We've all come in contact with corporations.
You might work for a corporation.
You might buy something from a corporation.
You might, I don't know, you might own
shares in a corporation.
So we kind of have a sense of what they are,
but I want to make that sense a little bit more precise
in this video and also give an understanding of
why corporations even exist.
And so a corporation, and you might already kind of
have a feeling for this, it's a legal entity.
It's a legal entity that can kind of act ... that can act,
that can act like a person ... like a person,
I put the act in quotes because obviously there's
some things that a person can do that a corporation can't.
A person can smile.
I guess one can debate whether a corporation can.
When I say act, I mean legally.
So a corporation can sue another corporation or person.
A corporation can be sued
by another corporation or a person.
A corporation can own things, just like a person owns things.
A corporation can owe other people or corporations
things, so that's what I mean by "act".
A corporation can't jump like a person or laugh like a person.
Well, that ... maybe that'll be a
a philosophical discussion for another video.
But what I want to focus on, other than just what a
corporation is, is why they exist.
So what's the "why" of a corporation?
And in my mind, there's two big reasons
and the first reason and this is the real biggest one
is limited liability.
Sounds like a very fancy word,
but we'll see it with an example,
it's not too ... it's not too fancy.
So there is limited liability and there's also kind of
transferrable share ownership.
Share ownership.
But what I want to do in this, which is you know
essentially more than one person can own the corporation,
they can transfer the shares between people,
they can trade them.
But what I want to focus on is the limited liability
because even if there's only one person
who owns the corporation, if they own the whole thing.
It still makes sense for them to create it
because of limited liability.
And to understand this, let me give you a little example.
Let's say that ... Let's, let's say that there's some guy.
Let's say he's Bill.
Let's say it's Bill's ,,, Bill's assets right over here
and let's say that he has a house.
Let's say that he has a house that is worth $500,000.
Let's say he has a car, maybe he has a very nice car.
Let's say he has a car that is worth 100 ...
No, that's too much for a car.
That's very ... Well, cars can cost that much
but let's be ... that's ... $50,000 is still a nice car.
Let's say that he has some investments,
some investment properties or maybe some stocks
that are worth another ... another $500,000
and let's say that he's interested, you know,
he looks around his town, he sees that there's a lot of
people who could use a ride.
So to make some extra money,
he wants to start a cab or car service business.
So he goes out there and he doesn't think
about starting a corporation and he just goes out there
and he buys a car, let me call a cab, plus licenses.
A cab plus licenses.
And these things are actually much more expensive
than what you would imagine.
You could ... could talk to a, the next time you're in a cab,
it costs much more than the cost of the car,
which would probably be $20,000 or $30,000.
It comes up close to six figures,
but let's say that it costs him $80,000.
And let's say that he spends $1,000,
at least for this first year.
Let's say he spends $1,000 on insurance,
on liability insurance. He realizes,
"Hey look, maybe you know,
"maybe something bad happens."
"This is a cab I could run into somebody"
"and I get sued. So, I want to get liability insurance."
So this is liability insurance,
in case anything like that happens
and let's say that it is a ... Let's say that it is a $100,000
policy. He says, "You know, how can I ...",
you know, he ... he's maybe a little bit optimistic
and he thinks that no one can sue him
for more than $100,000.
So it's a $100,000 ... It is a $100,000 policy.
Now, he goes out there. He starts driving that cab around,
picking up people, dropping them off
and by accident one day, he rolls over someone's foot
and that person whose foot he just crushed
happened to be a ... you know, a world-class soccer player.
So he ruined this person's career.
He ruined the career. So right here, here's the soccer ...
the soccer player right over here,
whose career is ruined or if you're watching this
outside of the United States, a futbol player.
But anyway, you have this soccer player.
His crushed ... His foot is crushed.
And so he sues Bill because Bill owns the cab.
And the court ... so he sues. Let me write it.
He sues Bill ... sues Bill for $1,000,000.
$1,000,000 because it ruined his career.
In fact, that's probably ... probably deservers more than that
if he was a world-class player.
And the court, you know, rightfully says,
"Look, you crushed this guy's player."
"You ... you ... you were kind of ... this guy's foot,"
"you were kind of negligent."
"You got a little bit too close to the curb."
"His foot was crushed."
So it rules in the soccer player's favor.
And so essentially, now Bill's on the line
for the entire $1,000,000.
So Bill is going to have to sell his house.
He's going to have to see his car.
Well, he wouldn't have to sell his car because
he has investments, sell his investments
and give his house or the proceeds from his house
and investment to the soccer player.
And so now all Bill is left with is a car and a cab
and not much else, so what did this ... this cab business
didn't work out too well for Bill.
It's a small part of his portfolio.
He didn't even have a chance to make much money from it
and it really just wiped him clean.
Now, what Bill should have done is create a separate
corporation, is create a separate corporation
called ... called Bill's ... Bill's Car Service ... Car Service, Inc.
and transferred enough money so that the cab,
the licenseses and the insurance could be owned
by this legal entity, by this corporation.
So here you would have the cabs ... cab + the license.
So he would have transferred $80,000
to the corporation and the corporation would have bought it
in the corporation's name.
Remember, it can act like a person.
It can buy things in its name.
The owner of this cab is Bill's Car Service not Bill.
It could also get the insurance, the $100,000 of insurance,
maybe this is what people think is a reasonable amount
for anyone who is running a cab business.
You have to have at least $100,000.
The reality is probably it's a much larger number than that
and he spends $1,000 to have that policy
and remember, this is $100,000 of liability insurance.
Now, let's play out the same situation.
The cab still rolls over the soccer player's foot.
The soccer player's foot gets crushed,
can't play soccer anymore, sues whoever owned that cab
for a $1,000,000.
But now the owner of that cab is no longer Bill.
It's Bill Car Service.
So he sues this, sues Bill's Car Service
and let me make it clear.
In this reality, Bill's assets wouldn't include the cab,
the licenses and the insurance anymore.
It would now include, 100% ownership ... ownership
of car service, of Bill's Car Service.
So the asset is now the shares, the 100% ownership in this
but this is a separate legal entity.
So now the soccer player sues
the cab service for $1,000,000.
The court rightfully says,
"Hey, yeah you owe this dude $1,000,000."
"You ruined his career.",
but unfortunate for the player and I guess
fortunate for Bill, I don't want to take sides here.
This is just how reality is set up
and this is what limited liability is,
is that now all the car service can produce is ... Well,
they could sell ... They could sell maybe these assets
for $80,000 and they'll get $100,000 ... They'll get
$100,000 from the insurance,
so all this corporation will be able to do is
give the guy $180,000 and then the cooperation
is just going to go bankrupt.
So it's going to declare corporate bankruptcy.
It's going to go bankrupt.
So this thing that Bill owed, this car service
which maybe originally he could write on his books as being
worth $81,000, had insurance policy and all this other stuff.
It's now worth 0.
The corporation's worth 0,
but the soccer player can't go after anything else.
We'll talk about in the future,
of reasons why they can.
If he didn't have enough insurance
or if he didn't ... if he was running this
like his own personal business.
If this car service didn't have its own bank account
or if it didn't ... if it was undercapitalized,
if it didn't have enough money in it,
then maybe the court would let the soccer player or
kind of "pierce the corporate veil" they say,
which is a very fancy way of still going after
the owners of the corporation.
But as long as this corporation was reasonably capitalized,
and I'm just made up these numbers here,
the soccer player will only be able to go after this corporation.
So what you see here is that Bill's liability was limited.
This was limited liability.
The most he could lose
as long as he ran the car service properly
and had enough insurance and had enough money in the
actual organization.
As long as he ran it in the right way,
the most he could lose is the value of the organization.
If this organization, you know, hits somebody
or rolled over their foot,
and ... but he ran the organization properly,
they can;t go over the rest of his assets.
So this is the number one reason
why people have corporations, for the limited liability.