How do entrepreneurs use their resources to start businesses?
Sometimes sole proprietors or partners realize that they need more financial capital to grow their businesses than they can provide on their own. One way to raise these funds is to seek venture capital. Venture capital is money from an individual investor or organization that invests in promising new businesses in exchange for a share of ownership. Another com mon way to raise money is to sell shares in the company to the public on the stock market. In either case, this is the time for the company to be reorganized as a corporation.
The word corporation has its roots in the Latin word corpus, which means “body.” The root of the word reflects the modern legal definition of corporation: a company treated under the law as a single body with its own powers, separate from its owners. A corporation can enter into a contract. It can buy and sell property, just as an individual can.
Corporations are owned by shareholders who purchase shares of company stock. When a business becomes a corporation, it may offer for sale anywhere from several thousand to several million shares of stock. Such a stock offering might bring the company millions or even billions of dollars in new financial capital. It is easy to see why companies looking to expand might choose incorporation.
Ben & Jerry’s offers a good example. Begun in 1978 as a partnership, the ice cream company became a corporation in 1984. That year, it offered stock to Vermont residents only, raising $750,000 for a new manufacturing facility. The following year, Ben & jerry’s stock was offered for sale to the general public. Using the revenue from stock sales, the company expanded its operations, distributing its ice cream outside of New England for the first time.
There are two kinds of business corporations. A privately held corporation is owned by an individual or a small group of individuals. It allows only a select group of people, often members of a family, to purchase stock. The stock is usually not for sale to the general public. A privately held corporation is also known as a closely held corporation.
If a privately held corporation grows Significantly, it may take steps to become, or may be sold to, a publicly held corporation. A publicly held corporation offers stock for sale to the general public and has many shareholders. This is the type of corporation Ben & Jerry’s became when it sold stock to the public. Stock in publicly held corporations is typically bought and sold through a stock exchange.
Corporations all tend to be organized in much the same way. As shown in Figure 9.5A, the typical corporation is a hierarchy with different levels of employees. Every employee in a corporation reports to a higher-level employee. That person reports to an even higher-level employee, and so on. At the top of the corporate hierarchy sits the board of directors, which reports to the shareholders.
A board of directors is a governing body that is elected by the shareholders. The board oversees management of the corporation. It also establishes corporate policy and makes sure the company’s resources are being managed effectively.
In many corporations, the board of directors is made up of “inside” as well as “outside” directors. An inside director is someone from within the firm, such as the company’s founder or a senior-level manager. An outside director is someone from outside the firm who can provide an independent perspective.
One of the board’s most important responsibilities is to select the corporation’s chief executive officer. The CEO is the highest-ranking person in charge of managing a corporation.
The CEO usually appoints other corporate officers-senior executives who oversee specific areas of the business. For example, the chief financial officer (CFO) is in charge of a company’s finances. The chief operating officer (COO) manages the day-today operations of a company. Other departments that are typically headed by corporate officers include marketing, legal, and information technology.
These corporate officers, along with other senior executives, make up the senior management of a corporation. Reporting to them is a broad swath of managers known as middle management. This next level includes vice presidents, department heads, and managers of various ranks. Middle management is responsible for supervising the day-to-day activities of the firm’s workers.
Businesses organized as corporations offer a number of advantages over sole proprietorships and partnerships.
Limited liability. A corporation’s owners-the shareholders-are liable only for the amount of money they have invested. For example, suppose an investor buys 100 shares of stock at $30 a share. If the corporation goes bankrupt, the investor will lose that $3,000 investment. His or her personal assets are never at risk. The corporation is liable for its debts, however, because the law considers it a legal entity, like a person.
Growth potential. Because corporations can use the sale of stock to raise financial capital, they have far greater potential for growth than do other forms of business. For example, Google offered stock to the public in 2004 in what is called an initial public offering. On the first day of Google’s IPO, 22 million shares were sold. This sale raised about $1.2 billion for the company.
Professional management. Whereas sole proprietors and partners must manage their businesses themselves, corporations are run by professional managers. These managers often specialize in a particular area, such as finance or public relations. With this expertise, corporations can increase efficiency to a level that often is not possible in smaller organizations.
Long life. Unlike sole proprietorships and partnerships, corporations continue to exist when founders die or owners sell their shares. As legal entities, corporations have permanence. For example. the company that became IBM Corporation was founded in 1888 and incorporated in 1911. Today it is one of the largest information technology employers in the world. This ability of corporations to continue indefinitely supports growth and long-range planning efforts.
Although incorporation provides businesses with important advantages, it also has disadvantages.
Complexity of start-up. Businesses that want to incorporate are legally required to follow certain procedures.
They must develop a prospectus. This document outlines for potential investors the main features of the enterprise and contains information about the stock being offered.
They must apply for a business license. All states require new corporations to file a set of documents called articles of incorporation, also known as a corporate charter. A corporate charter details the company’s objectives, structure, and planned operations. It also specifies the number of shares of stock that may be issued. When state officials approve the charter, the company becomes a legal corporation.
They must create corporate bylaws, or rules that govern the management of the corporation. Bylaws deal with such topics as how to conduct shareholder meetings, how to elect directors, what officers the organization will have. and what the duties of those officers will be.
They must hold a meeting of shareholders to elect a board of directors.
They must issue stock certificates to shareholders. A stock certificate is a legal document that certifies ownership of a specific number of shares in the corporation.
Loss of control. Once a business has been incorporated, the role of the original owner or founder may change. Decisions once made by the founder become the responsibility of the board of directors and the professional management team. For the founder, the change usually means giving up some control of the company.
More government regulation. Corporations are subject to more government regulation than are other types of businesses. For example, corporations are required to hold annual shareholder meetings. They must maintain detailed records of business transactions. Publicly held corporations must also file regular reports with the Securities and Exchange Commission, the federal agency that regulates the stock market.
Double taxation. Corporations face heavier taxes than do sole proprietorships or partnerships. As legal entities, corporations are required to pay taxes on their profits. In addition, shareholders must pay income tax on any dividends they receive. Taxation at the corporate level and again at the shareholder level is known as double taxation.
Business enterprises that operate in more than one country known as multinational corporations are not new. They have existed since the 1600s, when English and Dutch trading companies first established outposts in the East Indies.
However, in the past few decades. the number of global businesses has skyrocketed. In 1990, there were about 3,000 multinational corporations. By 2009, there were more than 82,000 parent corporations with over 807,000 affiliates around the globe. Contrary to what many people think, not all of them are corporate giants like Coca-Cola and Exxon. Most are smaller firms having fewer than 250 employees.
As Figure 9.5B shows, such corporations typically have headquarters in their “home” country. They then operate production facilities or deliver services in at least one other country. Each branch of a multinational must obey the laws of the country in which it is located, including tax laws.
Multinational corporations have advantages that other firms do not have. Their global reach gives them access to more markets, with greater potential for increased sales and growth. Access to multiple markets also makes it less likely that a multinational will go bankrupt than will a smaller firm operating in a single market. Moreover, multinational corporations often have access to cheaper labor and raw materials than they would find in their home countries. Locations in multiple countries may also reduce their transportation costs. For all these reasons, the number of global corporations is likely to continue to increase.