Structuring Your Tech Startup
What starting capital structure should you use?
1. Types of Shares in a Corporation: A corporation can have one or more classes of shares. In Canada, when there is only one class of shares, it must include certain rights, such as the right to vote, receive dividends, and claim remaining assets upon dissolution. Additional classes of shares, like preference or preferred shares, may be created to attract specific types of investors, offering them different rights.
2. Timing of Creating Multiple Share Classes: Typically, preference shares are issued just before a financing transaction to accommodate investors' specific needs. Most technology startups start with one class of shares (common shares) unless assets are being transferred to the corporation, in which case simple preference shares may be issued to the transferor.
3. Dilution of Founders' Ownership: Founders should be aware that as the company grows and new investors come on board, their ownership percentage will likely decrease. To maintain control and ownership, founders may consider purchasing all the shares they intend to have at the time of founding.
4. Valuing Founders' Shares: Founders' shares are usually issued at a nominal price (e.g., $0.0001 per share) since the startup typically has little value at the time of founding.
5. Income Splitting: Founders can use income-splitting strategies to reduce the tax burden. This involves distributing income among family members in lower tax brackets. However, specific rules apply, and not all income-splitting options are tax-efficient.
6. Shares Held Directly by Family Members: This is the simplest way to allocate shares to family members. However, it can lead to fragmented ownership and may not be suitable for some family members, especially minors or those with limited financial experience.
7. Shares Held by a Family Trust: Using a family trust can provide more control and flexibility over share ownership. It allows the founder to decide when and how to distribute income to beneficiaries. However, it comes with costs and potential tax implications.
8. Shares Held by a Holding Company: Shares can be issued to a holding company controlled by the founder or family members. This approach offers concentrated ownership but may involve higher costs and tax considerations. The capital gains exemption might not be available through this structure.
9. Funding Shares: It is crucial that the family member, trust, or holding company subscribing for the shares uses their own funds to pay for them. If the founder funds the subscription or transfers shares after they've gained value, it can have tax implications.
This information is relevant to the legal and financial considerations when structuring a startup in Canada, particularly regarding share ownership and taxation. It's essential for founders to work with legal and financial professionals to make informed decisions based on their specific circumstances.
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