Most businesses start as a sole proprietorship or partnership, with one or more owners responsible for all aspects of the business, including liabilities. Owners often contemplate whether and when to incorporate their business. It’s time to consider incorporation when the business
generates substantial income (There are tax advantages to incorporation, including receiving income by means of payment of dividends on shares.)
develops intellectual property (IP) (It’s more beneficial for one owner—the corporation—to control and further develop IP.)
enters into contracts (Third parties might be reluctant to enter into contracts with individuals. Incorporation also offers liability protection under contracts, because a corporation is a legal entity separate from its owner[s] and responsible for its own obligations and actions. If it defaults, the shareholders generally aren’t personally responsible.)
seeks funding (Most investors and grant programs require incorporation to fund.)
Properly planning for and structuring the corporation is critical to protect the corporation, its assets, and the shareholders; avoid future disputes; position the business to attract investors and strategic partners; and achieve a successful exit from the business if that’s a goal. Here are five key considerations about which every business owner should think before incorporating a business.
Where to incorporate
A business can incorporate under provincial or federal laws. There are differences between them and between provinces. To decide, consult legal counsel and consider
investors’ preferences (Switching later costs time and money.)
target market (Corporations can generally carry on business anywhere in Canada, but the red tape to do so varies.)
jurisdictions offering differing flexibility in structuring shares, limiting members’ liability, restricting directors’ powers, allocating liability, and stipulating directors’ “residency” as the corporations law defines (In particular, provincial laws restrict the ability of a corporation incorporated in Newfoundland and Labrador to provide financial assistance to shareholders, directors, officers, and affiliated corporations in certain circumstances.)
differing requirements for the location of the registered office, annual reporting, and business name search, approval, and registration.
A corporation’s name must meet legal requirements. It must be distinctive, not cause confusion with an existing name or trademark, include a legal element (e.g., Ltd., Corp., Inc.), and not include any terms unacceptable to the registering authority. Simply obtaining the name doesn’t give the corporation the right to use it as a trademark.
The corporation must structure its capital. There are two ordinary types of shares: common and preferred (which have certain rights over common). Within each, a corporation can have as many classes as desired. The best initial structure depends on the corporation’s circumstances and objectives. If there are multiple owners, a key decision is the initial equity split between them.
All shareholders benefit from a shareholders’ agreement: a written agreement among some or all the corporation’s shareholders that defines the relationship, rights, and obligations between them and the corporation, addressing potentially contentious issues before problems arise. Without one, corporate laws govern the relationship—but their default terms might not cover everything the shareholders want, or do so in a way the shareholders would choose. A shareholders’ agreement may include the required number of directors, share transfer restrictions, and pre-emptive rights on the sale of shares.
“Corporate governance” generally describes the processes, practices, and structures through which a corporation manages its business and affairs. The key stakeholders each have a defined role to play in the corporation:
Shareholders own the corporation and share in its profits; voting shareholders manage it through electing directors and through any rights they are granted under a shareholders’ agreement.
Directors oversee day-to-day operations (including appointing officers) and set the business strategy and plan; they must meet legal requirements and fulfill legal duties.
Officers manage day-to-day operations; they must also meet legal requirements and fulfill legal duties.
Staff are the employees and contractors who carry out day-to-day operations.
This article is information only; it is not legal advice. McInnes Cooper excludes all liability for anything contained in or any use of this article. © McInnes Cooper, 2018. All rights reserved.
Caroline Watton, McInnes Cooper
Caroline Watton is a leading business lawyer with McInnes Cooper in St. John’s. She provides strategic legal advice to start-ups, SMEs, and large corporations, assisting business owners, partnerships, and corporations on a wide range of corporate matters, including incorporation, corporate structuring, reorganization, mergers, acquisitions and dispositions, asset and share purchases, commercial leasing, and corporate governance and shareholder matters. Active in her community and profession, Caroline is a member of NLOWE, chair of McInnes Cooper’s local Collective Social Responsibility and Business Development Committees, and chair of the Canadian Bar Association’s provincial Business Law Section.