Potential Problems from Not Customizing Incorporation to your Business

Contact Neufeld Legal PC for your incorporation legal work at 403-400-4092 or Chris@NeufeldLegal.com

It is very easy to overlook the importance of customizing one's business incorporation to meet the distinctive aspects of your business arrangements and structuring it for financial optimization. Instead, far too often individuals incorporate their new business without any serious consideration or professional consultation, such that they have an inadequate corporate structure that ultimately creates business problems and/or fails to optimize available financial and tax opportunities.

Taking full advantage of incorporating one's business, comes with customizing one's incorporation, as opposed to simply opting for a "generic" or "off-the-shelf" business incorporation, which doesn't account for the unique needs, goals, and complexities of your business and its ownership. Frequent problems arising from a generic business incorporation include:

A. Inadequate Share Structure and Shareholder Rights

• Problem: Generic Articles of Incorporation often come with a very basic share structure (e.g., one class of common shares with full voting rights). This "one-size-fits-all" approach is rarely suitable for businesses with multiple founders, investors, or plans for future growth.

• Consequences:

  • Disputes: Without clearly defined rights for different classes of shares (e.g., voting vs. non-voting, preferred vs. common, dividend rights, liquidation preferences), disagreements can easily arise among shareholders.

  • Difficulty in Raising Capital: Investors will demand specific share classes that protect their interests (e.g., preferred shares with liquidation preferences, anti-dilution rights). A generic structure makes it difficult to accommodate these needs without complex and costly amendments later.

  • Estate Planning Issues: If a founder passes away, a generic structure may not facilitate a smooth transfer of shares or determine valuation fairly, leading to family disputes or business instability.

  • Tax Inefficiencies: An optimal share structure can be crucial for tax planning strategies like income splitting or the Lifetime Capital Gains Exemption. A generic structure might miss these opportunities.

B. Lack of a Comprehensive Shareholders' Agreement

• Problem: While technically a separate document from the Articles, a "generic incorporation" often implies skipping or underestimating the need for a tailored Shareholders' Agreement. This agreement governs the relationship between shareholders and the corporation.

• Consequences:

  • No Dispute Resolution: Without clear mechanisms for resolving deadlocks or disagreements, disputes can paralyze the company or force its dissolution.

  • No Exit Strategy: What happens if a shareholder wants to leave, is fired, or dies? A generic setup won't address buy-sell clauses, valuation methods, or rights of first refusal, creating uncertainty and potential forced sales.

  • Lack of Control Provisions: How are major decisions made? Who has veto power? Without these defined, power struggles or operational paralysis can occur.

  • Unclear Funding Obligations: If the company needs more capital, who contributes and on what terms?

  • "Shotgun" Clauses: Without proper agreements, default legal provisions (like "shotgun clauses" in some provinces) can force a shareholder to sell or buy shares at an undesirable price.

C. Default Bylaws That Don't Fit the Business

• Problem: Most incorporations come with a standard set of general bylaws. While functional, they might not be tailored to the specific operational needs, meeting requirements, or internal governance preferences of a particular company.

• Consequences: Inefficient decision-making, unclear director/officer roles, or a failure to properly document corporate actions.

D. Failure to Address Industry-Specific Needs or Regulatory Compliance

• Problem: A generic incorporation won't consider the unique regulatory environment of specific industries (e.g., healthcare, finance, cannabis, real estate).

• Consequences: Non-compliance with industry-specific laws, licensing requirements, professional body regulations, or environmental standards, leading to fines, legal action, or loss of operating licenses.

E. Inadequate Protection Against Personal Service Business Rules

• Problem: For independent contractors, a "generic" incorporation done without understanding Personal Service Business rules can negate the tax benefits. If the contractor primarily serves one client and operates like an employee, the Canada Revenue Agency can reclassify them as a Personal Service Business, leading to higher tax rates and limited deductions.

• Consequences: Unexpectedly high tax bills, penalties, and a loss of the very tax advantages that made incorporation attractive.

F. Unoptimized Tax Structure

• Problem: While incorporation offers tax benefits, a generic setup might not fully leverage them. Proper tax planning involves more than just incorporating; it requires careful consideration of salary vs. dividends, holding companies, family trusts, and other strategies.

• Consequences: Missing out on significant tax savings, paying more tax than necessary, or creating unforeseen tax liabilities.

G. Overlooking Ongoing Compliance Requirements

• Problem: A "generic" incorporation might give a false sense of completion. Many entrepreneurs aren't fully aware of the ongoing legal and accounting obligations.

• Consequences: Failure to maintain a corporate minute book, neglecting annual corporate filings, not keeping corporate records updated, or missing tax deadlines. This can lead to the corporation falling out of "good standing," potential dissolution, and loss of limited liability protection.

H. Choosing the Wrong Jurisdiction (Federal vs. Provincial)

• Problem: A generic approach might default to a federal incorporation, or the perceived cost savings might motivate one to select a federal corporation, which all too often are illusory.

• Consequences: With increased disadvantages associated with federal incorporation, as compared to further advantages being availabel through provincial incorporation and other legal arrangements to provincially incorporated companies, as well as long term cost and administrative demands.

If you value the long-term success of business incorporation and optimizing available legal opportunities through customization, as opposed to simply accepting the basic minimums of a generic incorporation, contact a knowledgeable incorporation lawyer at 403-400-4092 or via email at Chris@NeufeldLegal.com to undertake your business incorporation to optimize its long-term potential.

Incorporation of an Independent Contractor Many job opportunities in the resource sector in Alberta (e.g., oil and gas, mining} are only available to you as an independent contractor (as opposed to an employee), with the principal company further requiring that as an independent contractor you provide your services through a corporation, which contracts with the principal company. As such, as part of accepting the work assignment, not only will you need to review and sign off on the independent contractor agreement, but also incorporate an appropriate corporation to perform the work. Read more.

Entrepreneur & Start-Up Incorporation Entrepreneurs and business start-ups in Calgary are incessentally focused upon the pursuit and development of their business enterprise, giving their full time and commitment to its advancement, such that it becomes important that you engage with an experienced corporate business lawyer to handle critical legal matters pertaining to your business' development, including the incorporation of a company through which you might best conduct that business enterprise. Read more.

Potential Problems from Not Customizing Incorporation to your Business It is very easy to overlook the importance of customizing one's business incorporation to meet the distinctive aspects of your business arrangements and structuring it for financial optimization. Instead, far too often individuals incorporate their new business without any serious consideration or professional consultation, such that they have an inadequate corporate structure that ultimately creates business problems and/or fails to optimize available financial and tax opportunities. Read more.