Corporations play a significant role in the business world. Entrepreneurs use the legal structure of a corporation to protect themselves from risks and grow their businesses into large enterprises. While you may interact with corporations nearly every day, you may not fully understand how they work.
In this article, we break a corporation down into its main parts: shareholders, directors, and officers. We explain how this legal structure works and how incorporating can benefit your business.
What is a Corporation, Exactly?
Corporations are legal business entities that are separate from the real people who own them, run them and work for them. When a business becomes a corporation, it becomes its own person.
In the eyes of the law a corporation is a separate person, different from the real people who own it, run it, and work for it. This means that a corporation can own assets, sign contracts, and do business all in its own name.
The split between a corporation and the people who own and run it does two important things:
First, the corporate structure protects the personal assets of the company’s owners, known as shareholders, such as their homes and cars, from debts or lawsuits against the business.
2.) Perpetual Existence
Second, a corporation can keep doing business even if the owners or managers change.
Limited liability protection is the primary benefit of registering a corporation. Limited liability ensures that a corporation’s shareholders, directors and officers are not personally accountable for the financial obligations or other liabilities associated with the business.
How Does a Corporation Work?
State incorporation laws require corporations to have a specific business structure and follow strict rules. Most corporations are setup as “general corporations” and have three main parts:
- Shareholders – Have ownership in the corporation.
- Directors – Make major decisions for the corporation.
- Officers – Run the day-to-day business of the corporation.
Corporations: Who are the Shareholders?
- Shareholders are initial investors and own parts of a corporation.
- Shareholders elect the directors and decide on major issues.
- Shareholders anticipate returns but also face investment risks.
Shareholders are the people or other entities who own parts of a corporation. Shareholders often put money in when the business is just starting out. The corporation issues stock certificates to shareholders as proof of their ownership and rights in the company.
Shareholders play a crucial role in the corporation’s big-picture decisions. They avoid meddling in the day-to-day operations of the business; however, they have a crucial role: electing the board of directors. The directors are responsible for guiding the corporation’s overall strategy, so choosing the right people is essential.
Each shareholder gets a certain number of votes based on how many shares they own. Thus, an individual with many shares holds more voting power and greater influence over the selection of directors.
Shareholders also have a say in other big decisions that could affect the company’s future. For example, if the company is thinking about merging with another company, the shareholders would likely get to vote on that. Similarly, if the company wants to issue more shares, the shareholders would usually need to approve.
Shareholders typically hope to get a financial return on their investment. The company might distribute these as ‘dividends’, which are payments made from its profits. The value of the shares can also increase over time as the company grows and becomes more successful.
Being a shareholder can be risky, as their investment can decrease in value if the company doesn’t do well. However, it can also be rewarding if the company succeeds.
Corporations: Who are the Directors?
- Directors guide the corporation’s strategic decisions.
- Directors select corporation’s officers and represent shareholders’ interests.
- Directors are selected for their experience and industry knowledge.
Directors are like the guides or navigators of the corporation. Shareholders select them to make crucial decisions for the business. Each director sits on the Board of Directors, which is the group of people collectively responsible for the company’s overall direction. The Board of Directors ensures that the company remains on course and progresses towards its objectives.
The directors don’t usually get involved in the everyday tasks of the corporation. Instead, they focus on the big picture, making strategic decisions that shape the company’s future. For instance, they might decide to open a new branch, launch a new product, or invest in research and development.
The Board of Directors meets several times a year to discuss the company’s performance, review its strategy, and make critical decisions. These meetings might involve analyzing financial reports, discussing market trends, or deciding on major projects. In Delaware, where many companies choose to incorporate, the law requires the directors to hold at least one big meeting each year. This is known as the Annual Meeting.
A critical job for the directors is selecting the corporation’s officers. These are the people who will manage the daily operations of the business. The directors must choose competent, trustworthy individuals to ensure the company is run well.
Directors also have a responsibility towards the shareholders. They must make decisions that are in the best interests of the company and its shareholders. This might mean balancing short-term gains with long-term growth, or making tough decisions during challenging times.
Directors are usually chosen because of their experience and knowledge in the business or industry. They might be veteran businesspeople, industry experts, or individuals with unique skills that can help guide the company. It’s a significant role with considerable responsibility, but it’s also a chance to guide a corporation towards success.
Corporations: Who are the Officers?
- Officers manage daily operations with roles like “President”, “Treasurer”, or “Secretary”.
- They are responsible for strategic decision-making and operational tasks.
- The board of directors oversees the hiring and firing of officers.
Officers are the individuals who handle the daily operations and responsibilities of the corporation. They’re often referred to by their specific titles, such as “President”, “Treasurer”, or “Secretary”. These roles are critical for the smooth running of the company and play a significant role in its success.
The President, often also known as the CEO (Chief Executive Officer), is typically the highest-ranking officer in the company. They are responsible for making major corporate decisions and setting the company’s overall direction. They also act as the main point of communication between the Board of Directors and the rest of the company.
The Treasurer, or CFO (Chief Financial Officer), handles the company’s financial affairs. This includes:
- Overseeing financial planning,
- Tracking cash flow,
- Analyzing the company’s financial strengths and weaknesses, and
- Proposing corrective actions.
They might also handle investor relations, ensuring that shareholders receive updates on the company’s financial performance.
The Secretary is usually responsible for ensuring the company meets all its legal obligations. This includes:
- Maintaining corporate records,
- Preparing minutes of board meetings, and
- Ensuring the company’s documents are in order.
Other officer roles could include the COO (Chief Operating Officer), who oversees the company’s day-to-day administrative and operational functions, or the CMO (Chief Marketing Officer), who develops marketing strategies to boost the company’s brand and increase market share.
The board of directors is typically responsible for hiring and firing senior officers. This means the board must ensure they choose individuals who are capable of effectively running the company and guiding it towards its strategic objectives.
Officers must act in the best interests of the company, balancing various needs and goals. This often involves strategic thinking, decision-making, and a deep understanding of the business and its environment. A corporation’s officers are critical in steering the company towards its goals and ensuring its successful operation.
What are Fiduciary Duties for Directors and Officers?
Directors and officers of a corporation have specific fiduciary duties to the company. Directors and officers have a legal obligation to act in the best interest of the corporation and its shareholders because of these duties.
Fiduciary duties are guided by two main responsibilities: the duty of care and the duty of loyalty.
The duty of care means directors and officers need to make careful, well-informed decisions for the corporation. They should take time to understand the business fully, and their choices should be based on careful thought and honest judgment.
The duty of loyalty means that directors and officers need to put the corporation’s needs first, above their own. They should avoid situations where their personal interests might conflict with the corporation’s interests. Directors and officers cannot use their position, or any information they get from it, for personal benefits. In simple terms, this duty is about being loyal to the corporation and its shareholders.
What is Incorporation, or Incorporating?
“Incorporation”, or “incorporating”, is the process of a business becoming a corporation. Incorporation involves filling out legal documents and filing them in the state where the business wants to be a corporation. These documents tell the public important things about the corporation like its name, where it’s located, what it does, and how its shares (or pieces of ownership) work.
Some states call the incorporation document a “Certificate of Incorporation” or the “Articles of Incorporation”.
Where Does a Company Incorporate?
A business can register as a corporation in any state that it chooses, no matter where it does business. So you can be located in California or India and still incorporate your business in Delaware.
The incorporation process is done through the Secretary of State’s office in a given state. The Secretary of State keeps a record of all the corporations in the state and makes sure they are compliant with the state’s business laws and regulations.
The laws of the state where a company first incorporated legally govern a corporation. This means that business owners can shop around and take advantage of state laws that offer them the best protections.
Businesses from all over the world choose to incorporate as Delaware corporations for this reason.
Which State is Best for Corporations?
Delaware is well known as being the number one state to incorporate a business. Entrepreneurs from all over the world choose to incorporate their businesses in Delaware to take advantage of the state’s business friendly laws and tax advantages.
What are the Functions of a Corporation?
Corporations, as distinct legal entities, carry out several unique functions that set them apart from other business structures. Understanding these functions is important when deciding whether forming a corporation is the right move for your business:
1.) Separate Legal Identity: A corporation is its own legal entity that provides limited liability protection for its owners. This means it can enter into contracts, own property, and be sued, all under its name.
2.) Raising Capital: Corporations have the ability to issue shares of stock, which can be sold to investors. This provides a significant advantage when trying to raise capital for expansion or other large projects compared to other business structures.
3.) Governance Structure: A corporation has a formalized governance structure that involves a board of directors, officers, and shareholders.
4.) Continuity: The corporate structure ensures that a business can continue its operations regardless of changes in ownership or management.
5.) Compliance with State Laws: Since corporations are governed by state laws, they have to ensure that they comply with regulations, pay required fees, and file necessary paperwork, like Annual Reports.
Corporation vs. Limited Liability Company (LLC). What’s the difference?
Corporations and LLCs are similar in that they both provide limited liability protection and legal separation between a business and its owners. However, these two business structures have several key differences:
Corporation vs. LLC – Ownership:
LLCs are owned by “Members”, while corporations are owned by shareholders. Ownership in an LLC is often more flexible and can be distributed without the need for stock issuance.
Rather than issuing stock, rights and ownership in an LLC is detailed in the company’s Operating Agreement. The LLC Operating Agreement is a private contract between LLC Members.
Corporation vs. LLC – Management:
Corporations must maintain a rigid structure, while an LLC has the flexibility to determine its operational methods. While corporations operate with a board of directors and officers, members manage an LLC directly or appoint managers to do so.
Corporation vs. LLC – Profit Distribution:
Corporations typically distribute profits according to the number of shares an individual owns. In contrast, LLCs distribute profits according to the terms set in the Operating Agreement.
Corporation vs. LLC – Taxation:
Corporations are typically subject to double taxation (corporate level and then shareholder level when dividends are paid), whereas LLCs often benefit from pass-through taxation where profits and losses pass through to the owners’ personal tax returns.