WHAT IS A STOCK AND WHAT IS A COMPANY?

It’s hard to answer this question without addressing the issue of “what is a company?” first.  So, let’s start there.

Let’s say you had a great idea and decided to try and profit from it.  You could set up a separate activity, a company, let's say, to do just that.  The company would be formed with a goal in mind, an objective of some type, with the obvious intent of trying to make a profit for the owner.  Well, there are three basic ways that one can establish a company: (i) continue to be or form a sole proprietorship, (ii) create a partnership or (iii) establish a corporation.  The latter two exist to raise capital?funds to exploit your idea so you and your investors can profit?there's an additional valid reason to form a corporation.

Sole Proprietorship

In a sole proprietorship, an individual owns the company: the individual is the company.  That person often works in the company.  Profits from the company become income for the owner—increasing his or her tax burden.  A sole proprietorship is a popular form for a business; however, there are liability issues that force individuals to set up a different type of company.  If problems occur, say legal problems, the sole proprietor holds all the liability.  The person is the company: they're the same entity.

Partnership

A partnership is similar in many respects to a sole proprietorship.  A person might start a partnership if she didn’t have enough money to finance the business herself—she could get partners to help fund the business.  Another reason might be that other people have particular expertise that is important to the success of the business.  A partnership is when two or more people have an ownership interest in a company.  An agreement is created that determines the form of the partnership and the degree to which each partner owns the entity.  Profits and losses then pass to the partners in proportion to the ownership interest of each in the partnership.  A disadvantage of a partnership is that the partners share liability.  Let’s say that the partnership is granted a line of credit from a bank.  If one of the partners borrows against the line of credit and absconds with the money, the remaining partners are liable for that debt!

Today, many states have a hybrid entity between a partnership and a corporation−to be discussed next.  An LLP or Limited Liability Partnership is still a partnership, but it is also a legal construct, registered with the state, that serves to limit the personal liability of the partners.  Usually, the liability is limited to the capital that they invest in the partnership.  You'll often see the letters LLP after a firm of lawyers or accountants.

Corporation

Finally, a corporation is a legal fiction—it’s like creating a new person except this “person” can’t vote; can’t drive a car; can’t be a space shuttle astronaut—well, you get the picture.  However, a corporation does pay taxes, can employ people, enter into contracts, can own property and can even own other corporations.  A corporation is owned by its shareholders and this issue will be discussed in a moment.  To some extent, you can view a corporation as similar to a partnership except it’s a slightly different legal construct.  For one thing, the owners of a corporation don't have to be involved in the day-to-day business of the company; partners are generally active in their firm.

One great thing about a corporation is the issue of liability.  The owner or owners of a corporation, the shareholder, aren't liable if the corporation does something that might create financial or other problems for the business.  Now, there are some exceptions, but these exceptions don't impact shareholders in a public company.  This liability issue is an important reason why many businesses are structured as corporations.  The corporation gets sued for the actions of the company, not the owners or even the employees of that business. 

As an aside, there is a nice concept called "piercing the corporate veil," whereby employees, directors and even shareholders could be liable for the actions of the corporation.  This situation occurs when someone acts negligently or where, perhaps, fraud is involved, but it is generally difficult to pierce the corporate veil.  It's not something with which shareholders of a publicly traded companies should concern themselves.

A corporation can be created in any state.  A charter is usually written, kind of like a constitution for the company, that defines what the corporation is, what it does, and who the owners are.  The charter defines how the ownership of the corporation will be designated.  Shares in the corporation are created and these are divided up among the owners of the corporation.  This process is described next.

The people who invest money (capital) in the corporation in return for an ownership interest are stockholders.  They own part of the capital stock of the company.  This ownership interest is defined in a document called a stock certificate.  This document describes what portion of the company is owned by the person (or entity) named on that certificate.  Nowadays, for public companies, this designation is handled electronically.   The corporate charter states how the company will be divvied up!  It stipulates the number of shares of ownership in the capital stock.  For example, if the charter stipulates that the corporation will have one hundred shares and that each of a hundred people received one of these shares in return for their investment, then each person owns one percent of the corporation.  The shares of ownership in the capital stock of the corporation are held by the various owners in proportion to the amount they invested.  To summarize, investments made into the corporation by people or entities (other corporations for example) are represented by shares (shares of ownership); these shares in total are called “Capital Stock” of the corporation.

If a company "goes public," then these shares are sold to the public through a market or exchange like the NASDAQ or the NYSE.  Shares are then traded back and forth between or among people who usually have nothing to do with the company: these people are the owners of the company and the company keeps a record of who they are.  These owners are invited to vote on important matters, to attend the annual meeting of the company and to elect the board of directors for the corporation (the company).  When you own shares, you own part of a company, a corporation.  If the board of directors elects to share some of the corporate profit with shareholders, the company may pay a dividend.  These funds are transferred to the owners of the company, the shareholders of record.  The board also may also decide to pay a stock dividend−a stock split.

A corporation, partnership of sole proprietorship are ways to structure your business−your company.  There are millions of corporations in the US, only a small percentage of them are traded as public companies.  Shareholders are owners of the company.  They vote on critical issues, the most important of which is, arguably, electing a board of directors.

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