Part 1 of this Primer series talked about the history and limited liability of corporations. This post will dive into the structure of a corporation.
Shares and shareholders
Corporations have owners. For a typical corporation, these are the “shareholders” (sometimes called stockholders).
What are the shares? A company issues pieces of ownership, and each piece is called a “share”. You can think of this like on a pirate ship, where the Captain gets three shares of the treasure, the first mate two shares, and each crewman gets one share. Pirates didn’t make that up, the same idea has been used on trading vessels for thousands of years in Europe. The only difference now is that there is no ship, and there are typically a lot more shares.
How many shares? It doesn’t matter. Some companies issue 10 shares, some issue 10 million shares. Some public companies have issued hundreds of millions of shares.
The owners of the company each own a specific number of shares, and to figure out how much of a company any one owner owns, you have to not only know how many shares they own, but also how many shares in total have been issued.
(You might also need to know how many shares have been allocated, as in startups there can be shares issued but not yet allocated, such as shares to be shared with employees).
The corporate hierarchy
In a typical medium or large corporation, the shareholders and management are not the same people. There is in fact a hierarchy which corporations are expected to follow, which is codified in the specific corporate law where the corporation is incorporated. It typically goes like this:
The shareholders vote on whether to issue new shares, vote whether to sell the company in whole or in part to another investor or acquirer, vote on any changes to the Articles of Incorporation (a.k.a. Constitution) of the company, and vote on the members of the Board of Directors.
The Board of Directors is responsible for overseeing Management. The Board votes on the hiring and firing of the CEO and other corporate officers, as well as the salaries of Management. The Board discusses and votes on any big strategic decisions. The CEO keeps the Board abreast of the financial results of the company, providing quarterly financial reports (if not monthly).
The Board at a young, venture capital funded company will meet monthly for a few years, then every six weeks, then eventually quarterly.
Typically the CEO has a seat on the Board. If there is a co-founder, that person may or may not also have a seat on the Board depending on whether there are outside investors. Investors usually ask for and are granted a seat on the Board.
The CEO and the Management team are responsible for the day-to-day operations of the company. Management of a company with outside investors do not have “carte blanche” do anything they think best. Most often there are restrictions in the Articles of Incorporation, Bylaws, Shareholder Agreement, and/or Stock Purchase Agreement that require agreement by the Board or agreement by the investors on a specific list of decisions. This generally includes raising money, the price per share in raising equity, borrowing money, hiring and firing corporate officers, and any major changes in strategy.
What many first-time entrepreneurs fail to understand is the fact that investors are business partners. They are just as much partners as a co-founder, except when there are disagreements, you either have to work out a compromise or you have to quit your own startup. You can’t just ask the investors to leave and ignoring them will only cause you more and bigger issues.
You can offer to buy out investors if the business partnership doesn’t work, but rarely do young companies have enough money to do that, and even rarer is another investors who wants their money spent buying out an easier investor. Bad relations with investors is a red flag that typically will kill all chances of future funding.
So how do you make your investors happy? It’s simple. First and foremost, keep them informed on the business. Monthly email updates. Quarterly financial reports. Semi-annual detailed updates, if not quarterly. Second and not at all secondmost, remember the corporate hierarchy. Once you have investors, you need to ensure all your corporate paperwork follows the laws, all the corporate filings are accurate, and that big decisions are shared with your shareholders.
If you prefer to make all the decisions yourself, then don’t raise money from outsiders, don’t sell any equity, and don’t take on any debt, as the lenders are typically even more stringent about how they are treated than the equity investors.