The weird and wonderful world of corporate finance (by alaric)
Ok, so, let me start with this: I'm an engineer. I'm not an accountant or an economist or a hedge fund manager or anything.
However, I have studied those worlds from time to time for various reasons, and I've always kind of enjoyed it because it's a complex world of systems, and there's a lot of engineering behind it. But it's all explained in weird jargon and kind of inaccessible to engineers.
So, this blog post is my attempt to document the aspects of corporate finance I understand, but explained in a way that makes more sense to me, and hopefully to other engineers, or people who think they aren't engineers but are really.
If that sounds interesting to you, buckle up and let's get started!
So, the core concept behind corporate finance is that of the corporation itself. A "business" and a "corporation" are often, but not always, the same thing - there are businesses that aren't corporations, and corporations that aren't businesses.
What is a corporation?
A business is an organised activity to make money. A kid who buys sweets from a sweet shop and resells them in the school playground at a higher price is running a business. On the other hand, if they're buying sweets from the sweet shop and selling them at a loss, or just handing them out, because they have some motive other than profit (eg, to be nice to their friends) is something more like a charity. But neither of them are a corporation.
A corporation, however, is a legal concept, like a contract or a marriage. They arose around the time of the Industrial Revolution, a time of great creativity. People had ideas for a business, but didn't have the money to build the massive factories and machines and stuff they had invented. While there were folks who had money, but didn't have the new technical skills to do something exciting with that money.
The rich investors could just give a load of money to the aspiring young engineer with an amazing vision to create a railway system, in exchange for some kind of promise to let them have a share of the profits back, but this had a lot of complicated edge cases: What if they needed more money later, and other investors entered the deal; how would that alter the sharing of profits? What if the engineer died, or got sick, or just wanted to do something else, and somebody else had to take over? Some better way of managing these arrangements was needed.
So, the corporation (as we know it today - a predecessor existed, but it was something different) came to be.
A corporation is a "legal person"; it has some of the rights of a human being, like being able to own things or enter into contracts (or commit crimes). But as it exists purely as an entry in a database somewhere (in the UK, this database is maintained by a group called Companies House), and has no will of its own, it relies on having people who are appointed to act on its behalf: the directors. That Companies House database, for each company, lists the directors of the company, who are authorised to sign stuff on behalf of the company.
(As an aside: A corporation is a kind of company. There are a few other kinds, such as partnerships and so on. We're just talking about corporations here - which are often called "Limited Liability Companies" in the UK, and have names ending in "Limited" or "Ltd" or "PLC", but will often use the word "company" to refer to corporations, as that's common practice in the UK).
The exact authorisation the directors have is described in a document associated with the corporation, which under UK law is the "Memorandum and Articles of Association" (technically two documents, but whatever) or "M&A", that defines the rules of operation of the company, including how the directors get chosen. But a lot of the day to day practicalities aren't covered in the M&A; for instance, if the company opens a bank account, the bank will probably require the application to be signed by all the directors, and specify in the application who is allowed to spend the money: who is allowed to sign cheques, who gets a login to online banking to send bank transfers, who gets a payment card, that sort of thing. Likewise, if a company signs up with a provider of some service such as cloud hosting, they generally need a director to sign the contract on behalf of the company; but then whoever the directors appoint will have the admin logins and actually be able to "do stuff" as the company. So while the power to "control" the company technically all goes to the directors, exactly how many directors are needed to approve a thing, what happens if the directors disagree, and to what extent the directors can delegate that power to others varies and depends on the exact aspect of the company we're talking about.
What's to stop one director going rogue and signing whatever they want on behalf the company? Well, for big stuff like opening a bank account, third parties might demand that all directors sign to avoid such trouble, but many things just require one, and legally a contract signed by one director on behalf of the company binds the company - so that is a risk. You don't just make anyone a director, and you usually have informal or formal rules agreed between the directors about when directors can sign things. And if a director does go rogue... You sack them, if they're an employee (more on that in a moment); you revoke their directorship; maybe you sue them for damages; perhaps their actions violate the laws of your country (eg, fraud) and you involve the police.
Director's obligations
The directors have some legal responsibilities with regards to the company (making sure the company complies with certain laws, such as filing certain paperwork and reports) and can be personally punished if the company fails to meet those responsibilities.
In the UK, a limited company needs to make an annual filing to Companies House confirming the details of the company are still correct, and also file annual accounts explaining (to varying levels of depth, depending on the size of the company) what it owns, what it's spent, what it's earnt, etc; these are part of the public record, and you can go and look them up on the Companies House web site (it's interesting to do this for a company that you're interviewing for, and then ask questions about their finances in the interview... Most interviewers aren't prepared for that!).
They also need to do a tax return each year, to explain in a little more detail about their financial activities, so that the appropriate taxes on profits (more on that later) are justified and paid.
If the company doesn't do this stuff, or various other things that are relevant if the company performs certain optional activities (like employing people), then the appropriate authorities pursue the company and, if they have to, the individual directors, with penalties.
Are directors employees?
A director may or may not be an employee of a company; nothing requires them to be. Sure, you need to give them some reason to want to take on the role of being a director; employing them so you pay them a monthly wage is one way, but you might also give them shares in the company (which I've not explained yet! That's next!) so they profit from the company's success, or they might be a director just because they like the company or something (this is particularly relevant if the company is a non-profit company limited by guarantee, but that's not quite a corporation so I'll stop there).
So, a director may be hired or sacked (as an employee), or appointed or un-appointed as a director, and those are separate but often overlapping things.
Cryptocurrency, Society | alaric | 
Tue 8th Oct 2024 5:25 pm
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