One of the first questions that you have to ask yourself when you’re incorporating a company is, what share classes are my company going to have? This is a question that needs to be decided by the time you go to incorporate the company because it is written into the documents that you submit to the government at the time of incorporation.
In this article, we give you some background information to help you understand share classes so that you are better informed when structuring the share classes for your company.
Before you dive into this article, it’s important to know that for the vast majority of companies, the simplest share structure is the best share structure: one class of common shares. We will explain that in more detail later on in the article.
What is a share class, and what’s a share structure?
To explain what a share class is we first have to go back to basics.
First, corporations are fictional creations that come about because of the laws that we have in place in Canada. But they are treated as people under the law. You can think of a corporation as a type of robot person.
Second, corporations are owned and controlled by people. The common roles that people fill within a corporation are director, officer, and shareholder.
Third, the owners of the corporation are called the shareholders. Each shareholder has some kind of ownership stake in the corporation. But one thing that’s really cool about corporations is that each shareholder does not necessarily need to have the exact same stake. You can actually be very creative with the different types of ownership stakes that can be held in a corporation.
If there are different ownership stakes in a corporation, then each type of ownership stake is grouped into what we refer to as a “share class”. The share classes of a corporation are collectively referred to as its “share structure” (There are also “series” of shares, which you can think of as subcategories within different classes of shares, but that gets a bit more complex and this article will not be covering that topic).
So, the term “share class” refers to a category of ownership stake in a company that has a specific set of rights and restrictions.
What rights and restrictions can share classes have?
There are many, many different rights and restrictions that can be assigned to different share classes.
The most common rights and restrictions are:
- voting rights,
- dividend rights,
- rights to property upon the dissolution of the company,
- retraction,
- and redemption.
Voting rights
Voting rights refer to the ability to vote at meetings of shareholders and to have your votes count.
Generally, shares with voting rights have a right to vote at all shareholder meetings and shares without voting rights do not have a right to vote at shareholder meetings or even to receive materials or notices of meetings. However, it’s important to keep in mind that even non-voting shareholders have the right to vote on certain existential questions such as whether to amend the articles of the company in a way that would alter the class of shares that they hold.
Voting rights can even be varied by giving certain classes of shares extra voting rights. For example, one class of shares might get 10 votes per share, while another class of shares might only get one vote per share.
Dividend rates
Dividends are payments that a corporation makes to its shareholders out of excess profits that the Corporation has in its accounts. (For more information about dividends, see our article about choosing the right time to declare dividends.)
Some classes of shares need to be eligible to receive dividends, but not all classes of shares need to be dividend-eligible.
Even within classes of shares that are eligible for dividends there can be variations and hierarchies built-in. For example, you can establish ranks so that certain classes of shares get priority to receive dividends over other classes of shares. You can also establish caps on how much of a dividend can be issued to shares in a particular class within a particular timeframe, such as on an annual basis. The nuances that you can build are almost endless.
Keep in mind, however, that the payment of dividends is almost always at the sole discretion of the directors, so even dividend-eligible shares might not receive dividends if there are not sufficient funds in the company’s accounts to pay those dividends. Directors have an important responsibility to ensure that the corporation can still pay its liabilities when they become due after dividends are paid out.
Rights to property on dissolution
What happens if a company is dissolved? Who owns all of the leftover assets, whether it be equipment, cash, real estate or inventory? Well, that’s what is dealt with in the rights to property on dissolution.
Within a company’s share classes, you can specify exactly what each share class’s rights are to the property of the corporation if it is dissolved. Some common descriptions of rights to property on dissolution are as follows:
- Right to repayment of original purchase price;
- Right to repayment of paid-up capital;
- Right to be paid the full value of preferred shares when preferred shares were issued in exchange for assets with a specific value (like on a section 85 rollover);
- Right to all of the remaining property upon the dissolution.
Keep in mind that these rights are not absolute and these rights are limited by whatever property is left over once the corporation has paid out all of its liabilities and satisfied all of its creditors, including the payment of taxes. So, a situation can arise where someone whose right to property on dissolution is not fully satisfied because there’s just not enough property left over after the dissolution to fully satisfy them. Again, similar to dividend rights, ranks can be added so that certain classes of shares get priority to the property on dissolution, and the remaining property does not pass to the lower-ranked share classes until the priority share classes are first fully fulfilled.
Redemption and Retraction
Redemption and retraction both refer to the corporation repurchasing the shares from the shareholder. With redemption, the corporation triggers the repurchase, and with redemption, the shareholder can trigger the repurchase. If a corporation has more than one class of shares, then in the share classes, you can establish whether the shares are retractable or redeemable and the conditions on which each of those events can happen.
What if I don’t specify rights and restrictions for the shares of my corporation?
If you incorporate a company with just one class of shares, then that single class of shares would be referred to as common shares. When there is just one class of shares all three of the core rights are assigned to that one class of shares: voting rights, dividend rights, and rights to property on dissolution. Written another way, if you do not specify what rights and restrictions are associated with the one class of shares in your corporation, then that class is deemed to have all three core rights: voting rights, dividend rights, and rights to property on dissolution.
Are there any rights and restrictions that need to be included in the share classes?
Yes, every corporation needs to make sure that all three of the core rights—voting rights, dividend rights, and rights to property on dissolution—are present somewhere in the share classes. They do not all need to be found in one share class, but they each need to be present in at least one class of shares in the company’s share structure.
Can there be two classes of identical shares?
Yes, absolutely, there can be two classes of shares that have identical rights. The most important thing to ensure is that somewhere within the share classes, there are voting rights, dividend rights, and the right to property on the solution.
What share classes should I use for my corporation?
If you are trying to decide what share structure to use for your new corporation, one way to approach it is to first step back and take a look at where things stand right now and where you expect to be in the immediate future.
To help with this, some questions that you can ask yourself are:
Who will be the shareholders at the beginning?
If there is just going to be one or two shareholders, then you should be able to keep the share structure pretty short and clean.
Is each shareholder expecting to have equal rights and responsibilities as a shareholder?
Or, would there be reasons to have separate rights and restrictions on the ownership stake held by different individuals? For example, if one of the shareholders was a family trust or a family member that was not very involved in the business then you might want them to hold non-voting shares. Or if you and your spouse are going to hold shares, then you might want to each hold different classes of shares so that dividends can be paid out to one of you and not the other depending on your other income sources throughout the year. If there’s a small group of people who will be the initial shareholders and everyone intends to be treated equally, then it would be a good idea for everyone to have the same class of shares in order to facilitate that.
Will there be any employee shareholders or any employee stock option plans?
If so, those shares are usually non-voting and are usually a separate class of shares from the class owned by the company.
Do you have a profitable sole proprietorship that you are now incorporating?
If so, you may need to do a section 85 rollover after the incorporation, and so you may need a separate class of shares to issue back to yourself personally in exchange for all of the value that you transferred personally from your sole proprietorship to the new corporation (see more below).
These are just some examples of the questions that you want to ask yourself at the beginning when you are figuring out what share classes to establish.
When asking these questions, it is really important to focus on the here and now. Try not to focus on where you hope to be in 2, 3, 4, or 5 years down the road. If you do that, then you might get bogged down in trying to create share classes for imagined scenarios down the road, and chances are that those imagined scenarios will not occur, or even if they do occur, then the share classes you design might not quite fit when it comes time to use them.
The approach of keeping it simple at the beginning seems to work best. Choose a simple share structure that works for your current situation.
Can I change my share classes in the future?
Yes, if you need to update the share structure in the future, you can always do that. In most jurisdictions, you need to file an amendment to the articles of incorporation in order to make those changes. You will need the existing shareholders to agree to those changes, but if it’s just one person or a small group of people involved in the company, then it’s likely that you will be able to do that with ease.
There are some government fees and costs associated with changing share classes by filing articles of amendment, but you can use the Tobuso platform to help you with the paperwork and keep costs reasonable.
What types of share classes are there?
Typical names for share classes are as follows:
Common Shares
This refers to shares that typically have all or some of the three core rights: voting, dividends, and property on dissolution. However, these shares usually rank below preferred and special share classes when it comes to dividend entitlements or entitlements to property on dissolution.
Preferred Shares
This typically refers to shares that have a fixed dividend right and first right to the profits and assets of the corporation upon dissolution. They are usually redeemable and retractable as well. For example, if someone transfers a piece of equipment to the corporation that is worth $140,000 in exchange for shares in the corporation, then that person might seek to be issued preference shares that have a fixed dividend right, a right to the profits and assets of the corporation upon dissolution up to the original $140,000, and a right to retract the shares.
Special Shares
This refers to shares that cannot be neatly categorized within another group and might have various combinations of rights and restrictions.
Please keep in mind that these names in and of themselves do not mean anything. What is important are the rights and restrictions associated with the share class in question. In fact, these terms can sometimes lead to more confusion. As an alternative, you can simply name your share classes as “Class A”, “Class B”, “Class C”, etc.
What are some typical share structures?
If you incorporate your company on the Tobuso platform, then you will see that we give you the option of choosing from some pre-defined share structures or creating your own customized share structure.
Some of those pre-defined share structures are:
“Keep it Simple” – one class of common shares.
This share structure is usually appropriate for the vast majority of companies that are just getting started. If you have a great opportunity, but it’s still in the initial stages, and you want to pursue it using a corporation, then this share structure is probably the right place to begin. This works well if you are on your own as a sole shareholder and it also works well if you are in a group of cofounders that each intend on being equal owners.
“Keep it in the Family” – two classes of identical common voting shares with one class of non-voting shares.
We call this share structure “Keep it in the Family” because it’s not an uncommon structure to see if there are two spouses who personally own shares in a corporation and then one class of non-voting shares, for example, owned by a family trust. The benefit of having two equal classes of common shares is that the spouses can decide whether each will receive dividends or whether just one will receive dividends.
For example, maybe one person has a job that brings in additional income and therefore has a higher income than the other spouse. In that case, maybe the spouse with the lower income wants to take a higher dividend than the spouse with the additional source of income. By having them own separate classes of shares with similar rights then you can do that. You can also pay out dividends to the family trust without paying out dividends to the other shareholders.
“Keep it Equal” – two classes of identical common shares.
This is similar to “Keep it in the Family”, except it does not have a non-voting class of shares. This is well suited if there are two spouses who own the shares, and they want flexibility around the amount of dividends paid out to each. This is not necessarily suitable for groups of cofounders who want to be treated equally, for which the “Keep it simple” share structure is probably still the best.
“Roll it Over” – one common class and one preferred class of shares:
If you are incorporating a company to carry on a business that you’ve been running as a sole proprietor, then, in theory, you, as an individual, are selling the sole proprietorship business to the new corporation. The Canada Revenue Agency (CRA) sees that as a sale from the individual to the corporation, which they see as a taxable event. So even though the new corporation is not paying you cash for the assets that you are transferring to the corporation, the CRA still wants to tax you and ask you to pay taxes on the proceeds of that sale. Luckily there is a way to defer the payment of those cash taxes, and that is what is referred to as a section 85 rollover.
You will need to get guidance from your accountant on whether a section 85 rollover is advisable in your particular situation. Your accountant will most likely do an assessment of the value of assets that you are transferring into the corporation and, based on that and other considerations, provide you with advice about whether or not you should pursue a section 85 rollover. But, if you anticipate that a section 85 rollover might be required, then you can incorporate your company with an appropriate share structure in place in advance. This “Roll it Over” share structure has one class of common shares and also one class of preferred shares. The preferred shares can be issued to you personally with a specific value assigned in exchange for the assets that you roll into the corporation from your sole proprietorship.
“Share the Love” – one class of common shares and one class of non-voting shares for an employee share ownership program.
This share structure is designed to have the founder(s) owning the common shares, which have all of the core rights attached to them, and then also have one class of non-voting shares to be owned and issued to employees.
Cautions
Please keep in mind that while these off-the-shelf pre-defined share structures might work for your situation, everyone’s situation is unique and might change over time. So, you may find that when it comes time for your business to grow in one way or another the pre-defined share structure that you’ve chosen needs to be amended and doesn’t quite work the way that it is now.
Again, you can make those changes by filing amendments with the government. There are government fees associated with the paperwork required, and you need the consent of directors and or shareholders, but it is relatively easy to do (especially once you’re on the Tobuso platform!).
If you are at all unsure about what share structure to implement or what rights and restrictions should be assigned to each share class, it is highly recommended that you consult a qualified lawyer to obtain advice specific to your situation.
Shareholders’ Agreements
One final caution. If there is more than one shareholder, then it is always highly valuable to have a shareholder agreement in place. What most people do not realize is that the articles of incorporation, bylaws, and corporate laws in Canada do not in and of themselves adequately deal with all of the potential disputes and events that can occur between shareholders in the life of a corporation. That’s where the shareholders’ agreement comes in to fill the void. Even though shareholders agreements are not mandatory they become invaluable later on in the life of a corporation when there are changes, disputes, and other events that arise.
We hope that this article provides you with some helpful information as you consider what share structure to implement for your corporation.
When it comes time to incorporate, you can easily incorporate using the Tobuso platform. You’ll get a comprehensive company formation service, including a digital minute book with all of the required documents, and your new company will be well set up for whatever life brings your way!
