Please note that this is a general overview of corporations, what they are, and how they function. As with most legal questions, there are exceptions and nuances that we will not discuss here. If you are thinking about forming a corporation it is always advisable to seek the advice of a licensed attorney.
Advantages of Incorporating
Corporations are legal entities designed to pool the efforts, resources, and expertise of many individuals into a collective operation. And, perhaps more importantly, provide a layer of protection for the shareholders, directors, and officers from the liabilities of the corporation. This protection is not, however, absolute. The most notable exception is the legal principle often referred to as “piercing the corporate veil.” This is a complicated area that is beyond the scope of this article but underscores the notion that the protections offered by the “corporate veil” have their limitations.
Where to Incorporate
Where you chose to incorporate is critically important and must be carefully analyzed. Corporations are created under and governed by state statutes. Those rules are further refined by the courts. Statues and caselaw dictate a variety of critical issues such as whether and to what extent shareholders owe fiduciary duties to one another, what duties directors and officers owe to the corporation and its shareholders, and whether those duties can be eliminated.
The shareholders are the “owners” of the corporation. Large, publicly-traded companies might have millions of shareholders and tens of millions of shares outstanding. By contrast, the stock of a closely-held corporations is owned by a few people shareholders. Most corporations in the United States are closely held corporations with a limited number of shareholders.
A quick word on Shareholders’ Agreements or Buy-Sell Agreements. It is highly advisable for the corporation’s shareholders to negotiate amongst themselves and execute a Shareholders’ Agreement. A corporation or other type of entity (like an LLC) can own stock in another corporation. Shareholders’ Agreements provide the framework for the relationship by and among the shareholders and cover critically important issues like voting, management, money, and exit. Many statutes will defer to the Shareholders’ Agreement on these critical issues. The provisions in the statutes are looked to only if there is no Shareholders’ Agreement in place. Often the statutory provisions will result in unfavorable results, thus emphasizing the need for a Shareholders’ Agreement.
The Board of Directors
Directors are “elected” by the shareholders. Directors dictate and oversee the corporation’s general objectives; they focus on the “big picture” and provide direction to the officers of the corporation. It is generally advisable to have an odd number of directors to avoid a deadlock situation, which results in no clear majority.
Officers are “appointed” by the directors. Officers are responsible for implementing the corporation’s general objectives and are generally responsible for the day-to-day operations of the corporation. Officers report to the directors, who, in turn, report to the shareholders. There are certain required positions that must be filled and other optional positions, but these will vary by state and statute. Most corporations are required to have a President, Treasurer and Secretary. Other optional positions include Chief Executive Officer (position often held by the President of the corporation), Chief Operating Officer, Chief Financial Officer, Chief Technology Officer, and the ubiquitous position of Vice President. The number of officers a corporation has can vary widely depending on the size of the Corporation and the specific industry of the corporation.
An individual can hold one or more positions as a shareholder, director and/or officer.