If you form a corporation for a business, it can become very confusing when the issue of running the actual business arises. For instance, what is the difference between shareholders and directors?

The corporation is the oldest formal business entity we have. How old? Well, do you really care? It is old. The reason it has been with us for so long is it provides a unique protection for business owners. Simply put, individual owners are not responsible for the debts of the corporation. If a pharmaceutical company that is a corporation puts out a drug that hurts people, the people that have purchased shares in it on the stock exchange cannot be held liable for the resulting judgments.

This liability protection comes with a price. To maintain the protection, the corporation must be run in a formal manner. Meetings must be held, and certain positions must be filled or the entity can be considered a sham. A sham corporation loses the ability to protect its shareholders from liability.

Two of the positions that are key within a corporation are those of shareholders and directors. Most people confuse these two roles, particularly in a small business. This is because a small business that has incorporate may have the same people filling both roles. There are, however, distinct differences.

A shareholder is a person that owns part of the corporation. If I go out and buy 100 shares of Microsoft tomorrow, I am a shareholder and owner of Microsoft. Now, 100 shares are not exactly going to give me a lot of clout given the fact Microsoft has millions of shares, but I am technically an owner. So, can I storm in to the office of the CEO and demand the company put out a particular type of software? Of course, not. I don't own enough shares to have any such leverage. Even if I did, I could not directly harass the CEO. Ah, but I could do it indirectly through the directors.

Every corporation has a board of directors. This is true for a giant like Microsoft and a tiny small business that has incorporated. The board of directors is responsible for the performance of the business. They set general policy and strategy for the corporation. They do not handle day to day decisions unless they are significant ones. Instead, the board elects officers of the corporation to run the day to day stuff. This includes the CEO.

Every year, the corporation has an annual meeting. At the meeting, the shareholders vote on who will be directors for the next year. If things are going well, the same directors are usually re-elected. If things are going poorly, there can be changes. Regardless, this is how the owners of the corporation, the shareholders, control what is happening. If a majority of shareholders hate the CEO, they can push that officer out by voting in directors that will make a change.

In a small business corporation, the shareholder and director roles can become confused. Simply put, a corporation with three shareholders is not going to have an independent board. Instead, the three shareholders will often also be the three directors. In turn, they will also probably be the elected officers, receptionist, janitor and so on. Regardless, it is important to understand that shareholders own the corporation through their shares while board members guide the general course of the business.