If you are a fledgling or aspiring entrepreneur, you are probably thinking about the legal structure of organizations. You ponder questions like: should your company be an LLC or a C corporation?

The quick answer is to start as an LLC in your state. It is inexpensive, quick to establish, and provides valuable liability protection.

If you plan to raise money and take on investors like Angels and VCs, you will then re-form as a corporation.

Then you will want to know: what is a board meeting like, and what goes on in the C Suite?

The following, excerpted from my book MBA ASAP, is a quick primer on what a corporation is and the logic behind why it is the organizational structure of choice for companies.

Why do businesses form as Corporations?

The corporation form of business structure has proven itself to be one of the most revolutionary and productive forces of capitalism ever created. We rarely think of an organizational and legal structure as being a game-changing innovation, but in this case, it is difficult to overstate its impact.

Corporations are an ingenious innovation in how humans organize their efforts and protect the owners. This legal concept has been at the center of economic development for more than a century. The corporate form of organization and governance is an engine of prosperity. In the grand scheme of things, that isn’t such a long time. It is a surprisingly recent invention.

The corporate structure allows an enterprise to exist in perpetuity. It provides mechanisms of governance and capital formation that enable the relatively simple, stable, and predictable transfer of authority, power, and ownership.

It is the most flexible and productive enterprise vehicle ever created. Its importance and influence impact every aspect of modern life.

I am not exaggerating the importance of the concept of the corporation and want to take a moment to understand how it evolved.

History of the Corporation

Adolph Berle was a famous lawyer and economist who detailed the evolution of the modern corporation in a landmark book, The Modern Corporation and Private Property, published in 1932.

The main concern of this book was to describe the division of ownership and control: those who own corporations, the shareholders, are separate from the management of the corporation, which is handled by the Board of Directors and the executive management headed by the Chief Executive Officer (CEO) or President. It is governance by plurality and means that more than one person sets and votes on the strategic direction and plan to achieve it. A formal set of instructions guides the running of a corporation: the Articles of Incorporation and the Bylaws.

Separation of ownership and control, liability protection, and being actively traded on the stock market, are the innovations that allow people to invest relatively modest amounts in giant enterprises. Investors in stock are the owners of the company. Their reward is their share of the profits and the growth of the value of the enterprise. These incentives and protections are what have allowed for capital formation and investment in massive-scale enterprises.

The industrial revolution made scale an advantage. These innovations in capital formation allowed enormous enterprises to develop and take advantage of that scale. Not many people can afford to invest the money to start a big operation like an automobile or airplane or computer company. That’s why capital formation through stock markets and corporations are an ideal match and present the first form of crowdsourcing. Stock divides ownership across many investors. Capital can be raised from lots of people interested in the prospects and profit potential of a corporation and used to invest in plant and equipment, supplies, and employees.

The modern corporation is an ideal match for innovations brought about by the stock market. They create a powerful symbiosis: money can be aggregated in the stock market and allocated and traded to the most promising ventures in the form of corporations. Investors can make their investment decisions based on the performance of the corporations.

Business performance is reported quarterly in the form of profits and other accounting measures. Investor ownership interest is separate from the operating issues of management. They reap the benefits of ownership as the company they invested in generates profits.

Corporate Profits, Shareholders, and Stakeholders

Corporate profits flow into two categories. A portion stays within the enterprise to support future growth, and the balance goes to the shareholders as dividends. There can be tensions related to how the profits are divvied up.

Recently there has been vocal demand from shareholders for companies to dividend out more of the earnings and put the money in the shareholder’s hands (and pockets). Since the 1980s in the U.S., maximizing shareholder value and using profits to buy back shares and increase dividends has been the general mantra of U.S. capitalism.

This practice has been widespread but is now coming under increased scrutiny and criticism as short-term thinking. Too high a dividend payout ratio erodes the long term viability of the enterprise.

It is unsustainable. A corporation needs to deploy profits to upgrade and invest in new equipment and training. It requires the resources to increase its prospects.

Shareholder maximization of this sort focuses on enriching current shareholders, who are the ostensible owners but also have the least long term interest in the company since they can sell their shares quickly in the stock market.

Put starkly, they can advocate for draining the lifeblood of a corporation and exit by selling their shares when the prospects for the future start to look grim or compromised. This situation leaves other stakeholders like the community, employees, and suppliers in the lurch as they can’t switch so quickly and have more vested in the long-term viability of the enterprise.

There are advocates for no longer just running a corporation to maximize profits solely for the benefit of shareholders. It has become a prominent practice to broaden the awareness of stakeholders and widen the goals of the operation to include other stakeholders.

Addressing these concerns creates a more enlightened form of capitalism. In other parts of the world from the U.S., such as Europe and Asia, governments, employees, and other long term stakeholders have seats on boards and help guide the direction of the enterprise.

The separation of ownership and control is convenient since it gives investors the best bang for their bucks. Executives and employees of the company are primarily working for them and hopefully increase the value of their investment.

Yet this creates a conflict of interest because executives and workers are motivated differently than the shareholders. Ostensibly all the workers are trying to increase the value of the company successfully and as such, increase shareholder value. Increasing shareholder value is the stated task of the executives who are planning and running the company.

Often people are more interested in their private gain, security, and well-being than in the firm’s future. These survival concerns can put their goals and motivations in conflict with those of the owners (shareholders).

This conflict of interest is the main reason communism has not been able to operate successful and sustainable businesses: People in power tend to squander all resources for their private gain.

The management who is responsible for the day-to-day operation of the corporation can manage the resources of the company to their advantage. They can do this because there is no effective oversight or scrutiny by the shareholders. How to align these different interest groups and how to properly motivate the workers to achieve the goals of the owners is a vital issue of Management, Strategy, and Corporate Governance.

Corporate Oversight

Ways in which these tensions between owners and executives of corporations are managed and mediated are:

· Voting rights of shareholders: if shareholders are not satisfied with the running of the company, they can vote out directors and vote in ones that more align with their operating ideas. The annual voting documents are called Proxy Statements. The Proxy Statement allows investors to vote remotely. Votes are tabulated at the annual meeting. In most cases, a majority of shares are needed to ratify a vote.

· Transparency in reporting: for publicly traded companies, regulations require corporate executives, directors, and their auditors to provide clear and understandable reporting, in documents like 10Ks, as well as accuracy in accounting. There are also mechanisms and materials designed to hold executives accountable for their actions and to address reducing fraud. The Securities and Exchange Commission (SEC) oversees this corporate reporting. The SEC oversees regulations designed to maintain public trust in the fundamental fairness of the financial markets.

Moral Hazard is a term used to describes a lack of accountability when someone is not held responsible for their actions and the risks that arise from those actions. Reducing and eliminating moral hazard is a fundamental principle of financial and securities regulation. Although removing it is not a practical possibility, the goal is to minimize moral hazard to the level of an unusual occurrence. This effort helps significantly to promote trust in the markets and, in turn, encourages investment money to continue to flow into the stock market and supports the funding of promising enterprises.

Board of Directors

The Board of Directors charts the course of the company through developing and approving the strategy and the budget. The Board usually consists of an odd number of participants, so voting is never tied, and usually consists of outside directors with expertise in various aspects of the business like law, marketing, management, finance and accounting; and directors that are also top executives like the CEO and CFO.

This concept of multiple people with different points of view, experience, and expertise, is called governance by plurality.

The Chairperson leads the Board of Directors. The Chair sets the agenda and runs the meetings. Board meetings discuss issues at hand and to vote on them, thus in effect setting the course of the company.

Board minutes document and record the content of the meetings. The minutes are prepared and archived by the Corporate Secretary. An archive of the minutes is in the board book along with the Articles of Incorporation and the Bylaws.

Executives

The Executives execute the strategy and budget approved by the Directors. The top executive is the CEO Chief Executive Officer; sometimes, this role is called the President. Other “C” level executives include:

· CFO Chief Financial Officer, who oversees the accounting, financing, budgeting, and reporting.

· COO Chief Operating Officer, who oversees the operations, supply chains, factories, equipment, and personnel.

As the digital age has progressed and evolved, two more C level roles have become crucial:

· CTO Chief Technology Officer

· CIO Chief Information Officer

There has been a proliferation of “C” level executive titles in recent years as part of the evolving organizational design and structure of complex enterprises.

Corporate Governance

The charter documents of the corporation, the Articles of Incorporation, and the Bylaws document corporate governance practices. These documents detail how decisions are made that affect the enterprise, such as:

· Election and Term of Directors (usually three years and staggered),

· Voting rights of Shareholders (the owners),

· The scope of power of the CEO,

· How to inform shareholders of news that materially affects the corporation, and

· Scheduling and notification of the Annual Meeting.

At the Annual Meeting, executives and the Board inform the shareholders of the year’s progress and performance. The Proxy Statement documents the vote items and the vote tally.

Delaware as Corporate Headquarters

In U.S. corporate law, C corporations are the most flexible and common form of an organizational structure. Delaware is the state where most companies incorporate in the U.S. Delaware has become the de facto standard location for corporate residency in the U.S. Delaware has developed a legal system especially honed to deal with corporate law and disputes.

From a capital formation or capital raise standpoint, it is a good idea to incorporate in Delaware because venture capitalists and investors are familiar with the laws and structure. This familiarity can eliminate a stumbling block in due diligence proceedings related to raising capital and investing.

Nevada has mirrored Delaware’s laws and offers more reasonable pricing to incorporate to lure corporate business and headquarters.

The Role of Corporate Structure

The benefits of the corporate structure began to become apparent as the Industrial Revolution evolved, expanded, and created the need and the opportunity for large enterprises to undertake large-scale business activities.

Corporations provided the organizational structure to grow and manage large-scale operations in a perpetual manner that transcended a single dominant, charismatic, entrepreneurial personality like a Carnegie, Rockefeller, or Edison.

Corporations also evolved into the perfect vehicle and match for stock and bond markets for capital formation, raising, and investment. They developed simultaneously to meet the needs of each other.

The corporate structure allowed capitalism and the capital markets to infinitely scale. Capital markets provide the vehicle to aggregate money and channel it in promising projects represented by corporations. This symbiosis drove the economic development of capitalist countries, especially in the United States.

The concept of Limited Liability and the corporate veil were major contributing catalysts that helped it all fall into place. Regulations to capital markets, like the stock market reporting requirements, allowed investors to review the results and allocate and re-allocate funds based on corporate performance.

The heroic entrepreneurs of early capitalism eventually were replaced by a new group of bureaucratic, professional managers as companies grew in scale and matured over time. The MBA curriculum was created in the early twentieth century to train competent managers for this new and developing professional field.

Evolving Role

The business world has changed dramatically in the past thirty years with the astonishingly rapid development of technologies, including computers, communications networks, and mobile devices. Companies have been able to develop without the need for significant start-up capital.

In today’s economy, ideas can be developed, tested, and refined on tiny budgets. Barriers to starting and scaling an enterprise no longer exist.

A product or service can be developed on a laptop and launched via an App or website and downloaded as many times as there is a customer’s appetite without concerns for manufacturing or inventory.

No longer is significant capital an initial requirement to roll out a world-changing idea. Marketing and awareness campaigns can be run on-line via targeted pay-per-click PPC advertisements. Projects, products, and services can go viral, creating vast awareness on social media.

The interest generated can be converted to sales through credit card or PayPal account charging. This type of model requires little infrastructure other than what is publicly and freely available, and supply can scale rapidly to meet any level of demand.

A consequence of this structural shift is a resurgence of high profile entrepreneurs that are leading new enterprises with vision and charisma. Launching companies by converting ideas into products and services, rely more on heroic leadership than operational efficiency. There is less initial reliance on the stewardship of professional managers, sometimes referred to as “adult supervision.”

However, at some point in the life of every growing company, the skills of managers are needed. Many cutting-edge entrepreneurs are adept at continuing to lead their enterprises past the initial ideation stage and have proven to be excellent managers. Others have thought more like owners than employees and stepped aside at the appropriate transition time to let capable others work to increase the value of their equity stakes.

Through this recent transformation of the role of management, corporations continue to be the most viable form of legal and organizational structure. The significant benefits of corporations are a limited liability to protect founders and investors against failure and risk aversion, and a flexible stock structure that provides equity and stock options to investors, key employees, and founders.

The early-stage barriers concerning capital for starting a company are gone. But after attaining product/market fit, and a sustainable business model, money is still obviously strategically crucial to scale up production and support marketing and sales. The corporate structure is the vehicle for seeking and attaining venture capital investment and other funding sources.

Summary

The corporation form is one of the most revolutionary and productive forces that capitalism ever created. It is difficult to overstate its impact. As we have seen, it needs some tweaking to address important issues.

Some of the important benefits are:

Liability protection

Separation of management and ownership

Ability to raise capital from multiple investors

Operate in perpetuity

Governance by plurality

In the coming decade corporate structure will evolve how humans organize their efforts, protect owners, and spread the benefits to wider stakeholders.

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