21 Questions: Incorporation Basics

Setting up an incorporation is often one of the first steps for a new company. However, that doesn’t mean it’s always the right place to start. Before taking the leap, it is crucial to understand exactly what a corporation is, and whether owning one makes sense for your business.

A corporation is a fictitious “legal person”. The idea of the corporation was to create a way to keep business interests, assets, and liabilities separate from the individuals behind those businesses. This separation will, ideally, ensure that the consequences of a business’ failures will not be borne by an individual and their family.

In Ontario, a corporation is created by filing a registration with the Ministry of Government and Consumer Services. Every new corporation is either assigned a number or named by its shareholders. When you register a new corporation, you must pay the filing fee, a separate fee for what’s called the initial return (first declaration of the company’s officers), and an additional fee for a name search (if required).

Every corporation is owned by what are called shareholders. There can be any number of shareholders in a corporation, subject to certain legal requirements. Each shareholder owns shares, which are themselves a fiction created to tangibly describe the division of ownership of a corporation. A share is considered to be property (like a car or furniture), and therefore has value. However, in a new corporation with no assets, that value will be very low. When a company has just started, the number of shares (ie. the number of pieces the corporation is divided into) can be decided by the shareholders. For example, a corporation with two shareholders may choose to issue (legal term for “give”) 50 shares to each shareholder.

The creator of a new company can say they own a million shares in their corporation, worth a million dollars each. Or they can say the corporation has one hundred shares, worth a dollar each. In either case, only the open market can truly determine the value of the business. However, it should be mentioned that overvaluing or undervaluing a corporation’s shares can have major tax implications.

Often, corporations that are just starting out choose to issue 100 shares at $1.00 each, as a matter of simplicity. The corporation can issue more shares in the future when needed. The issued shares are typically represented by share certificates, paper documents that list the number of shares a person owns. Because shares are a form of property, once issued, they are considered to be purchased and owned by the shareholder.

As a lawyer, when a client asks me about incorporation, it often sets off a stampede of questions. With the definitions and basics out of the way, I’m going to work 5W’s-style through some of the questions I ask to determine if a corporation is the right choice:    

1. Who?

Who are the shareholders, directors, and officers?

Shareholders own a corporation, directors are in charge of its day-to-day management, and officers (directors who hold the titles of president, secretary, and treasurer) are responsible for signing contracts, legal documents, and corporate resolutions. In a one-person corporation, one individual holds every role and title. As the corporation grows, the division of these roles becomes increasingly a matter of strategy, efficiency, and comfort for the business and its owners.

2. What?

What restrictions and structural elements does the corporation need?

When a corporation is registered, it receives from the government a document called the Articles of Incorporation that includes details such as the name of the corporation, the office address, and the names of the directors. When registering a corporation, the shareholders can decide to include specific restrictions that will be listed in the Articles. For example, many corporate articles include a restriction that shares cannot be transferred without the consent of a majority of the directors.

In the Articles, the shareholders can also decide to divide the shares into what are called classes. This is a way of dividing rights and obligations between shareholders. For example, a corporation can have “Class A” and “Class B” shares, and list in the Articles that only shareholders who own “Class A” shares can vote at shareholder meetings.

Another common way to split the rights of shareholders is by making a class of Preferred Shares. A holder of Preferred Shares is entitled to a dividend (a payout from the corporation’s accounts to a shareholder) any time dividends are given to any shareholders. So, if a corporation has Class A, Class B, and Class C shareholders, and only Class C is preferred, then any time the Class A or Class B shareholders are given a dividend, the Class C shareholders must be given a dividend as well.

Within the Articles, the shareholders can also set specific formulas for how dividends will be paid to different share classes, or they can leave dividend payouts to the discretion of the directors. If the Articles are left blank, all shares are deemed to be Common Shares, which all hold the same voting rights and are all deemed to be equal.

3. Where?

Should your corporation be incorporated federally or provincially?

Incorporating in Ontario is more expensive than incorporating federally; however, federal corporations have to pay an annual fee whereas Ontario corporations do not. Budgetary concerns aside, you do not need a federal incorporation simply because you sell goods/services to individuals in other provinces. Federal incorporations are preferable if the business will, from the outset, operate with offices or storefronts in multiple provinces. Otherwise, a provincial incorporation is likely more appropriate.

4. When?

Is this actually the right time to incorporate?

As soon as the corporation is created, administrative, accounting, and tax obligations arise. If the business is still gearing up or lacks the tax or liability incentives to necessitate incorporation, it may be worthwhile to wait.

5. Why?

Why does the client want an incorporation? Is an incorporation the best business structure for this particular business?

There are many business structures including not-for-profit, sole proprietor, partnership, incorporation, and more. Corporations often make sense for profit-oriented endeavours where there is a tax or liability-based incentive to isolate the earnings and liabilities of the endeavour (ie. food processing, sports and athletics, etc.)

And if I may throw in one more question, it’s “what’s next”? After incorporating, businesses need to keep a record of their articles, their bylaws (set of rules for governing meetings, audits, etc.), the share certificates, director registry, etc. This can be done through the creation of a minute book, a binder which holds the company records and resolutions (documents listing approved decisions of the directors or shareholders). In order to sell a business or to pass it on through an estate, having a minute book for your corporation is practically essential.

The new corporation should also consider entering into a shareholders’ agreement if there are multiple shareholders. As mentioned, shares are property, so if there’s no contract between the shareholders, each is free to treat their shares as they wish, even by selling the shares to a random person. A shareholders’ agreement is a contract between the shareholders. It sets rules that control the use and sale of the shares and assigns roles and responsibilities for the shareholders. It is the equivalent of a partnership agreement, meant to ensure the functionality of the business and the rights and obligations of its owners.

Lastly, the new corporation will have ongoing yearly requirements both in terms of government filings and internal requirements (including for annual meetings and audits, if necessary). It is crucial that a corporation work with an accountant and a lawyer on an ongoing basis. This will ensure that legal and tax requirements are met, while maximizing any potential financial benefits from the incorporation.

Ready to incorporate? Want to learn more? Send us an email – contact@smlegal.ca