What’s the Right Structure For Your New Business? | Schnell Hardy Jones LLP

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When starting a new business, one of the most common vehicles used to operate the business is through a corporation which, depending on your situation, can have a big impact on taxes, management, personal liability and financial responsibilities. A lawyer can help to choose the right corporate structure for your business. The purpose of the memorandum is to outline some basic concepts and considerations for one considering incorporating a company to operate the business.

  1. The Corporation

A Corporation is created by filing its Articles of Incorporation (the “Articles”) with the office of the Registrar of Corporations in Alberta which contain the basic components of the corporation such as its name (if any), share structure, share rights, restrictions on share transfer, and any restrictions on its business. The corporation has the capacity to do all those things that an individual can do except as may be restricted by the Business Corporations Act or the Articles.

  1. Shareholders

Shares are allotted and issued to the shareholders. The shares will have certain rights that go with them such as rights to dividends, rights to vote and rights on dissolution of the Corporation. By authorizing various classes of shares in its articles with a variety of rights attached to them, the corporation can issue shares to the shareholders to achieve their desired involvement in the corporation. Some shareholders may want to maintain control over the direction of the corporation (voting shares, non-dividend rights), some may only want a financial interest (non-voting, dividend rights) and most will want both (voting and dividend rights). An experienced corporate lawyer can ensure that each shareholder’s involvement corresponds to their desire by confirming appropriate shares and their respective rights are issued to the proper shareholders.

While the shareholders may have an interest in how the corporation is managed, its profits and its business generally, the fact is a shareholder does not by itself entitle one to participate in the day-to-day management of the corporation. For example, unless specifically authorized, shareholders cannot enter into contracts in the name of the corporation.

The shareholders are required to have an annual meeting in which they will elect directors, appoint or dispense with the appointments of auditors, reviewing the financing statements, and doing such other things as may be brought before the meeting.

Other shareholders meetings may be held and reference should be made to the Corporation’s bylaws as to the timing of the shareholders’ meetings and the requirements to be met in order to hold such a meeting.

  1. Directors

The directors of a corporation are elected by the shareholders, in order to exercise general control over the corporation.

Unless there is a shareholders agreement, the management of the business and affairs of the corporation is overseen by the directors. The directors are responsible for the overall operation and direction of the corporation and are involved in all policy decisions of importance. Officers are usually appointed to run the day to day operations of the corporation. In carrying out their duties directors have an obligation to act honestly and in good faith with a view to the best interests of the corporation and to exercise care, diligence and skill in carrying out their duties.

  1. Shareholder Agreements

When there is more than one shareholder and/or director in a corporation, the parties may wish to enter a shareholders’ agreement that better addresses the parties particular situation. An experienced corporate lawyer can assist in avoiding complicated disagreements down the road and ensure everyone involved in the business understands their role and is treated fairly. Generally there are two main aspects dealt with in most shareholder agreements:

a. Corporate Management

As noted above, the general rule is that the management of business and affairs of a corporation is overseen by the directors. A Shareholders’ Agreement can change this general rule by putting certain limitations on the decision making powers of the directors. A Shareholders’ Agreement may give the shareholders some or all of the power to manage the corporation’s business and affairs or provide that the directors and the corporation shall not take certain action unless all or some specified majority of the shareholders otherwise agree; and

b. Buy Sell Events

Certain terms of a Shareholders’ Agreement may deal with certain events (“buy/sell events”) that provide for the buying and selling of shares and other interests. The main buy/sell events found in a Shareholders’ Agreement are death, disagreement between the parties and other events that may happen to an individual shareholder or a corporate shareholder that would make it preferable to the other shareholders to buy that person or corporate shareholder out. A business lawyer can review these buy/sell events to determine which, if any, apply to a certain situation.

i. Buy/sell on Death

Most shareholders recognize the need for a buy/sell on the death of a shareholder or of a principal of a corporate shareholder. From the remaining shareholders point of view, the buy/sell is desired because while they may have enjoyed being in business with the deceased shareholder they probably do not want to be in business with his or her relatives. Thus the remaining shareholders want to avoid the potential problems that could be caused by the deceased’s relatives.

There are a number of ways in which the corporation or the remaining shareholders can structure the buy/sell of the deceased’s shares – each of which may have differing tax consequences. A number of tax issues must be considered in determining the method of structuring the buy/sell on death that best suits the parties needs. For example, capital gains and capital gains exemptions should be considered if the remaining shareholders buy the shares and deemed dividends and capital dividend accounts should be considered if the corporation redeems or purchases the shares for cancellation. There are a few ways in which the corporation or the remaining shareholders can fund the purchase of the deceased’s shares. For example, life insurance is a strong consideration due to the advantages offered by the capital dividend account but the costs of obtaining such life insurance is sometimes an obstacle and as well of the cost of insuring the various shareholders lives may vary greatly from shareholder to shareholder.

In any event it is important to set out in the Shareholders’ Agreement how the purchase price will be determined for the deceased’s shares and their shareholder loans, otherwise disputes may arise as to the purchase price.

ii. Disagreements

As with any relationship, situations may arise at a later date when the shareholders can no longer co-exist together. A Shareholders’ Agreements can be used to provide ways to resolve these disputes with the use of Right of First Refusals, Drag-a-long rights, Tag-a-long rights or shotgun clauses.

One must proceed with great caution with shotgun clauses. They work ideally when there are 2 shareholders with equal means and participation in the corporation. Their practicality is diminished when there are more than two shareholders, the shareholders own an unequal percentage of the shares, the shareholders have unequal financial means, the shareholders have unequal roles in the corporation’s day to day business activities, etc. Such circumstances may make the “shotgun clause” unfair to one party or the other.

iii. Other Events

During the course of a corporation carrying on business, something may occur to a shareholder or a shareholder may do something in which remaining shareholders no longer want that shareholder to remain a shareholder. If such an event occurs with respect to a particular shareholder then the remaining shareholders may wish to have the option to purchase such shareholder’s shares and shareholder’s loans. Some examples of these occurrences with respect to an individual shareholder include bankruptcy, no longer contributing to the day to day operations of the corporation, disability, marriage breakup, criminal activity, failing to comply with the Shareholders Agreement etc.

Some examples of these occurrences with respect to a Corporate Shareholder include the occurrence of any of the events listed above with respect to such Shareholder’s Principal or controlling shareholder, winding up the corporation, etc.

Also in some of the above events, it may also be preferable to allow the remaining shareholders to purchase the shareholder’s shares and loans at a discounted price. This must be determined by the shareholders at the outset. In any event, as with death above, it is important to set out in the Shareholders’ Agreement how the purchase price will be determined for the shares and their shareholder loans, otherwise disputes may arise as to the purchase price.

*This memorandum is very general in its nature and should never be used in place of a careful examination of the relevant documents, a careful examination of the Act or consultation with a solicitor, or all three, with respect to any particular fact situation that may arise. This memorandum is designed to state concepts only and not to provide specific advice or direction on a particular matter.