Do It Right, Not Over: 5 Key Pre-Incorporation Considerations
March 29, 2017
By Beth McGrath, Financial Services & Restructuring Practice Group Leader, Partner at McInnes Cooper,
Trent Skanes, Associate at McInnes Cooper
Corporations are the leading business vehicle in modern commerce. For start-ups, properly structuring and incorporating now is critical to avoid disputes, protect the corporation (and the founders) if they do come up and avoid the time and expense of doing it over later. Doing it right means thinking and planning ahead.
Here are five key considerations you should think about before you incorporate.
The three main ways to structure a business are sole proprietorship, partnership and incorporation. Of these, incorporation is the most complex and expensive to create and to operate. So most businesses kick off as a sole proprietorship: one owner/operator responsible for all aspects – and risks and liabilities – of the business. But as the business grows to include more than one “owner” (or begins that way), the time is right to look at incorporation and its benefits. A corporation is a legal entity separate from its owners (the shareholders). It alone is responsible for its debts, obligations, and actions – and if it fails to make good on them, generally the shareholders aren’t personally responsible. There are also several tax advantages to incorporation, especially after a business is profitable.
- Incorporating Jurisdiction
A company can incorporate provincially or federally. There are differences between them and between provinces, and each has pros and cons. The right choice depends on your objectives. Discuss these key considerations with your legal team to help you make that decision:
- Investor-readiness.Investors may have a preference; switching later will cost time and money.
- Target Market.Both can generally carry on business anywhere in Canada, but the amount of red tape to do so varies.
- Share Structure.Provincial and federal incorporation offers differing flexibility in structuring your shares, including the opportunity of limiting members’ liability, restricting directors’ powers, and liability allocation.
- They also place differing residency restrictions on directors.
- Registered Office, Reporting & Business Name.There are also differing requirements for locating the registered office, annual reporting requirements, and business name search and approval.
A corporate name must be distinctive. It must not cause confusion with an existing name or trademark, include a legal element (e.g. Ltd., Corp., Inc.) and must not include any unacceptable terms. A NUANS report determines whether the proposed name has already been registered as a company name or trademark. But remember: obtaining the name doesn’t alone give the corporation the right to use the name as a trademark.
- Share Structuring
Start-ups need to decide what type of shares to create, what rights to give shareholders and how many shares to issue.
- Form & Number. There are two forms of shares: common and preference. Within these, there can be as many classes as desired. A corporation can have one type of shares with all the basic shareholder rights attached, or multiple classes with a combination of attached rights and privileges. The key shareholder rights include voting, dividends, and distribution of assets; founders often want common shares and voting rights. For start-ups it’s often best to authorize an unlimited amount of common voting shares to create an easy-to-understand capital structure; preferential characteristics can be added later if needed.
- Beware Securities Laws. Corporations should, however, be careful to not unintentionally cross the line from “private” into “public” status. A public corporation normally sells its shares to the general public, trades them on a stock exchange, and is subject to securities laws that ensure public confidence – and impose significant financial and administrative burdens. Many businesses are private companies that don’t trade their shares on the stock market, using prospectus exemptions to issue securities. But without realizing it, their actions can result in loss of their “private” status. Help avoid this by limiting the number of shareholders, restricting the transfer of shares (even if just with one extra step, like director consent) and ensuring it doesn’t “publicly” solicit new shareholders.
- Shareholders’ Agreement. All shareholders can benefit from a shareholders’ agreement: a written agreement among some or all of a company’s shareholders defining the relationship, rights, and obligations between the shareholders and the company – and addressing potentially contentious issues before problems arise. Without one, laws govern the relationship, but the default provisions probably don’t cover everything the shareholders might want or do so in the way they would choose. And investors will likely want to see a shareholders’ agreement in place before they consider financing the company.
- Choosing First Directors
The choice of Directors is critical to building a strong, qualified Board of Directors to help you run your business and meet your goals. The voting shareholders manage the corporation through the election of Directors, but aren’t otherwise entitled to participate in its business. The Directors run the day-to-day operations, so shareholders want to be Directors in many start-ups. The majority of your Directors should be independent. They should not be a member of management or have any direct or indirect material relationship that could interfere with their judgment. When choosing Directors, particularly your first ones, look for people with these key traits:
- Knowledgeable with expertise relevant to the business.
- Qualified and competent.
- Possess strong ethics and integrity.
- Diverse backgrounds and skill sets.
- Sufficient time to commit to their duties.
Please contact your McInnes Cooper lawyer or any member of the Entrepreneurial Services Team @ McInnes Cooper to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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