I have a 2-year-old daughter, her name is Zarie. At this stage, she’s fascinated with blocks. The fun thing is that I love watching her play too. She stacks them together, then when it’s high enough, she pushes everything to the ground with gleeful abandon.
What she likes about the entire thing though, is the fact that the can pick any block, attach it to any other block, and create something new. This is creation at its simplest.
You can do the same with Companies
Corporations function the same way as these blocks. Imagine the whole business being made of parts clumped together by a master builder. These blocks are what we call “Shares”.
These blocks can be owned by certain people, or they can be unowned. They’re just there as part of the big structure. The blocks who have owners are called “subscribed shares”, while the owners of these blocks are appropriately called “shareholders”
Call for Reservations for future Shareholders
They are called that way because that’s how you initiate owning shares in the corporate world. You call the master builder and say, “Hey, I want to be part of this creation. I want to put my name on a certain number of blocks and subscribe to them.”
Now, if you subscribe to these blocks, think of that like putting “reserved” signs on products on display in the store. I do this all the time with books at the bookstore. Once I call and ask to reserve an item, they take it off the shelf and keep it close to the cashier where no other customer can get to them.
They do this until a pre-determined number of days, and if I don’t claim them, they place them back on the shelves and offer them for sale to the next customer who’s interested. If I really push thru with the reservation, then I am obligated to pay for them.
This turns the shares into “subscribed and fully paid” shares. I now own these blocks and I’m officially part of the building project.
Blocks make Corporations versatile
Once these blocks are together, they perform a specific function such as manufacture products or provide services for other people. They also provide Corporations with a degree of flexibility unavailable to other types of business entities such as Partnerships and Single Proprietorships.
How much do you control?
Imagine that my daughter Zarie made a wall of bricks in front of you, and all the blue blocks were yours. Would you agree that it’s easy to name, down to the specific percentage, how much of the block sculpture you own? You can say with confidence, “I own 51% of the whole thing!”
That’s the wonderful thing about corporations. No matter how many people participate in the project, you can easily identify how much your participation is.
Undetermined ownership
However, I want to point something out. When you deal with shares in a corporation, we deal with inchoate or undetermined interests in the business venture. Let’s get a little bit technical for a moment.
When you say you own 20% interest in a company, you are referring to the entire company or the entire operation as a whole. That does not mean that you own particular portions of the company.
You can’t go around saying, “Hey, I own 20% of this building, 20% of this table, 20% of that stack of bond paper!” Under the law, you own 20% of the idea of the corporation. Think of the spirit which animates or keeps the company alive. You compose 20% of that, not the specific tangible items you see.
The only time we refer to 20% of tangibles is if the company goes out of business and it is time to liquidate the assets. In that case, the law says that all the tangible assets would be bunched together and distributed to the owners.
Only then would you be able to say, “This chair is mine, this building is mine, this ream of bond paper is mine…”. Otherwise, while the company is operating, you own 20% of the essence of the company.
You can transfer easily
Since the portions of the company are easily defined, it is very easy to treat your interest in the company as items. As items, these blocks can be sold, transferred, mortgaged or donated just like other types of property. If you think about it, this is so cool because you get to distribute the influence or control you hold over a business.
Here’s some legal trivia for you: if the company was just born or created, and you are the first owners of the shares, the law calls you “Incorporators” or people who were there when the company was incorporated. If you bought shares after the incorporation, then you just get called “shareholder”. Not as dramatic, in my opinion (lol!).
Companies raise money by selling itself
Now that you understand that shares are specific, and you can easily transfer them, you’re ready to understand the best advantage of all from companies being made of blocks. That, ladies and gentlemen, is to raise capital.
Imagine this for a moment. You’re in a new business and you need money to rent a warehouse, buy equipment or pay the salaries of your employees. What are your options?
- First, you can put up your own money. In which case, you’ll be lending money to the company and the company has to pay you at some point.
- Next, you can borrow money from other people. Same rules. You would have to pay them back.
- Third, you can sell some stuff. And the money which comes in as a result of the sale is what you use for the new expenses.
Or, why don’t you invite some people to be part owners of the company? With the money they pay to be part of the team, you use that as operating capital. That is the essence of selling shares to people. The company is selling portions of itself so it can fund its own operations.
In return for selling parts of itself, the company allows these people (now called “stockholders”) to participate in decision making and to a share of the profits of the company. In an ideal world that’s a win-win. The company gets cash flow while the people who believed in the company get to benefit from its success.
Hope this was able to shed some light on how companies are considered to be made up of blocks of ownership by the law. Hopefully, you also got a glimpse of how to turn that to your advantage. In the next post, we will tackle the next advantage: replication.
