Corporations–what the heck are they, anyway?

A lawyer here once lamented to me that a case he was involved in was turning into a murky mess because the jury probably didn’t understand what a “corporation” is.

The corporation really is a brilliant idea, without which we’d have no modern means of finance and probably no modern economy at all.

So what is a “corporation,” it’s just a big company, right? That’s a sensible answer–one that most folks might give–but it’s not really on the mark.

The nature of a corporation is this: limited liability. In fact, you might have seen signs or advertisements for firms called, say, “Computers, Ltd.” (The “Ltd.” stands for limited.)

The “limited” doesn’t mean that they’ve got a limited supply of computers. The limited means that the outfit is a corporation, and “limited” means limited liability.

Of course, the store could also be called “The Computer Corp.,” or “Computers, Inc.” (The “Inc.” meaning “incorporated”). It’s all the same thing–it all means it’s a corporation, and, more to the point, it faces limited liability.

Ah, yes, we’re back to that liability thing again. A corporation basically shelters its shareholders from personal liability for the corporation’s debts. If you own shares in a corporation and the corporation can’t pay its bills, they can’t hunt you down for the money. Creditors can take the corporation to court and squeeze every last penny out of it, but they can’t hold the shareholders (who are, in essence, the owners and the investors) in the corporation liable for the bills.

Contrast this with a “proprietorship.” A proprietorship is simply a person doing business. If he borrows money (under his name, or under the name of his proprietorship–it doesn’t make a difference because he IS the proprietorship), and the business can’t pay its bills…there’s trouble brewing. The creditors can hold him personally liable for those bills. The liability isn’t limited to the business, it follows a trail all the way to the wallet of the business owner.

When people think of starting up a business, there’s risk enough in that gig without worrying about their personal funds being taken if the business tanks. So they form a corporation and issue themselves shares in it. The shares allow them to vote (generally) and take profits (as dividends) from the corporation. If it’s a small corporation–a bunch of friends starting a business–they also may hold jobs with the corporation and draw salaries, too.

But, small or large, the shareholders don’t have to worry about their personal funds being taken if the corporation can’t pay its bills.

A corporation is its own entity, “entity” being a three dollar word for “thing.” It has its own name, and its own bills to pay, and if it dies, it dies away without the shareholders being buried along with it. Sure, they may lose the money they invested in it, but they won’t lose any more.

The first law recognizing corporations in the modern sense was passed in New York state in 1811, which exempted shareholders of manufacturing companies protection from liability.

Investors liked the idea, of course, and New York started pulling in a lot of capital.

Other states passed similar laws in order to attract investors. And even stodgy Britain–the world’s leading economy back then–jumped on the bandwagon in 1854.

And that is the “quick and dirty” scoop on what corporations are. So if you’re ever on a jury concerned with such things–now you know.