Companies are essentially organisations owned by their shareholders. The business and its owners are separate legal entities and there is a separation of control and ownership with the owners appointing managers to run the business on their behalf.
Incorporated firms are legal bodies in their own right. Companies may be known as joint-stock companies or corporations in North America.
Be careful not to confuse public limited companies or corporations which are in the private sector and owned by private individuals with Public Corporations which are owned by the government.
Companies have legal continuity as they continue to exist even if the owners change (i.e. shares are sold on stock markets). Shares are just a slice of the business and signify what proportion, in monetary value, of the business is owned by each individual shareholder. In some countries, shares are called stocks. However, in other countries stocks and shares have different meanings.
Firms pay corporation tax. This is usually a flat rate, and stays the same proportionately, even if profits increase.
The owners of the companies have limited liability; they are only responsible for their investment in the firm through their share capital. The maximum they can lose, on a liquidation, therefore, is the value of their shareholding - personal assets cannot be seized to pay for the debts of the business. This can be a major advantage over being the owner of an unincorporated firm. The owners of the business are its shareholders.
There are two types of company:
Private limited company (Ltd)
- Most companies start as private limited companies. They can be set up quickly and cheaply, and firms of lawyers are set up which specialise in this. Many private limited companies are family businesses as there is less risk of a takeover. Shareholders in private companies can put restrictions on the sale of shares.
- To become a limited company, its owners have to prepare legal documents, including the Memorandum and Articles of association and be registered with the national government. The Articles lay out the internal rules of the business, such as the calling of meetings, the types of shares and the power of the directors. The Memorandum details any relationship between the business and its external environment. It shows the objectives of the business, the address of its head office and its maximum share capital. These documents can sometimes be bought 'off the shelf' by firms that sell 'shell' companies as their product.
- Limited companies have to prepare and publish each year a set of legal accounts, which have to be checked and approved (audited) by independent accountants. These can sometimes be bought 'off the shelf' by firms that sell 'shell' companies as their product.
- The owners also have to prepare and publish each year a set of legal accounts and should send these to the appropriate government organisation each year.
- There has to be at least one director, but other requirements are few. Shares can be sold, privately, but not on the national stock market. There is no minimum capital requirement, however. Shareholders have limited liability. That means they can only lose their share capital; creditors cannot claim any other assets. Private companies are hard to take over without the agreement of the existing shareholders. Equally, they may be hard to sell.
- Many private limited companies are family businesses as there is less risk of a takeover. With private companies, any owner wishing to sell their shares must offer them to existing shareholders first. This protects the original owners from losing their control of the business.
Public limited company (plc)
These are the public companies whose shares are traded on national and international stock exchanges.
A flotation or an initial public offering (IPO) occurs when a private limited company issues shares to the public for the first time seeking capital to expand. The company becomes a public limited company and is listed one, or several, stock exchanges.
With a public limited company qualifying shares are sold on the Stock Exchange to the general public. Anybody can buy them, and if a shareholder buys 50% of the shares plus one more, they can control the business by outvoting all the other owners and appointing their own representatives as Directors. This is because shareholders receive one vote for every share they hold. In practice, not all shareholders vote when they have the opportunity (often only 2 - 3% bother!), so practical control can be achieved with fewer than 50% of shares.
A considerable amount of finance is usually required to become a plc as the company must usually have a minimum share capital which is more than many entrepreneurs can afford. There may also be many other requirements such as:
- A minimum number of directors.
- A fully qualified Company Secretary (the chief administrative officer responsible for all legal affairs).
- Legal accounts prepared each year and sent to the appropriate national government organisation.
A plc can be taken over without the agreement of the present Directors. If the firm is performing well shares will sell easily - in fact they will be in high demand.
The law sets out a series of requirements governing the formation and operation of companies, which are shown below:
The legal differences between private and public limited companies
Private Limited Company
Public Limited Company
|Memorandum of Association||Must state that the company is a public company|
|Name||Must end with the word 'Limited' or the letters 'Ltd'||Must end with plc, or the words in full|
|Minimum Authorised Capital||None||Varies according to local law, but usually a set limit|
|Retirement of Directors||No age set, unless the firm is a subsidiary of a plc, when they must retire at 70||Must retire at 70|
|Issue of shares to the public||No advertising to the public. Sale by private agreement only||May do so on the Stock Exchange, by means of a Prospectus.|
|Company Secretary||Anybody||Must be professionally qualified as a Company Secretary|
|Accounts||Small and medium size companies may submit shortened accounts||Must file full accounts and Directors reports with national government.|
|Meetings||Proxy (a representative of the shareholder) may address the meeting||A proxy cannot speak at a public meeting.|
Some of these requirements may differ in detail between countries, but this gives a useful guide as to the basis of incorporation of firms.
In incorporated companies, plc's or limited companies, the decision makers (the Executive Directors) are often not the owners; it is the shareholders who are. This separation (often called 'divorce') between ownership and control can cause major problems, as has been seen with firms like Enron and WorldCom, where Directors do not always act in the interest of the shareholders.
Typically a new business will start as a sole trader, and then become a private limited company as soon as possible. It will then 'go public' (float shares), when it thinks it is appropriate.
It is possible to set up as a private limited company quite easily and cheaply these days as shell companies are available to buy, i.e. companies where all the legal requirements have been completed, but the purpose is left very general. A good advisor can select the right one providing instant limited liability.
Advantages of companies:
- Companies have access to large amounts of capital by selling shares, although private limited companies cannot advertise their shares for sale publicly, which limits the capital available
- Money raised by selling shares is permanent capital and never has to be repaid, unless the business is liquidated. Unlike loans which require interest to be paid, companies pay a dividend to shareholders, but the amount is decided by the company itself and may not be paid at all when profits are low or losses made.
- Companies benefit from legal continuity
- Directors are often shareholders which provides an incentive to improve performance to maximise dividends
- As companies tend to be larger than sole traders and partnerships, they enjoy economies of scale which should result in lower costs and therefore lower prices and/or higher profit margins
- Companies have many managers and employees who can be specialists improving the efficiency and performance of the business
- Larger organisations are likely to have better customer recognition and may be more trusted by the public who know more about them.
Disadvantages of companies:
- Lack of confidentiality and privacy since companies must produce audited accounts, which are available to the public. Private limited companies can restrict access to these accounts more easily than Plcs who must produce annual reports containing their final accounts
- Large firms may be less agile and flexible as diseconomies of scale set in
- Large firms may provide a more standardised and less personal service
- The costs of setting up a company can be high, because of the legal requirements involved
- The original owners may lose control of their own businesses, especially in the case of Plcs where sales by any shareholder are unrestricted