Getting Start-Up Funds Into Your New Company

When you are first setting up a company, one of the early decisions that you will need to make is how to get start-up funds into your company. 

The term “capitalize” is sometimes used to refer to the process of getting funds into a company (and the corresponding term “capitalization” to refer to the resulting cash and other assets in the company), and that’s how we will use those terms in this article. 

This article focuses on the initial capitalization of a new company (the considerations might be a little different at later stages in the company’s lifecycle). 

Why is capitalizing my new company important?

A new company is like a baby (you can think of it as a new robot person). 

It has no cash or assets of its own. But, it will need cash and/or assets to start up and run its business (in most cases). 

So, you need to find a way for your new company to get cash and/or assets of its own. That’s what it means to “capitalize” your company.

What are my options for capitalizing my new company?

Two common methods of capitalizing private companies in Canada are: (1) share subscriptions (i.e. sale of equity in the company) and (2) shareholder loans. There are also, of course, (3) many alternative methods available for capitalizing a new company.

1. Share Subscriptions

This is the method that most people think of first when they are considering how to get money into their new company. 

This is how it works: 

1. The founding shareholders subscribe for shares of the new company and agree to pay a specified price to purchase those shares. 
2. The new company collects that money from the founding shareholders and issues the shares to the founding shareholders. 
3. In the end the bank account balance of the company has grown and the founding shareholders hold shares with a capital cost equal to what they paid to purchase those shares.   

For example, if a company with two equal founding shareholders wants to start off with $50,000 in start-up funds then each shareholder would subscribe for 25,000 shares at $1.00 each (or 250,000 shares at $0.10 per share, or 25 shares at $1,000 per share, or whatever other combination is desired). The company would have $50,000 in its bank account.

2. Shareholder Loans

Although this method is less known amongst first time entrepreneurs, it seems to be the most common way for closely held private corporations in Canada to be funded early on.

This is how shareholder loans work:

1. The founding shareholders subscribe for shares at a nominal valuation.
2. The founding shareholders then loan start-up funds to the new company. Usually these loans are interest free with no specified repayment date (repayable on demand).
3. The end result is that the bank account balance of the company has grown, but so have its liabilities to the founding shareholders. 

For example,  if a company with two equal founding shareholders wants to start off with $50,000 in start-up funds from shareholder loans then each of the founding shareholders would subscribe for an equal amount of shares at a nominal value, perhaps 5,000 each at $0.01 per share (i.e. $50 each). That would raise $100 from the initial share subscriptions and the founding shareholders would each hold 5,000 shares with a capital cost of $50. Each of the founding shareholders would then loan $25,000 to the new company. So, the new company would have $50,100 in its bank account but would also have a debt of $50,000 owing to its shareholders. 

3. Alternatives

There are many alternative methods of capitalizing a new company…pretty much as many alternatives as the imagination and law allow! 

Some common alternatives are:

• a mixture of capitalization through share subscriptions and shareholder loans,
• issuing debt instruments to private investors (such as debentures),
• entering into Simple Agreements for Future Equity (SAFE),
• rolling in assets from a related person, and
• loans from institutions (e.g. banks).

What is the best way to capitalize my new company?

Our entirely predictable answer is: It depends. 

The decision about how to capitalize your new company is specific to your particular situation. It’s a decision that ideally would be made with input from three perspectives: tax/accounting professionals, legal professionals, and business professionals. 

Here are some pros and cons of the common capitalization methods, to help you figure out what might be the best approach for your new company:

Share Subscriptions 

• Pro = The money is in the accounts of the company with no corresponding debt. That means that it automatically increases the value of the company. 
• Con = It locks more of the founding shareholders’ money into the company. The founding shareholders will not be able to get that money back until the shares of the company are sold or the company is wound up.

Shareholder Loans 

• Pro = Once the company generates excess revenues, the principal amount of the shareholder loans can be repaid to the founding shareholders tax-free. (There is no need to wait for the sale of the shares or for the company to wind up.)
• Con = The cash is tied to a corresponding liability to the founding shareholders, which is reflected in the books of the company.

Do I need to show a certain level of capitalization in my new company?

There is no general corporate law requirement for a new company to have a minimum level of capitalization. 

However, there might be other reasons why your new company needs to have a certain level of capitalization. 

Some common examples:

Business Immigration 

Suppose you have set up your new company in Canada as part of your plans to immigrate to Canada (or to facilitate the immigration of others to Canada). In that case, there may be minimum capitalization requirements for the immigration application. You should speak with your immigration lawyer to get specific instructions about what is required. 

Loans

It is common for business loans to include conditions that need to be met to receive and maintain the loan. One or more of those metrics might relate to the level of capitalization of the company. Speak with your banker or financier to clarify what exactly those metrics are.

Attract Investors

Investors might be more inclined to purchase equity in a company if they see that the founding shareholders also have a significant amount of funds tied up in the equity of the company (as opposed to shareholder loans). This becomes more of a strategic decision that you will make in discussion with your finance advisors and/or investors.

What steps do I need to take to capitalize my new company?

Once you have decided how to capitalize your new company you need to put in place appropriate paperwork to document how the company is being capitalized. 

The paperwork should be in two places: your corporate Minute Book and your bookkeeping records. And it’s important that the paperwork in those two locations match!

You can generate the paperwork for your Minute Book in one of these ways:

• If your company is not yet incorporated, you can easily take care of it by starting the incorporation process with Tobuso.

• If your company is already incorporated but not yet organized (no by-laws, no initial share subscriptions, etc.) then you can quickly take care of the organizing process with Tobuso.

• Contact Tobuso’s team if your situation is a little different, and we’ll see what we can do to help.

Once your Minute Book is updated with the correct paperwork, it’s easy as pie to share it with your bookkeeper! You will have all your records matching and up-to-date in no time!

Final Thoughts

We hope that this article is helpful for you in your efforts to figure out how to capitalize your new company. 

For more information about how Tobuso can help you, and your company, please visit us at tobuso.ca.