beyond the stock that the owners purchased, they are not legally liable for the corporation's debts.

3. A corporation is not easily disbanded because an owner of the corporation leaves or dies.

4. Owners & operators of a corporation can easily change without it affecting the businesses existence.

Disadvantages of Corporate Ownership

1. A corporation is usually taxed more than a partnership or proprietorship.

2. Profits distributed to stockholders as dividends are taxed twice.

3. A corporation can not a business any location that it chooses. In addition, if a corporation chooses to conduct business in different states, it must first obtain a license and pay a fee to each state.

4. All stockholders must be informed of corporate matters, notified of meetings, & given the right to vote. This requires a lot of correspondence, which can be time-consuming & costly.

5. A corporation cannot change its selling activities easily. Anytime the owner's of a corporation want to add an item they must seek government approval first. This required them to obtain a new charter or to modify their old one.

6. Corporations are more susceptible to an agency dilemma. This occurs when an agent, or someone who works for another, pursues their own interest over their employers. For example, managers conveniencing the BOD to give them a raise, which diminishes the return that stockholders could receive.