Tips for the New Entrepreneur

How Can I Best Organize My New Business?

With the excitement of turning a new endeavour into reality, the decision-making and multitude of choices and considerations related to the actual setting of your new business may quickly become overwhelming – not to mention somewhat confusing when trying to decipher and assess what is best from the vast array of information contained on the Internet or provided freely from peers, family and friends.

This blog brings together information from various sources to serve as a guide to some of the key considerations when trying to make one of the first decisions concerning your business.

What Is the Business Structure Best Suited for My Business?

This is often one, if not the first, question of most New Entrepreneurs in Ontario.  Most technical nomenclature usually refer to three different forms of business structure: the sole proprietorship, a partnership or a corporation.

Generally speaking, in a sole proprietorship which is a non-incorporated business, you will be the sole owner of the business with full responsibility for its debts and obligations.  You will be able to keep all of the company’s profits but will also be personally liable to its creditors should the business revenues and assets not be sufficient to pay the company’s expenses and debts.

A partnership, also a non-incorporated business, is a structure whereby two or more people, the partners, combine their financial resources, knowledge and experience to create the business.  You and your business partners will share the profits and each partner will be jointly responsible for the debts and obligations of the business.

The third business structure is the corporation, which is created by application to either the federal government or a provincial/territorial government. The corporation is a separate legal entity from its owner, namely the shareholder.  This means that as a shareholder of the corporation, you will be usually only liable for the maximum amount that you have invested in buying your shares in the corporation.

When choosing the business structure that is most suitable for your business endeavour, you may wish to assess certain factors such as the type of business, the number of people involved, your risk tolerance, tax considerations and financial requirements. For the New Entrepreneur who is still undecided, it may also be useful to align its business structure with its long-term business plan. It is important to mention that some entrepreneurs may launch their business using one form of business structure, for example a sole proprietorship, and decide to change it, for example moving to a corporation model, at a later date as the business is growing.

At a glance, this is an overview of some key considerations when choosing your business structure.

When Should The New Entrepreneur Incorporate Its Company?

As you may have noted, each form of business structure has its advantages and disadvantages.  Therefore, there is not one formula that meets the objectives of every business.  This is often a decision that the New Entrepreneur will be making in consultation with its professional advisors, including its business lawyer.

Together, they will assess a number of elements in order to determine the correct form of business structure.  Some of these factors include:

• Tolerance for risk
• Protection of the owner’s personal assets
• Credibility to secure business financing
• Growth and longevity of the business
• Optimization of tax benefits and tax deferrals for the business and owners
• Attracting and hiring qualified employees and contractors
• Commercial dealings with other corporate entities (such as commercial contracts and leasing agreements, licenses)

Additional Sources of Reference

• “Legal Issues for Small Business” – Innovation, Science and Economic Development Canada [ https://canadabusiness.ca/managing-your-business]
• “Start, dissolve and change a corporation” – Government and Consumer Services Ontario [https://www.ontario.ca]
• “RC4070 Tax Information for Canadian Small Business” – Canada Revenue Agency [ https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4070.html]

Incorporation, Share Structure and Shareholders’ Agreements

What Are The Main Differences Between Federal and Provincial Incorporation In Canada?

You can decide to incorporate your new company federally or provincially.  Both types of incorporation will allow you to, for example, enter into contracts or sell goods and services in any provinces or territories in Canada. 

However, you will also need to register your company – be it that you originally incorporated federally or provincially – in any other province or territory where you wish to set up an office or retail outlet, for example.  More specifically, you will need to complete an Extra-Provincial Incorporation in any province or territory where you have actual facilities, employees or offices in that jurisdiction. 

One of the advantages of incorporating federally is that it provides you with “increased name protection” which means that once you have registered your name, you can do business under the same name across Canada.  This is in contrast with a provincial incorporation where there is no protection of your name outside of that province.  It is also worthy to note that a federally incorporated company may also provide increased global recognition should it want to conduct business in other countries.  Finally, the original filing of the Articles of Incorporation, or any additional amendment to the original Articles of Incorporation, as well any required annual filings can be done electronically through Corporations Canada website.

This being said, there are certain advantages to incorporating your business provincially.  While the federal incorporation fees may be less initially – meaning $200.00 for online filing with Corporations Canada plus a minimal fee for a NUANS name search, compared for example to a one-time incorporation fee of $300.00 in Ontario – there is additional paperwork and extra long-term costs related to a federal incorporation. Specifically, you will need to file an annual return with associated annual fees of $20.00 (when electronically) and this every year during the entire existence of your company.  Hence, if you plan to carry on business mainly in one province, for example in Ontario, you may decide for expediency and cost-related reasons to incorporate initially only in that jurisdiction. It is also feasible to first incorporate provincially and change to a federal incorporation at a later date when, for example, you wish to grow and expand your business on international markets or seek increased name protection and recognition.

What Should Be the Share Structure of My New Company?

When you decide to incorporate your new company, you must determine its share structure which is linked to making some decisions on the ownership of the company.  A company’s ownership is divided into “shares” which typically corresponds to one “unit of ownership interest” in the corporation.  A person who owns shares in the company is called a “shareholder”.

There are usually two main categories of shares that are usually defined in the Articles of Incorporation of the new company: (1) common shares; and (2) preferred shares (sometimes also called “preference shares”).  In general, there are three types of rights or attributes associated with shares:  (1) the right to vote; (2) the right to receive dividends; and (3) the right to receive the remaining property of the corporation upon dissolution.  Not all rights have to apply to all classes of shares.

In summary, a company can have several “classes” of shares in each category.  However, a company must have at the very least one class of shares, that are usually common shares, whereby the holders of these shares must at minimum have the right to vote at any meetings of the shareholders, receive any dividend declared by the corporation and receive the remaining property of the corporation on dissolution.

As a New Entrepreneur or founder, you may also wish to create a share structure comprised of several classes of shares that would allow you to provide different rights to the holders of the various classes of shares and plan ahead for future transactions.  Some considerations when determining the share structure of your company are:

• Retention of control of your company
• Creation of a stock option plan to issue shares, for example, to key employees, directors, contractors or others
• Incentives to attract new investors and raise equity financing
• Tax considerations such as income splitting, capital gains exemptions
• Future reorganizations such as estate freezes, acquisitions and mergers

Do I Need a Shareholders’ Agreement?

A shareholders’ agreement is a binding contract, preferably in a written format, between two or more shareholders that governs the relationship between the parties, the management of the company as well as the ownership and transfer of shares. There are basically two types of shareholder agreement. First, a Unanimous Shareholders Agreement (the “USA”) is an agreement where all shareholders of a corporation become parties to the agreement. Pursuant to the Canada Business Corporations Act and the Ontario Business Corporations Act, the USA can restrict the powers of the directors to manage the affairs of the corporation by limiting certain of their decision powers. Consequently, it is worthy to note that under a USA, the shareholders may inherit certain rights, powers and duties, and associated liabilities, of the directors or Board of Directors.   In contrast, a general or Non-unanimous Shareholder Agreement may be entered into among some or all of the shareholders when its purpose is not necessarily to restrict the powers of the directors.  Irrespective of what type of shareholder agreement you contemplate, it is often a useful tool for privately held corporations where there is more than one shareholder, including when there may be more than one founder of a new company. 

This is because one of the main goals for entering into a shareholder agreement is to anticipate potential future events or issues and determine how these matters will be proactively dealt with should they arise. The shareholder agreement is usually tailored to the type of business and its specific shareholders and investors’ requirements. In addition to defining procedural matters pertaining to the management of a company such as the frequency of shareholders’ meetings, a shareholder agreement can be used to deal with more substantive issues related to ownership and transfer of shares.  Examples of various types of issues that can be addressed in such an agreement are co-founder disagreements through the inclusion of a pre-determined dispute resolution process, protection of minority shareholders’ rights, control of share issuances, transfers and dispositions, setting out voting thresholds and requirements for shareholders’ approval for certain fundamental corporate decisions or actions to be undertaken, as well as key provisions and restrictions in the event that an existing shareholder ceases to be a shareholder due for example to insolvency, retirement or termination as an employee, death or disability and loss of capacity.  A shareholder agreement can also confer other rights, restrictions and obligations with respect to financing and contribution of funds, non-competition and non-solicitation provisions prohibiting shareholders from competing or taking clients or key employees from the company during their tenure and for a reasonable period of time thereafter.

In conclusion, it is believed that one of the main reasons to put in place a shareholders’ agreement is to encourage the shareholders to discuss any potential issues or problems and have in place a roadmap that clearly delineates possible solutions at the onset of the relationship and alleviate the risk of higher costs of resolving future disputes. In fact, a well-drafted shareholder agreement can be useful to supplement the legislative framework, the Articles of Incorporation and by-laws of a privately-held company.

Additional Sources of Reference:

• Steps to incorporating – Innovation, Science and Economic Development Canada – Corporations Canada website: https://www.ic.gc.ca
• Business services – Service Ontario (Start, dissolve and change a corporation): https://www.ontario.ca/page/business-services
• Ontario Business Corporations Act, R.S.O. 1990, c. B.16, Section 108: https://www.ontario.ca/page/start-dissolve-and-change-corporation
• Canada Business Corporations Act, R.S.C. 1985, c. C-44, Section 146: https://laws-lois.justice.gc.ca

Overview of Corporate Governance

What Does A Corporate Governance Structure Look Like?

Now that you have decided to incorporate your new company either federally or provincially, the next step is to establish a robust, yet nimble, corporate governance structure based on your business requirements and good corporate principles. 

The corporate governance structure usually distributes the rights and responsibilities among three main levels of decision-making stakeholders or groups: (1) the Shareholders, (2) the Board of Directors and (3) the Officers.  It is important to know that some of these obligations are prescribed by provincial and federal legislation. 

1. The Shareholders of Your Corporation

The Shareholders are the owners of the Corporation.  They invest in the company by purchasing one or more shares directly from the company or from an existing Shareholder who sells the shares it currently owns.  The Shareholder’s liability in the Corporation at the time of purchasing its shares is usually limited to the amount paid for the shares.

The Articles of Incorporation determine the specific rights and privileges attached to the shares which may include (1) the right to vote and be notified about shareholders’ meetings; (2) the right to receive dividends; and (3) the right to receive a portion of the remaining property of the corporation upon dissolution. They also have the very important role to elect and dismiss the Directors.

A critical aspect of share ownership pertains to the “controlling interest” that may be held by the Majority Shareholders whereby one or a group of shareholders hold more than 50% of the voting shares of the Corporation.  Minority Shareholders, for their part, own less than 50% of the voting shares. Consequently, this implies that unless otherwise specified in a shareholder’s agreement the Majority Shareholders basically determine the composition of the Board of Directors.  

2. Its Board of Directors

The role of the Directors is to manage, or supervise the management of, the business and affairs of the Corporation.  A Director must be an individual who is at least 18 years old, not have been declared incapable by law and not be in bankrupt status. The number of Directors is designated by the Articles of Incorporation and at least 25% of the Directors must be resident Canadians. Each Director usually has only one vote on any decision taken at the Board of Directors.  The Directors may also select the Officers who will manage the day-to-day business operations of the Corporation.  The Directors have a high level of discretion in managing the affairs of the Corporation.  There is an overarching principle that the Directors must exercise sufficient oversight over the business affairs such that certain matters cannot be delegated to others such as:

• Approval of the Financial Statements
• Issuance of shares and declaration of dividends
• Calling Board of Directors’ or Shareholders’ meetings
• Nominating Directors

3. And Its Corporate Officers

The Officers of the Corporation are usually responsible for the day-to-day management of the business and affairs of the Corporation. Some of the standard officer positions are the President, the Secretary and the Treasurer.  One person can hold the three positions simultaneously. The Officers are appointed by the Board of Directors and their respective duties are determined by the Directors and by the by-laws of the Corporation.  You can appoint any individual as an Officer of your Corporation and this person does not have to be a Director or own any shares in your company.

Pursuant to the Canada Business Corporations Act (the “CBCA”) and the Ontario Business Corporations Act (the “OBCA”), any privately-held corporation must have at least one Shareholder and one Director. It is noteworthy that in some small corporations, it is possible for the same person to be the sole shareholder, the sole director and only officer and therefore perform all associated duties.

What Are My Key Responsibilities And Accountabilities As A New Shareholder And/Or As A New Director Of The Corporation?

As a Shareholder, your basic rights and obligations are determined by the provincial or federal corporate statutes under which the company is incorporated.  They include:

• Responsibility for oversight and monitoring of the company’s performance by reviewing corporate financial statements and directors’ reports, appointing an auditor (or waiving the requirement for an audit of the financial statements);
• Participating in Shareholders Meetings and voting on key matters such as fundamental changes to the constitution of the corporation including its capital structure, nominating and appointing directors, creating and modifying the corporation’s by-laws;
• Furthermore, the Articles of Incorporation, the corporate by-laws and a Shareholder’s Agreement can create additional rights, obligations and restrictions for any and/or all groups of shareholders of a company.

As a Director, you have the all-encompassing fiduciary duty and duty of care.  These duties are included in Section 122(1) of the CBCA, or Section 134(1) of the OBCA:

“Every director and officer of a corporation in exercising his or her powers
and discharging his or her duties to the corporation shall, (a) act honestly
and in good faith with a view to the best interests of the corporation; and
(b) exercise the care, diligence and skill that a reasonably prudent person
would exercise in comparable circumstances.”

To fulfil your fiduciary duty, you must ensure that the interests of the corporation are always paramount.  This means, for example, that the Director acts in good faith and places the interest of the Corporation over others and must not disclose corporate confidential information.  Under the premise of its fiduciary duty, the Director must also proactively disclose any conflict of interest it may have with the Corporation and abstain from voting on any such matter in accordance with the applicable legislation (Section 132(1) of the OBCA; Section 120(1) of the CBCA).

The Supreme Court of Canada has also stated that the duty of care is relevant to the assessment of the “standard behaviour that should reasonably be expected of a director in similar circumstances”. It is also interesting to note that while this is an objective test, the competence expected of any one director may vary based on the professional experience of such Director.  Consequently, a Director should be able to demonstrate that it acted with honesty and diligence by reviewing the information provided and documenting the Board of Directors’ decision-making process to be able to demonstrate that it consulted experts as required and exercised due diligence in reaching its decisions.

Finally, the CBCA, the OBCA and other statutes dealing with specific matters such as income tax, the environment or in relation to health and safety can impose certain specific liabilities on directors of a corporation.  For example, in certain circumstances, the directors of a corporation may be jointly and severally liable to employees for up to six months’ worth of unpaid salaries and associated source deductions.

What are Recent Changes or New Corporate Obligations that I Should Know About as A New Entrepreneur?

After your company has been duly incorporated and you have received your Articles of Incorporation, the Corporation has certain ongoing corporate obligations. They include the preparation of annual financial statements, appointing auditors (or waiving such appointment) and maintaining corporate records at its registered office including the Articles of Incorporation, By-Laws and all amendments thereto, a copy of any Shareholders’ Agreement, minutes of meetings and resolutions of Shareholders and/or of the Directors and corporate registers of the shareholders, directors and officers of the Corporation.

Recent changes introduced to the CBCA require that privately-held corporations that are incorporated federally collect and retain additional information with respect to individuals who exercise “significant control” over the corporation.  More specifically, the shareholders registry of these corporations will need to be updated with additional information on any individual with “significant control” whereby:

• such individual is the registered or beneficial owner, or has direct or indirect control, over a number of shares that carry at least 25% of the voting rights attached to all of the corporation’s outstanding voting shares, or is equal to at least 25% of the fair market value of all of the corporation’s outstanding shares; or any individual who has any direct or indirect influence such that if exercised would result in the control in fact of the corporation.
• Two or more individuals with joint ownership of a significant number of voting shares may each considered to be an individual with “significant control”.
• The updated Shareholders Register will contain the following information regarding all individuals with “significant control: (1) their name, date of birth, and last known address; (2) their jurisdiction of residence for tax purposes; (3) the date on which the individuals acquired or lost significant control status; (4) a description of how the individual qualify for the “significant control” status such as its right, title and interest in the voting shares of the corporation; (5) steps taken to identify all individuals with “significant control” and to ensure that the new registry is accurate and up-to-date; (6) any other prescribed information to be determined through the associated regulations in the future.

Additional Sources of Reference:

• Share structure and shareholders, Innovation, Science and Economic Development Canada website: https://www.ic.gc.ca
• Business services – Service Ontario (Start, dissolve and change a corporation): https://www.ontario.ca/page/business-services

• Ontario Business Corporations Act, R.S.O. 1990, c. B.16, Sections 132-134, 149, 154: https://www.ontario.ca/laws/statute/90b16
• Canada Business Corporations Act, R.S.C. 1985, c. C-44, Sections 120-122, 140: https://laws-lois.justice.gc.ca
• Budget Implementation Act, 2018, No.2 (Bill C-86): https://www.parl.ca/

How we can help

As demonstrated above, it is clear that starting a new business involves a multitude of decisions. For experienced advice on your best course of action regarding the structure of your business, incorporations, shareholders agreements and corporate governance, contact the Business Law Team at Merovitz Potechin LLP.

The content on this website is for information purposes only and is not legal advice, which cannot be given without knowing the facts of a specific situation. You should never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. The use of the website does not establish a solicitor and client relationship. If you would like to discuss your specific legal needs with us, please contact our office at 613-563-7544 and one of our lawyers will be happy to assist you.