Setting up a Small Business Corporate Share Structure

Incorporating a business is a relatively easy, quick and inexpensive thing to do. In fact, many people follow books, software or internet advice and incorporate themselves in order to save money.
Decisions regarding the share structure of the corporation and the naming of directors and officers are often made without much thought. They are often made with little or no consideration of future consequences for the business and its shareholders (owners), the duties and liabilities of officers and directors, creditor proofing, estate planning and other issues.

We have seen clients with various companies: some operating, some dormant, some as a single company and some with multiple holding companies. In essence, a holding company generally carries on no business other than owning the shares of other companies. Sometimes these extensive groups of companies make sense, but all too often they don’t. On the flip side we also see clients with a variety of businesses and multiple assets (for example, land and buildings) in a single corporation when, for a variety of reasons, there should be separate companies for some of these businesses and assets.

Companies are almost as quick and easy to create as babies some might say! However, we all know that babies require a lot of work, can’t fend for themselves, are costly and require the constant foresight of their parents to keep them healthy and progressing well. A company is no different except that babies grow up and hopefully one day stand on their own. Companies never grow up. They always need their directors and officers to act on their behalf. Even if the company has no operations and is dormant, it requires the cost and attention of maintaining a corporate records office, filing annual legal reports, preparing and filing financial statements and corporate income tax returns, and compliance with any additional laws and regulations affecting the specific corporation.

I cannot emphasize enough how important it is to seek appropriate specialist advice before deciding to create a new company or companies (including holding companies), and deciding who the shareholders, directors and officers will be.

Many people believe that all of their business ventures must be immediately incorporated because, in this manner, they will enjoy limited liability from creditors and those who could sue for some alleged wrongdoing. In fact, some are naïve enough to believe that they can act with virtual impunity. As discussed earlier, it is clear that directors and officers face various responsibilities and liabilities because of various statutes and regulations. Let’s look at the practical side of business life.

Most businesses of any size eventually have bank or other borrowings in order to finance the working capital requirements of the business. In addition to specific charges on certain fixed assets and a General Security Agreement (GSA) on all assets of the business, banks and other lenders will almost 100% of the time require personal guarantees from the shareholder or shareholders of the borrowing company and often they will want to place a charge on the home(s) of the shareholders. Before lending to the business, banks and other lenders want to see that the shareholders have put their cash into the business in the form of share capital or shareholder loans. Banks will often require the shareholders to subordinate their loans to the priority of the bank so that the bank is not funding the repayment of the loans and increasing its exposure and risk while the shareholders lower their exposure and risk. Even suppliers and other parties extending any significant amounts of credit may require the shareholders to sign personal guarantees. All of these situations strip away the perceived protection of having a corporation and the shareholders’ liabilities being limited to the amount they invested as share capital.
A corporation does not prevent the directors, officers and corporate employees from being sued for damages resulting from a wide variety of acts of commission or omission, including negligence, fraud, human rights violations, etc.

The advice is to not be too worried about immediately incorporating every venture. Given that the legal protection is of limited value, other considerations should affect the decision as to when or if to incorporate. One of the most important considerations is that of taxation. There are often situations where it makes sense to allow the business to start as a proprietorship or partnership so that the losses usually incurred in the start-up phase can be applied against any and all other forms of personal income.

In general, certain types of assets should be held in corporations separate from other assets or business ventures. As an example, in a situation where there is an active business and the land and buildings from which it conducts its activities are owned (i.e. not leased), these may be financed. It is usually a good practice to have the active business in one corporation and the land and buildings in the other. The business then leases those assets from the other company. If the operating business becomes insolvent for any reason, the land and buildings will generally be safe.
Some couples set up their corporations and automatically agree to have the shareholdings be 50/50, have both as directors, and both as named officers. This is true even when one of the spouses is not active in the business in any real sense. Sometimes children are included in this. Often the reason cited for doing this comes down to the notion of income splitting. The fact is that this approach is a simplistic one that is fraught with potential danger for the entire family.

Income splitting can be achieved by having a spouse, and in some cases children, hired as employees and being paid wages, salary, bonus or some other method of compensation. If the spouse and/or children are shareholders, they can participate in dividends. You do NOT want to have your spouse or your children be directors or officers unless necessary. This is due to the issues of liabilities (such as CRA debts) that attach to directors and officers as we mentioned earlier, and because of the laws that govern insolvency and bankruptcy of corporations and liabilities that survive and attach to the directors and officers.

Advice — when possible seek to have one spouse facing all the potential director, officer and business related debt and liabilities and have the other spouse own all the personal assets such as the house and all other significant assets. It is important to retain proper professional advice with competence in this specific area. To deal with some issues it takes a team who coordinate their work and let the client know of all possible ways of dealing with their affairs along with the pros and cons of each approach. Then it becomes the client’s responsibility to choose their priorities and the best way to proceed. The more you plan these things out the better and more certain the future outcomes are likely to be.