© 2014 Shmoop University, Inc. All rights reserved.
 

Just the Facts

What are the most common ways of organizing a business?

One is a sole proprietorship which one individual, the sole proprietor, exercises complete control over the business. Another is a partnership in which two or more individuals combine their efforts and share the profits of the business. Under both business forms, the business is an asset owned by the owner or owner, it has no existence separate from them, and any financial or legal problems encountered by the business are their responsibility. All of the owners’ assets, even those not involved in the business, are at risk. Liability is unlimited.

What is a corporation?

A corporation is type of business organization in which the business is legally separated from its owners. As distinct legal entities, corporations can buy and sell property, enter into contracts, sue, and be sued just like a person.

How does a sole proprietorship or a partnership become a corporation?

They obtain a charter, most commonly from a state government. A charter is like a birth certificate introducing the existence of a new legal entity.

Does that mean corporations are not defined by their size?

Exactly. America’s largest businesses are corporations. They are assisted by the legal and financial benefits of incorporating. But many individuals form corporations as well and remain the sole owners of their corporations.

What are the financial and legal benefits of incorporating?

Financially, corporations benefits from being allowed to raise capital by selling stock. In purchasing stock, stockholders become partial owners of the corporation and are entitled to a share of the profits. Corporations can also raise money by selling bonds like a government. Legally, corporations benefit from limited liability. Since the corporation is a legal entity separate from its owners, the owners’ personal assets are not placed at risk by any action taken by the corporation. Should the corporation be sued or have financial problems, only corporate assets can be seized.

Are there any disadvantages?

Yes. Through what is commonly labeled “double taxation,” corporate profits are taxed and then, if distributed in the form of dividends, these same profits are taxed again along with the rest of the shareholder’s income.

What exactly is a dividend?

A dividend is a quarterly distribution of corporate profits to company shareholders.

Do corporations always pay dividends?

No. The board of directors (the governing body of the corporation) determines how profits should be spent. They may decide to re-invest all of the profits into the business.

Who selects the board of directors?

They are elected by the shareholders. Most shares of stock convey a voting interest in the company. Stockholders have one vote for every share they own.

Why would anyone buy stock in a company that did not pay dividends?

Many investors are more interested in the long-term appreciation of their stock than the short-term income derived through dividends. They purchase stock in the hope that its value will increase overtime and they can sell the stock for a profit.

What if I was primarily interested in the dividend?

Then make sure to buy a stock that pays one!  One thing to keep in mind about dividends:  they're effectively taxed twice, once at the corporate level and then again as individual income to the investor.

Where do I buy stock?

You can buy stocks through a full-service broker, a discount broker, or an online broker.  The more service you want from your broker, the more you'll pay in fees, of course.   But if that helps you make a better investment, it may be worth it.

Are there ways to reduce the risks in buying stock?

Yes. You can place standing orders with your broker to buy or sell a stock when it reaches a certain price. These are called stop orders. You can also purchase options allowing you to buy or sell a stock when at some date in the near future at its current price.

What should investors do if stock prices are falling across the board?

Some investors make money by selling short. In a short sale, the usual sequence of a stock transaction is reversed. An investor borrows stock from his broker and sells it while its price is relatively high, then waits for the price to drop before buying the stock and returning it to his broker.

Advertisement
Advertisement
Advertisement
back to top