Founders run a company right? Or is it the CEO? Or the investors?
How do companies really work?
Here’s a summary of how companies really work…
This article is intended as a lay-persons overview, and I am not legal professional. Company law can be complex and you should always seek professional legal and accounting advice before making decisions about starting, operating or closing your own business.
Creating a Company
Creating a company is very straightforward – all you need to do is register it with companies house. Most companies in the startup space are “Private Limited Companies” – and must include “Ltd” or “Limited” in their name. The “Limited” means that the shareholders can’t be held liable for the companies actions or debts, so investors only stand to lose the money they actually put into a company.
Big companies traded on public stock exchanges are “Public Limited Companies” or PLCs. They are subject to MUCH more complex regulation, and are beyond the scope of this article.
Most companies need money to operate and grow. If the founders can’t supply it they may need to look at getting loans (tough in the current climate) or investment. I’ve written a whole series on investment if that interests you: The Investment Series
Controlling a Company
How a company is controlled depends on a number of factors:
- The Companies Act 2006 sets out the basic framework
- The “Articles of Association” are the “user manual” for the company and define its procedures. This is a matter of public record – it is filed at Companies House and can be downloaded from there for £1. If no articles are specified, the Companies Act provides a “model” set which apply by default.
- Frequently there is also a Shareholders Agreement or Investor Agreement which defines additional rules agreed between shareholders. This is not a matter of public record, but can dramatically change the practical control of a company. For example, investors frequently have the right to “veto” key decisions.
Subject to the rules defined in these documents, a company is controlled by…
- Shareholders, who exercise their power only by nominating/electing a board of directors, and by voting at General Meetings.
- The Board, which can collectively exercise all the rights and powers of the company, and is collectively responsible for all of its actions
- The Board is made up of Directors. A lot of people have “director” in their job title, but only directors registered with companies house (you can download a list free) are on the board.
- Individual directors may have anything from no individual power to the ability to exercise all the powers of the company – their power comes from the articles and delegation by the board so can vary hugely.
- ALL directors share responsibility for the actions of the company legally – regardless of whether they are exec or non-exec, voted in favour, or were even present at the meeting where a decision was made.
- Even after a director resigns, responsibility remains.
- Unlike shareholders who have limited liability for the debts of a company, a director’s liability is unlimited if they fail to act properly, and they can even go to prison for failing to live up to their duties (e.g. for corporate manslaughter or bribery related offences committed by the company)
- Staff have ONLY the powers delegated by the board. In many companies the CEO and CFO have wide-reaching authority, and often there is no written delegation so their powers are implied (e.g. by a job description).
You may notice that Founders don’t appear here. Founders have no specific control of a company. They are likely to be shareholders, but if there are other shareholders such as investors then their power will be diluted. It is also common for a founder to be a Director, or even CEO – even so, they may have the powers delegated by the board, which is appointed by the shareholders. Founders who want to maintain complete control of their business can only do so by avoiding external investors: Investment Part 5: Don’t Do It
Even though the shareholders have the ultimate power, they do not have a means of exercising it on a day-to-day basis. If they don’t like what the board is doing, their sanction is to call an extraordinary general meeting a vote on replacing the board! Owning a majority stake in a company does not guarantee control either – There’s no magic in 51%.
Solvency and Insolvency
At the start I qualified this with “as long as they are solvent”. Solvency means a company can pay its bills as they fall due. If a company can’t pay its bills, it is insolvent.
It sounds clear cut but in practice it’s not. The board has to make its best judgement on what is likely to happen, and whether they expect the company to be able to pay its bills. Any number of changes of circumstances can rapidly make a company insolvent. That’s what probably happened to Blipfoto as I explained in my last blog, The Fragility of Startups. It all looked OK until an investor withdrew promised funding.
If a company is insolvent then the directors or creditors apply to the court to have a professional administrator (or liquidator) appointed. This independent insolvency professional then has complete control of the company – the shareholders, board, directors and executives lose any powers they previously had.
The insolvency practitioner’s job is to act in the best interests of the creditors – to get them back as much of what they are owed as possible. A company can recover from administration, for example by negotiating a “Creditors Voluntary Agreement” (CVA) or finding new investors. If such a recovery is unlikely or an attempt fails, the company will enter liquidation/
Closing a Company – Liquidation
In liquidation the assets of the company are sold by the liquidator, again acting in the best interests of the creditors (not the shareholders). A company will always cease to exist after liquidation, although the business may keep operating in a new company in some form if someone buys the brand, premises, website etc as assets.
Often creditors get only a small percentage of what they are owed, and shareholders get only what is left over after creditors are paid in full (often nothing).
Closing a Company – Dissolution
Sometimes a company is solvent, but has reached the end of its useful life. For example, a startup may have discovered there is no market for its intended product, and laid off the staff and shut down operations in an orderly manner without ever running out of cash.
Tthe board of a solvent company can apply to have it dissolved – at which point it ceases to exist. That is the only way to escape the administrative burden of filing the annual return and accounts with Companies House and the HMRC.
When a company is dissolved, all the assets of the company pass to the crown, even bank accounts! Any board considering dissolving a company needs to make sure it gets the assets out first if it wants the shareholders to benefit instead of the crown!