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).