Many of our clients, after reading our blog about business structures HERE, end up choosing Corporation as their preferred vehicle to conduct business due to its limited liability and tax deferral features.
Now that you have chosen to incorporate, what are some key decisions you should make?
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Understanding the Difference between Directors vs. Shareholders
In Ontario and Canada, Directors are the people who runs the business on a day-to-day basis and make all crucial decisions. They usually have the authority to decide all financial matters (opening business bank accounts, issuing cheques, accepting payments, borrowing and lending), all employee concerns (hiring, firing, training, and management), and all client & operational affairs (client agreement and interactions, relationship with suppliers).
Of course, with great powers come great responsibilities – they are the ones held liable if anything goes wrong with the Corporation. In the worst-case scenarios, they may be sued by clients, shareholders, and/or 3rd parties. While it’s true that they are protected under the corporation’s limited liability umbrella (other people may only pursue the assets of the corporation, not the personal assets of directors), their personal assets may be at risk if they ever personally guaranteed something (e.g. a business loan) or if the issue concerns an employee matter.
Directors are usually issued a salary from the corporation unless they are also shareholders.
In contrast, shareholders are people who owns the corporation. They do not engage in the day-to-day management of the company, and are called upon only to approve of major decisions made by directors such as the selling of the corporation. Shareholders are the ones who choose the directors. They typically add or remove directors by majority vote.
Often, Shareholders receive income via dividends issued by the directors. Dividends may be issued routinely (e.g. monthly) or whenever the directors declare dividends to be issued (e.g. when the corporation has sufficient income). Shareholders rarely have legal liability and are rarely sued personally.
It is possible, and quite likely, for the same people to act as both directors and shareholders. In those cases, they would have the rights & responsibilities of both roles.
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Choosing Your Share Structures and Share Transfer Limitations
Share structures can be very simple or extremely complex, depending on the needs of the corporation. Nevertheless, two main concepts permeates most, if not all, share structures.
Voting
Shareholders with voting rights may add or remove directors, usually by majority vote. They may also approve or turn down major decisions made by directors pursuant to a shareholder agreement. In essence, they are the ones who control the corporation. Commonly, voting shares are called Common or Class A shares.
Typically, in exchange for having control, the voting shareholders would be lower in priority when it comes to dividend or asset distribution. Usually preferred shareholders (next section) get paid out first before the common shareholders.
Dividend
Shareholders with only dividend rights do not have control over the corporation, and typically do not make any decisions unless it affects their share class. Their only interest is to invest money (by buying shares) and then receive earnings (dividends) from the corporation routinely or when declared by directors.
To make such share classes more attractive, those shareholders may receive dividends before common shareholders, and are first to take the corporation’s assets if the corporation dissolves one day. Those shareholders are commonly called Preferred Shareholders.
Share Restrictions
To prevent any existing shareholders from freely selling shares to strangers, one can set restrictions on share transfer. Typically, share transfers would require the consent of the majority of shareholders.
This may be effective at preventing strangers from becoming voting shareholders and having control of the corporation.
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Choosing a Business Name and Business Activities
Your corporation may be a numbered corporation, meaning its name just consist of a random string of numbers chosen by the system. Or, it can have a chosen business name, such our firm’s name of “Varity Law”. If it’s the latter, a proper search would need to be done to ensure that name is not already taken, so it’s always good to provide several versions of the names to be searched.
You may limit your business activities to a specific area, such as “property management”, from the beginning. The reason is to prevent future shareholders from changing your business activity to something completely different such as “event planning”.
However, if you set a business activity restriction, changing it later would usually require the consent of all shareholders.
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Get Your Agreements Done Early
When everything is happy and dandy, we do not think about how bad dispute resolution may be, which could lead to endless court battles and high legal fees.
Thus, it’s great to set the rules clearly from the beginning. Below is a list of agreements that are very beneficial to have from the get-go:
- Shareholder Agreement
- Employee Agreement
- Independent Contractors/Suppliers Agreement
- Client Service Agreement
- Lease Agreement with your commercial landlord, if applicable
Conclusion
Incorporation is great way to limit your liability as a business owner, and is a wonderful tax deferral mechanism. As your expertise is in your product or service, it may be daunting to think about all the legal concerns in setting up and running a corporation. We hope this break down make things easier. For your specific situation, we also invite you to contact Varity Law to book a free initial consultation with a licensed and experienced business lawyer.
Yi Dan (Sabrina) Ding is the principal lawyer at Varity Law. We offer one-stop-shop services in Business Law – Business Immigration, and Real Estate – Wills & Estates.
This article is only meant to give general legal information. For legal advice on your specific legal situation, please consult a legal professional by booking a FREE 30 mins consultation with us here.
