(Hello again, my dear readers. It’s time once again to head back to class, in order to learn some interesting and helpful facts about the investing world. After all, if we’re hoping to be educated investors and stewards of our money, we first have to be educated. Today, we’re going to start veering a bit away from the different types of investments available, and towards some of the finer points of business and the economy. To start with, it’s one of the defining features of the modern business world: corporations.)
Q: So, what exactly is a corporation?
A: A corporation is legal entity that is distinct from the shareholders, workers, or anyone else involved in its function. It’s considered for purposes of law to be a separate individual from the shareholders or other owners, and can be involved in legal proceedings as either a plaintiff or a defendant. One of the major features of corporations is the concept of limited liability.
Q: Alright, what’s this limited liability all about?
A: Let’s go through a little thought experiment. You own a small business and run into a small snafu legally. Perhaps a worker ran over a poodle or something similar. (No offense intended to any poodle lovers, of course.) If you owned the company outright, as a sole proprietorship in your own name, the poodle owner could sue you and take not only the assets associated with the company, but any personal assets you happen to own, as well (car, house, pets, etc). If the company is arranged as a corporation with limited liability, though, then the only money you can lose is the money that was already put into the corporation. You can lose the money you put into your business, as well as the value of any corporate stock you own (assuming you’ve gone public with the company), but beyond that, all your other assets are safe.
Q: Reasonable enough; but doesn’t that make corporations just a way for the wealthy to dodge responsibility?
A: Well, that’s one criticism that’s leveled at them, sure. Limited liability is one of the biggest (if not THE biggest) selling point of corporations, but it benefits everyone involved; owners and shareholders (which include most of us, at least for larger companies) can invest without fearing that a mistake made by the corporation will cost them everything. By limiting the potential to the invested amount (and ONLY the invested amount), investing becomes safer and companies can draw in more investment dollars. If you own any stock, you’re benefiting from the corporate structure.
Q: I guess I’ll accept that; what are some of the other benefits of a corporation?
A: Besides a possible sense of pride in being able to call your business a ‘corporation’, there are several more tangible benefits, as noted on Find Law. Many of them have to do with issuing stock; once your company is a corporation, you’ll be able to sell of tiny portions of it as stock, either to raise money or to give to employees. The corporate structure also sets up a number of positions: the directors, who provide direction to the company; the officers, such as CEOs and COOs, who oversee the business’s daily activities; and shareholders, who hold stock, have an ownership interest in the company, and elect the directors.
Q: I’ve done this enough to know what comes now: what are the downsides of corporations?
A: Yup, corporations aren’t all peaches and cream; they do have a few negatives, as noted in the above Find Law article. It mentions both the costs of setting up a corporation (which can be substantial) in terms of time and effort, as well as the rules that corporations have to follow in order to preserve its existence as an independent entity (and keep that limited liability in place). One of the most griped about problems, though, is the possible ‘double-taxation’ within the corporate structure, where profits are taxed first when they accrue to the corporation, and second, when they are distributed to the shareholders as dividends. (The logic behind this is that, as corporations are separate persons, the money they make should be taxed as their income, and then also taxed when the money is transferred to other people (the investors). It’s similar to you paying your mechanic out of your own paycheck; the money is taxed when each one of you receives it as income. The only trick is here is that one person in our corporate example is not actually a person, but a legally created entity.) There are ways around this double taxation, mainly by choosing a different type of corporation.
Q: Wait, there’s more than one type of corporation?
A: Yes, indeed. In fact, if we go to Wikipedia’s Companies Law page and look at the index over on the right, we can see that there are a great number of different types of corporations, all with different governing rules and regulations. Depending on your needs, any number might meet your purposes, although you’d have to do careful research and consideration in order to be sure. I’ll try to cover some of the types more in depth during the coming weeks.
That’s all for now; hopefully, you’re a little better informed on just what a corporation is, and how it can affect you.