Corporations

What kinds of shares should I issue?

A “share” is a percentage of ownership in a corporation that entitles its owner to certain rights in that corporation. These rights can generally be categorized as “control rights” and “income rights”. Control rights refer to the shareholder’s ability to influence decisions of the corporation, whereas income rights refer to the shareholder’s ability to share in the corporation’s profit or loss. Many of our clients have found it helpful to consider the balancing of these rights prior to determining the specific classes of shares to issue.

Control Rights

Voting – The ability to influence decision-making such as electing directors of the corporation, approving by-laws and passing resolutions is the primary control feature of voting shares. Each corporation is required to have at least one class of shares with voting rights. Once this class is established, the corporation is free to issue shares that have limited or no voting rights. Despite this flexibility, there are certain circumstances in which even non-voting shareholders are entitled to a statutory right to vote

Conversion – Conversion rights provide a shareholder with the opportunity to convert their existing shares to shares of another class, which may be desired for efficient tax planning purposes or to increase in their control of the corporation.

Income Rights

Dividends – Dividends are the primary method of distributing income from a corporation to shareholders. The types of dividends available by holding a class of shares will likely determine the type of investors they will attract. Shares offering fixed dividends that are paid in priority to other dividends are appropriate for investors seeking a predictable return from the corporation, whereas shares eligible to share in the profits of the corporation are appropriate for investors willing to tie their potential financial returns to the corporation’s underlying performance.

Dissolution Rights – Upon a corporation’s dissolution there are different potential rights available to shareholders. Some classes of shares are only eligible to participate to fixed amounts, whereas others may be entitled to a larger return of capital. The corporation must also consider in what priority different classes of shares will be eligible to participate in the return of capital upon dissolution.

Redemption, Retraction & Conversion – A corporation may redeem (repurchase) certain classes of shares for a stated amount. Exercising this option provides shareholders with a fixed return on their investment, but may preclude them from future earnings. Similarly, certain classes of shares may include retraction rights, which provide shareholders with the right to demand that the corporation repurchase their shares for a fixed price. Having this option available provides flexibility to investors to realize their return on investment on demand. Conversion rights may also provide shareholders with the opportunity to alter their income rights in the corporation.

After considering their desired allocations of control and income rights, we often focus our discussion on the following classes of shares with our clients:

Common Shares – Common shares are the most typical type of shares issued by a corporation. They often come with voting rights, a dividend structure tied to the profits of the corporation and the opportunity to participate upon dissolution after higher-ranking stakeholders (e.g. creditors, preferred shareholders). Common shareholders are likely to value pre-emptive rights and may also benefit from the right of conversion. Common shares are most commonly issued to founders, employees and advisors.

Preferred Shares – Preferred shares are typically issued to investors seeking predictable returns from the corporation. They are often non-voting and provide fixed dividends and priority participation upon dissolution. Preferred shareholders are likely to value conversion and retraction rights, while resisting redemption rights. Preferred shares are most commonly issued to investors.

Special Shares – Special shares often include elements of both common and preferred shares. These “hybrid” shares offer the corporation the opportunity to issue shares with a unique mix of rights that are desirable in specific fundraising circumstances. Special shares are also often utilized as part of an effective tax-planning strategy to take advantage of tax-saving opportunities such as income splitting, capital gains exemptions and estate freezes.

Determining which class of shares to issue, and which rights to attribute to those shares, is an ongoing and fundamental consideration in the life of a corporation. We are always happy to work with our clients and their accounting advisors to determine the optimal mix of shares that meet their operational, fundraising and tax-planning needs.

Note: Special thanks to our LPP Candidate Donald P. Brown for his contributions to this post.

[1] CBCA: s. 163(3), s. 176, s. 183 (3), s. 188(4), s. 189(6), s. 210(2), s. 211 (3).

OBCA: s. 148, s. 170, s. 176 (3), s. 182(4), s. 184(6).

What is a “Minute Book” and why should I care?

After completing the incorporation process, your lawyer should provide you with a corporate minute book which becomes the permanent repository of your corporation’s key documents (the “Minute Book”). The Minute Book must be kept at the corporation’s registered office or at another place in Canada as designated by the corporation’s board of directors (the “Board”).

Your Minute Book should include Incorporation Documents and Annual Corporate Governance along with appropriately documenting and reflecting any decisions made by the Board or shareholders.

There are at least three good reasons to maintain your Minute Book:

1. It’s the Law: Both federally and provincially incorporated companies are required to maintain corporate records that meet the statutory requirements of the Canadian Business Corporations Act (section 20) and Ontario Business Corporations Act (section 140) respectively. Although rare, it is possible statutory penalties may be assessed for failure to attend to these matters.
2. Equity Transactions: An investor or purchaser of your corporation will likely want legal opinions relating to various corporate governance matters. Having an up-to-date Minute Book will provide for a smoother (and likely less expensive) transaction process. Even if you wish to transfer the corporation to a family member, you will want to ensure that the transfer is appropriately documented in order to avoid costly remediation in the future.
3. Third Party Review: Various other parties may also want or need to examine your Minute Book from time to time to verify corporate authority or structure including:

• Professional service providers (e.g. lawyers, accountants) prior to being retained
• Lenders prior to issuing a loan
• Real estate agents prior to completing commercial real estate transactions
• The Canada Revenue Agency (as part of a tax audit)
• Other federal/provincial taxation authorities.

As you can imagine, time is usually of the essence when a Minute Book is requested for review and remediating an out-of-date Minute Book can increase costs.  Setting up a Minute Book from incorporation and regularly maintaining it will save money and aggravation.

What is Annual Corporate Governance?

All corporations incorporated federally and provincially in Ontario are required by law to hold annual meetings of shareholders or to have annual resolutions signed by all of the shareholders in lieu of holding an annual meeting. Both the annual meeting and the annual resolutions are used to document certain critical decisions affecting the corporation both in the year that just past, and the year to come. Correctly identifying, preparing, passing, documenting and filing these decisions make up a corporation’s Annual Corporate Governance.

How is Annual Corporate Governance Helpful?

In addition to the legal obligation, engaging in appropriate Annual Corporate Governance is helpful in two ways:

1. Liability Management – Annual Corporate Governance helps ensure that the responsibility and authority to manage the corporation (along with the associated liability) is clearly understood. This is of particular concern to directors and officers for whom liability insurance should be purchased.
2. Changes in Structure (Investment, New Shareholders) / Major Transactions – When a corporation finds itself in a position to raise capital through investment, or is taking on new shareholders for any purpose, one of the first inquiries a potential investor or shareholder will make it to review the Minute Book (which includes all of the Annual Corporate Governance) to get a better understanding of your corporation’s governance structure. Corporations that have not maintained complete records generally find it very time consuming (and costly) to try and update and fully rectify their Minute Book at the time of investment. Furthermore, holding incomplete records can risk alienating the potential investor or shareholder from participating in the transaction. This can also be the case when a corporation is entering into other major transactions (including financing), as counterparties often wish to ensure that the individuals they are dealing with have the appropriate authority to bind the corporation to a significant commitment.

What decisions need to be documented?

Annual Corporate Governance documents involving several key decisions, including:

• Financial Statements – Approval by the directors and submission to the shareholders
• Approval of dividends, management salaries or bonuses
• Directors – Resignations during the year, elections for the next year and consents to act as directors
• Officers – Resignations during the year and appointments for the next year
• The issuance and transfer of any shares in the corporation
• Appointing Auditors & Accountants for the following year
• Exemption from statutory audit requirements
• Address Changes – Changes in the registered addresses of the corporation, shareholders, directors or officers, all of which require filing notice with the government.

What are the potential consequences of not maintaining Annual Corporate Governance?

In addition to the concerns with Liability Management, Changes in Structure and Major Transactions discussed above, not maintaining Annual Corporate Governance exposes a corporation to the following:

• Substantial fines and penalties for breaching the Business Corporations Act (Ontario) or the Canada Business Corporations Act levied against the corporation and directors
• Reassessment of income tax position by the Canada Revenue Agency
• Significant (and costly) room for contention regarding decisions & accounting practices during a shareholder dispute
• Missing critical communication from the government

Can I prepare the Annual Corporate Governance myself?

We are always happy to work with our clients to craft a bespoke solution to their Annual Corporate Governance needs. Smaller start-up clients often wish to draft initial resolutions themselves and have us provide a simple review, whereas more mature businesses often appreciate a comprehensive overview conversation prior to having us prepare their Annual Corporate Governance materials.

At incorporation, the first documents you should find in your corporation’s Minute Book include:

1. General Operating By-law (“By-Law No. 1”) – By-Law No. 1 is a list of general operating rules for the corporation.
2. First Director(s) Resolution – The individual(s) who agreed to be the first director(s) on the Articles have a legal obligation to approve certain things right after incorporation including: the allocation of shares and confirming the consideration (i.e. amount) paid for those shares. Once the first director(s) has approved these matters they officially resign as the “first director(s)”.
3. First Shareholders Meetings – Once the shares are allocated, the shareholders hold their first meeting (or unanimously sign resolutions in lieu of a meeting). A shareholder (owner of a company) does not have to be a director and a director does not have to be a shareholder. Some of the items approved at the first shareholders meeting are:
   • Establishing the number of directors
   • Accepting the resignation of the first director(s) and voting on the new director(s)
   • Confirming By-Law No. 1.
4. Consent to Act – Directors must consent to act as directors and this consent must be signed and inserted into the Minute Book.  This ensures that a director is not elected to the Board and his or her name is not put on the public record without his or her consent.
5. Exemption from Appointment of an Auditor – Most privately held corporations are not required to have audited books. However, the statute governing a Canadian or Ontario corporation will require that the shareholders approve an audit exemption.
6. Registers – Registers must be prepared for the corporation listing (i) the addresses and dates of appointment and resignation for directors and officers, and (ii) all of the individuals or corporate entities that hold shares in the corporation, the number of shares they own and the date they received those shares. It also records when shares are returned to the company or transferred to other individuals or corporate entities. Each shareholder will also have an individual ledger showing the date upon which shares were received and how many shares were allotted.
7. Government Forms – All corporations must file returns with the government under which they are incorporated regarding changes to the status or personal information of the directors and officers.
8. Share Certificates – Every shareholder has a right to a share certificate. This certificate evidences ownership and should be a part of the Minute Book.