Legal advice during incorporation helps avoid ‘sleeper’ issues

By Staff

For B.C. business owners, it may seem simple and straightforward to self-incorporate online — but as Vancouver corporate lawyer Jonathan Reilly explains, there are several critical decisions to be made during this process that will affect the company for years to come.

“Incorporating is easy to do, which means it’s actually easy to do wrong without even realizing it. We have lots of clients for whom we help fix this later when it’s usually more expensive to fix than to just get right in the beginning,” says Reilly, founder of English Bay Law Corporation.

Reilly tells that businesses are required to make a number of decisions during the incorporation process that will impact their share structure, tax issues and governance in the future.

By improperly carrying out specific steps while self-incorporating, he says, “You can unwittingly restrict yourself in what might otherwise be certain flexibility, or you can hurt the business outright by doing things that will cause problems on the tax or governance front,” says Reilly.

For example, he says, for those incorporating in B.C., one of the most basic items to decide will be the rules by which the company operates.

“If you don’t have rules geared to your company, then by default, you get what are called Table 1 which are appended to the Business Corporations Act,” he says.

“The default rules contain special rights and restrictions, but when you incorporate a company, the incorporation portal doesn’t tell you that,” adds Reilly.

Another initial question will be whether there will be special rights and restrictions on the shares the company is about to create.

“That’s an important question if you’re a private company which most companies are. An example of a special right or restriction could be that no one can transfer their shares unless the directors consent. And in a family-held business, that might be a very important restriction,” he says.

Often, says Reilly, those who self-incorporate online are unsure about how to name the share classes.

“I’ve seen someone set up a share class and a sub-series of the same class when what they meant to do was set up two different classes. We can give you advice on how to structure, which shares vote, and which shares don’t. We’ve seen a client set up a company that had no voting shares. That makes it difficult to appoint or change directors,” he says.

Business owners may also be unsure of whether there should be a limit on their share capital — after limiting the share capital, he says, if the board of directors later issues a number of shares that is greater than the authorized amount, that may create a problem.

“Whether or not the share capital is limited affects the board of directors’ ability to issue more shares with or without the shareholders’ permission. So, if you’re all alone in the company, you may not care — you’re probably the director as well as the shareholder. But if you’re one of a number of shareholders who may be strangers to one another, you may care very much if the others can issue shares, not including you, and dilute you,” says Reilly.

Ultimately, says Reilly, entrepreneurs who are excited about starting their own company may opt to go it alone during the incorporation process and end up making up answers asked by the registration portal, for example, regarding the type or number of shares. They should be cautious about creating problems that will arise at a later date.

“A year or maybe five years later, your accountant might come to you and say ‘your shares aren’t eligible to pay dividends, but you’ve been paying dividends to yourself.’ Now you have a tax problem.

“Or you go to borrow money at the bank, and the bank says ‘Who are your directors?’ and it turns out, none of your shares have the right to vote, so how do we know if the directors are properly authorized?

“Some of these problems are sleepers — you don’t know you’ve got a problem until sometime later, and then it requires more work to fix,” says Reilly.

Instead, says Reilly, working with a lawyer to ensure the incorporation process is completed properly from the start can save businesses the expense and difficulty of fixing problems in the future.

“Incorporation is the foundation of their business, and if there are cracks in that foundation it gets very difficult to fix them later on,” he says.

“For us as lawyers, incorporating is an enjoyable time to meet and get to know a client — they’re often just starting out, you get to hear about the business they’re trying to build. You’re at the starting point of doing that, and we’re happy to help.”

To Read More Jonathan Reilly Posts Click Here