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Current time:0:00Total duration:9:58

Corporations and limited liability

Video transcript

we've all come in contact with corporations you might work for 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 could debate whether a corporation can when I say act I mean legally so a corporation can sue another corporation or a 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 oh 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 may be that'll be 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 in the first reason and this is the real of the biggest one is limited liability it 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's limited liability and there's also kind of transferable 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 a 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 his bill let's say it's bills 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 that he has a car maybe he has a very nice car let's say he has a car that is worth 100 that's too much for a car that's very well cars can cost that much but let's be 50 thousands of dollars it's 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 you would imagine you could you 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 twenty or thirty thousand dollars and it comes up close to six figures but let's say that it costs him eighty thousand dollars 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's he realized 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 hundred thousand dollar policy he says you know how can I you know there's he's maybe a little bit optimistic and he thinks that no one can sue him for more than a hundred thousand dollars so it is $100,000 it is a hundred thousand dollar 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 the right here here's the soccer the soccer player right over whose career is ruined or if that you're watching this outside of the the United States a football player but anyway you have this soccer player his crush his his his his his foot is crushed and so he sues bill he's because bill owns owns the cab and the court so he sues let me write it he sues bill sues bill for 1 million dollars 1 million dollars because it ruined his career in fact that's probably probably deserves more than that if he was a world-class player and the court you know rightfully says look you crush this guy's player you you were you were kind of this guy's foot you were kind of negligent you got a little bit too close to the curb and his foot was crushed so it rules in the soccer players favor and so essentially now Bill's on the line for the entire million dollars so Bill's going to have to sell his house he's going to have to sell his car well actually wouldn't have to sell his car because he has investments ellas investments and give his house or the the proceeds from his house and investment to the soccer player and so now all bills left with is a car and a cab and not much else so what did this this this cab business didn't work out too well for bills this from all part of his portfolio he didn't have even 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 it's create a separate corporation called called bills Bill's car service car service Inc and transferred enough money so that the cabs a licenses and insurance could be owned by this legal entity by this corporation so here you would have the cab's cab plus the license so he would have transferred eighty thousand dollars 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 hundred thousand dollars of insurance maybe this is what people think is a reasonable amount for anyone who's running a cab business you have to have at least a hundred thousand 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 a hundred thousand dollars of liability insurance now let's play out the same situation the cab still rolls over the soccer players foot the soccer players foot gets crushed can't play soccer anymore sues whoever owned that cab four million dollars but now the owner of that cab is no longer bill it's the bills car service so he Sue's this sues Bill's car service and let me make it clear in this reality bills assets would include the cab the licenses and the insurance anymore it would now include 100% ownership ownership of car service of bills car service so the asset is now the shares 100% ownership in this but this is a separate legal entity so now the soccer player sues the cab service for a million dollars the court rightfully says hey yeah you owe this do two million dollars you ruined his career but unfortunate for the player and I guess fortunate for Bill and I don't want to take sides here this is just how reality set up and this is what limited liability is is that now all 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 is going to be able to do is give the guy one hundred and eighty thousand dollars and then the corporation 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 eighty one thousand dollars had insurance policy and all this other stuff it's now worth zero the corporation's worth zero 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 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 bills liability was limited this was limited liability the most he could lose as long as he ran the car service properly and put had enough insurance and it had enough money in 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 and if this organization you know hit somebody or rolled over their foot it did and he 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