People who own and operate small business like to incorporate. The common perception is that by incorporating they will protect their homes and other assets from creditors if their small business fails. Is their perception correct? A good answer to that question requires some background. Let’s start with where corporations came from as company history and why. In Part Two, we’ll look at the steps necessary to create a corporation and the logic of its structure. In Part Three, we’ll return to our starting point and talk about what a corporation does and doesn’t do to protect its owner’s other assets.
Centuries ago corporations didn't exist. There were only two ways to conduct business. One was what we now call a sole proprietorship. The other was a partnership.
A sole proprietorship is just what you would expect it to be from the name - one person owns the small business. All the assets of the business belong to that one person, that person is the only person liable for the debts of the business, and that person is liable for all of them.
A partnership is the next step up, but not by much. People put their money together and own the business as partners, each with a pro rata share of the assets. However, like a sole proprietor each partner still has unlimited liability for the partnership’s debts.
You need money to start a business. If you didn’t have much money you couldn’t start much of a business as a sole proprietor. If two or more people pooled their money as partners, they could aim higher. On the other hand, each of them could still lose everything if the business failed. This unpleasant prospect made it difficult to amass enough money for a major venture, which is one reason why Columbus had to go to King Ferdinand and Queen Isabella to fund the discovery of America.
A monopoly was one of the expedients devised to ameliorate the problem. The crown could grant one, and that inducement lowered the risk of loss. Avoiding debt and spreading the risk of loss over a large number of partners also helped, as well as the idea of putting only some of them in charge. The result was a company, a mega-partnership with a royal charter, directors, and a trade, development, or manufacturing monopoly. The phenomenally profitable British East India Company, chartered in 1600 by Queen Elizabeth, is perhaps the best known example. Unlimited liability was tamed, but not eliminated.
You can be forgiven if you don’t know that the elimination of limited liability for companies was still a long time coming. In fact it did not appear until the British Parliament, with many misgivings, passed the Companies Act of 1844. Shareholders in a special kind of company, a corporation, could at last invest their money with no risk of losing any more than they invested.
As you might expect if you are old enough to have taken Latin, the word corporation comes from the Latin corporatis, the past participle of the Latin verb corporare, to make into a body, which comes in turn from the Latin noun for body, corpus. But you couldn’t see or touch a corporation, so this body is described legally as a fictitious entity, as opposed to a natural person.
Every body needs a head, so corporate promoters and directors are called capitalists, and the money paid by the shareholders for their stock capital, nouns ultimately derived from the Latin word for head, caput. The word capitalism entered the English language only in 1854.
It may also surprise you that corporate charters were only sparingly granted by state legislatures until the beginning of the twentieth century, when articles of incorporation began to be issued by secretaries of state’s offices merely for the asking and a small fee. The limited liability corporation is credited by many with our modem prosperity.
San Diego Business Attorney Stanley D. Prowse specializes in California Corporate Law. We are located in Carlsbad California and welcome your legal inquiries.