How Do I Set Up Share Classes for My New Corporation?
You May Want to Have More Than One Share Class
Question: How Do I Set Up Share Classes for My New Corporation?
When you are creating a new corporation in Canada and preparing your Articles of Incorporation, one of the things you will have to do is set up share classes. A share in a company represents a fractional part of the ownership of the company.
This article explains three share classes that may be used when setting up a new corporation in Canada (Common Voting Shares, Common Non-Voting Shares, and Preferred Shares) and explains when and why you might want to use each share class.
Single Share Class (Common Voting Shares)
Setting up share classes for a new corporation doesn't have to be complicated. As corporations are owned by their shareholders, you have to have one class of shares.
Legally, that's all a small, non-reporting corporation has to have – one share class of Common Voting Shares. These are distributed among all the shareholders, who then have the right to vote at any shareholder meetings, receive dividends as declared from time to time and receive the remaining property of the corporation on dissolution (after all the corporation's creditors are paid). (See Closing a Business for the steps required to dissolve a corporation.)
Note that a non-reporting corporation cannot be listed on a stock exchange. Reporting corporations can list their shares on an exchange; however, in order to do so they must adhere to a higher level of regulatory compliance and issue a prospectus to potential purchasers.
It is entirely possible to have a single shareholder; in that case, the person setting up the new corporation sets up the single share class so that he or she has one hundred percent of the shares. (Remember when it comes to shares, it's the percentage of shares that determines ownership, not the number.
One hundred percent of the shares may mean 1 share or 100,000 shares, depending on how many shares the corporate owners decide to issue when the corporation is set up.)
When one member of a married couple sets up a corporation it is quite common for the shares to be split between partners so the other member can receive dividends from the company. See Salary or Dividends - How Do I Pay Myself?
Multiple Share Classes (Non-Voting Common Shares)
So if one share class is all you need to have when you set up a new corporation in Canada, why would you want to have any more?
Well, maybe there are people you want to have as shareholders in your new corporation but you don’t want them to have the right to vote. For instance, you might want to assign shares to your children. Or you may want to use shares as a way to get employees more vested in your company – without giving them the means to determine company policy.
For these reasons and others, it's often advantageous to set up at least one other share class when you're setting up a new corporation, Non-Voting Common Shares. These shareholders would be entitled to receive dividends and have a place in line if your corporation ends up being dissolved, but would not be able to vote.
Corporation Canada's Incorporation Kit provides this example of such an arrangement of share classes for the Articles of Incorporation:
"The corporation is authorized to issue an unlimited number of Class A and Class B shares. The Class A shareholders shall be entitled to vote at all shareholder meetings, except meetings at which only holders of a specified class of share entitle their holders to vote and to receive such dividend as the board of directors in their discretion shall declare. Subject to the provisions of the Canada Business Corporations Act, the Class B shares shall be non-voting. Upon liquidation or dissolution, the holders of Class A and Class B shares shall share equally the remaining property of the corporation."
You may also wish to set up x number of share classes of Preferred Shares.
Preferred shares are just that from a prospective investor’s point of view; they offer shareholders advantages over shareholders that only hold Common Shares. Like Common Shares, they can be voting or non-voting, but other than that, the preferences are specified when the share class is created.
For instance, when you are creating your new corporation, you might set up a Class C of shares which are Preferred Shares that are non-voting but give shareholders of that class the right to collect dividends at a set amount and to be first in line (after creditors) if the corporation is dissolved.
Any number of Preferred Share Classes can be set up, each with distinct rights attached. This is why Preferred Shares are often used to try and entice people to invest and raise money for the corporation. In return for investing in a business, most Angel Investors and Venture Capitalists receive preferred shares which give them specific rights and privileges over those of the common shareholders.
So when you are setting up share classes for your new corporation, you want to consider who you want to participate in the corporation and what that participation will entail.
Issue Extra Shares for Future Use
One last point about setting up share classes. For future flexibility, it's a good idea not to issue all the shares in your corporation but to keep some in your Treasury. This makes it much easier to have new shareholders join the corporation later on and avoids getting into things such as fractional shares.
For the same reason, originally issuing a larger number of shares than a smaller number often turns out to be more convenient. For instance, if there are two shareholders in your new corporation and you issue only two shares, one each, you have none to sell to anyone else.
Tax Changes to Reduce "Income Sprinkling"
Beginning in the 2018 tax year the federal government introduced a number of changes to the tax code to curb so-called "income sprinkling", a tactic used by some higher-income small business owners to shift income to lower-taxed family members. Income sprinkling was typically accomplished by incorporating and issuing shares to a spouse and/or children, who could then be paid dividends in any amount in a given tax year.
The changes involve a so-called "reasonableness test", which requires that shareholders who receive dividends from a family business must be actively engaged in the business. To qualify for the lower tax rate a family member must:
- Be a spouse over age 65
- Be over 18 and make a "substantial labor contribution" of at least 20 hours per week (be sure to keep timesheets or logbooks of hours worked in case these are required by the CRA)
- Be over 25 and own 10 per cent or more of a business that earns less than 90 per of its income from the "provision of services"
Those who do not meet the requirements are subject to taxation at the marginal rate of the primary owner. Note that this does not apply to salaried employees - salaries are always deductible by the corporation (provided they are reasonable according to services rendered).