INCORPORATION AND BUSINESS GUIDE FOR ONTARIOM. Stephen Georgas, LLB

Self-Counsel Press(a division of)

International Self-Counsel Press Ltd.Canada USA

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Copyright © 1971, 2003 by International Self-Counsel Press Ltd.

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Library and Archives Canada Cataloguing in Publication

Georgas, M. Stephen, 1949–Incorporation and business guide for Ontario / M. Stephen Georgas.—18th ed.

(Self-counsel legal series)ISBN 978-1-55180-561-0

1. Incorporation—Ontario—Popular works. I. Title. II. Series.KEO403.Z82G46 2003 346.713'06622 C2003-905453-5

Self-Counsel Press(a division of)

International Self-Counsel Press Ltd.

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Canada USA

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CONTENTS

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PREFACE xi

ACKNOWLEDGEMENTS xii

1 INTRODUCTION TO THE INCORPORATED BUSINESS 1a. Methods of carrying on business 1

1. The sole proprietorship and partnership 12. The corporate entity and advantages to incorporating 33. Disadvantages to incorporating 4

b. Financial statements and their importance 51. Balance sheet 62. Profit and loss statement 63. Statement of retained earnings 7

c. Where to incorporate 7d. Public versus private corporations 7

1. Listed corporations 72. Non-listed offering corporations 73. Closely held (private) corporations 7

e. One-person corporations 10f. How many shares should you issue? 11g. Classes of shares 13

2 TAX ADVANTAGES TO INCORPORATING 16a. Basic corporate rate 16b. Qualifying for the small business tax rate 16c. Split your income 17d. Estate planning benefits 18e. Capital gains exemption 18f. Use salary and bonus accruals 18g. Expense deductions 19h. Planning for your retirement 19i. Loans to employees and shareholders 19j. Manufacturing and processing credit (M&P) 20k. Anti-avoidance 20l. Conclusion 21

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3 INCORPORATION PROCEDURE FOR AN ONTARIOCORPORATION NOT OFFERING ITS SECURITIES TO THE PUBLIC 22a. Summary of procedures 22b. Choosing a name 23c. Checking your name 25d. Business names 26e. Business licence 26f. Drafting the articles of incorporation 27

1. Name 272. Registered office 273. Number of directors 284. First directors 285. Restrictions 286. Class of shares 317. Rights, privileges, restrictions, and conditions on each class of share 318. Restrictions, transfer, and ownership of shares 319. Special provisions 31

10. Names of incorporators 31g. Consent to act as a director 31h. Consent by individual 32i. Consent to use of name of partnership or proprietorship 32j. Consent to use of name similar to existing corporation 32k. Filing the application 32l. The Business Names Act: Penalties 32

4 COMPLYING WITH GOVERNMENT REGULATIONS 46a. What other licences and permits do you need? 46b. Federal requirements and regulations 47

1. Goods and services tax 472. Federal excise tax 473. Customs duties 474. Federal income tax 485. Employment insurance 486. Canada Pension Plan 48

c. Provincial government requirements and regulations 491. Ontario Corporations Tax and Annual Returns 492. Licensing 493. Sales tax 504. Power to hold land 505. The Workplace Safety and Insurance Board 50

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d. Municipal government requirements and regulations you should know about 521. Licensing 522. Municipal taxes 523. Building requirements 52

e. Miscellaneous information you should know about 531. The metric system 532. Weights and measures 533. Packaging and labelling 534. Patents, copyright, trademarks, and industrial designs 545. Immigration and citizenship 55

5 POST-INCORPORATION PROCEDURES 56a. Purchase of minute book, seal, and share certificates 56b. Organizing the corporation 56

1. By-laws and resolutions 562. The general by-law 57

c. Banking arrangements 57d. Directors’ resolutions 67e. Shareholders’ resolutions 70f. Completion of various registers 71

1. Securities’ register 712. Shareholders’ ledger 723. Stock transfer register 724. Directors’ register 725. Officers’ register 72

g. The Initial Return and Notice of Change 72

6 HOW TO ISSUE, CANCEL, AND TRANSFER SHARES 77a. Introduction 77b. Subsequent issue of shares 77c. The Securities Act (Ontario) 81d. Transfer of shares 82

7 TRANSFERRING ASSETS INTO A NEW CORPORATION 85a. Federal income tax considerations 85b. Section 85 rollover 85c. Provincial tax considerations 87d. Goods and services tax 87e. Completing the transfer of assets 87f. Financing the transaction 88g. Loans to corporation and Limitations Act, 2002 (Ontario) 89

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8 DO YOU NEED A SHAREHOLDERS’ AGREEMENT? 91a. Right to nominate a director 91b. Pro rata rights and obligations 92c. Restrictions on the transfer of shares 92d. Buy-sell provisions 92e. Keep it simple 93

9 RUNNING YOUR CORPORATION SMOOTHLY 98a. Annual general meeting 98

1. Common items dealt with at a meeting 982. Why hold a meeting? 98

b. All about shareholders and directors 981. Your rights as a shareholder 1002. Shareholders’ liabilities 1023. Directors’ rights and duties 1024. Directors’ indemnification 1045. Appointment and removal of directors 104

10 HOW TO CHANGE YOUR CORPORATE NAME 105

11 HOW TO DISSOLVE YOUR CORPORATION 108

12 REGISTRATION OF OUT-OF-PROVINCE CORPORATIONS 115a. Canadian corporations 115b. Corporations incorporated outside Canada 115

APPENDIXDetailed checklist of steps to be followed 123

TABLE

1 Schedule of fees 22

SAMPLES

1 Business name registration form 22 Balance sheet 53 Balance sheet for unincorporated business 84 Balance sheet (where 10 shares are issued) 145 Balance sheet (where 10,000 shares are issued) 156 Letter to name search organization 287 Name search form 298 Statement of name registration 309 Articles of incorporation 3410 Consent to act as first director 40

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11 Consent by individual 4112 Consent and undertaking (by partnership) 4213 Consent and undertaking (by corporation) 4314 Letter of submission 4415 Stamped articles of incorporation 4516 A general by-law 5817 Directors’ resolutions 6818 Shareholders’ resolution appointing accountant 7019 Consent to exemption from audit 7120 Shareholders’ resolution on election of director 7221 Initial Return — Form 1 7522 Completed share certificate 7823 Cancelled share certificate 8024 Directors’ resolutions to issue shares 8325 Directors’ resolutions to transfer shares 8426 Demand promissory note 9027 Shareholders’ agreement 9428 Resolution of annual general meeting 9929 Articles of amendment 10630 Resolution for dissolution 11031 Consent of creditors to dissolution 11032 a. Articles of dissolution — Form 10 111

b. Articles of dissolution — Form 11 11333 Initial notice of extra-provincial company — Form 2 11734 Application for extra-provincial licence 11935 Appointment of agent 122

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NOTICE TO READERS

Laws are constantly changing. Every effort is made to keep this publication as current aspossible. However, the author, the publisher, and the vendor of this book make no repre-sentations or warranties regarding the outcome or the use to which the information in thisbook is put and are not assuming any liability for any claims, losses, or damages arisingout of the use of this book. The reader should not rely on the author or the publisher of thisbook for any professional advice. Please be sure that you have the most recent edition.

Note: The fees quoted in this book are correct at the date of publication. However, feesare subject to change without notice. For current fees, please check with the court registryor appropriate government office nearest you.

Note: The CD-ROM included with this kit contains a link to applicable updates. Pleaseeither:

• install the CD-ROM on your PC and check for updates to ensure you have the mostcurrent information, or

• visit http://www.self-counsel.com/updates/inc/onincorp/2008upd.htm.

Government updates can occur frequently and without notice, so checking for updatesis required. For further inquiries, please contact Customer Service toll free at 1-800-663-3007, or email service@self-counsel.com.

Online updates allow Self-Counsel to keep costs lower and pass the savings on to you,as well as provide you with the most current information at any given time.

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The purpose of this book is to provide suf-ficient information of a legal and practicalnature to assist you in understanding in-corporation procedures and to enable youto incorporate your own corporation.

By following the procedures set out inthis book, you can save a substantialamount in legal fees for incorporating acorporation.

The book applies to a corporation thatdoes not offer its securities to the public —in other words, the “private corporation.”

By explaining each step of an actual in-corporation, the book will not only enableyou to incorporate your own corporation,but will also provide information to helpyou maintain your corporate status. Onceyour corporation is incorporated, you mustattend to various matters on a continualbasis to preserve that status.

If questions of a complicated naturearise, such as tax, estate planning, share-holders’ agreements, or basic structural

xi

PREFACE

corporate changes, you should seek com-petent legal and accounting advice.

In any case, it is recommended thatcompetent professional help be sought asyour business grows and with it your needfor legal, accounting, financial, and otheradvice. This book is not meant to circum-vent or to derogate from the value of pro-fessional help. It is meant as an aid topeople who desire to incorporate and whosimply want to become acquainted withthe legal and practical implications of incorporation.

The incorporation procedures set out inthe book apply only to “profit-making”businesses, not clubs, social corporations,co-operatives, credit unions, or the like.

The act governing the incorporation of businesses is administered by the Min-istry of Government and Consumer Ser-vices, Companies and Personal PropertySecurity Branch (CPPSB), whose membershave been most co-operative and helpful inproviding valuable assistance.

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I would like to express my gratitude to Paul Edmonds and Gerry Courage, lawyers withthe law firm Miller Thomson, LLP, for their assistance in editing Chapter 2, and to Cather-ine D’Aversa, Director of Corporate Services with Miller Thomson, LLP, for editing thisedition of the Guide.

ACKNOWLEDGEMENTS

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Note: The CD-ROM included with this kit con-tains a link to applicable updates. Please installthe CD-ROM on your PC and check for updatesto ensure you have the most current information,or simply visit www.self-counsel.com/updates/inc/onincorp/upd.htm. Government updates canoccur frequently and without notice, so installa-tion of the CD-ROM is required.

You are probably already engaged in asmall business or are thinking about start-ing one, either by yourself or with someoneelse. One of the first decisions to make iswhether your business “vehicle” should bea proprietorship, a partnership (two ormore persons), or a limited corporation.

a. METHODS OF CARRYING ONBUSINESS

Whether you run a small corner store or alarge business like General Motors ofCanada Limited, there are only three waysto carry on any business: through a corpo-ration, as a sole proprietor, or as a partnerin a business. There are also special entitiessuch as organizations engaged in charita-ble or semi-charitable enterprises. These donot concern us here, and therfore will notbe discussed.

1. The sole proprietorship andpartnership

You are free to carry on business underpractically any name you or your partnerschoose, subject to a possible “passing off”action for appropriating someone else’sname or a trademark infringement action.It is important to realize, however, that thelaw does not recognize the name of a proprietorship or partnership and, in any

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legal action, the proprietor and/or partnersmust be named personally.

For example, Joe Citizen, carrying onbusiness as XYZ GROCERY, if sued, wouldbe named as “JOE CITIZEN carrying onbusiness under the firm name and style ofXYZ GROCERY.” The legal consequencesof carrying on business in this fashion areexplained later on.

The assets of a proprietorship belong tothe individual parties and not to the busi-ness. Further, parties carrying on businesseither as a proprietorship or partnership arepersonally liable for any debts they incurthrough the business in favour of third-party creditors.

In addition, partners are fully liable fordebts incurred by each other while actingin the course of business. That is, they arejointly and individually liable, regardlessof the proportionate capital contribution ofthe individual parties.

It is important to realize that you maybe deemed in partnership with someoneeven though you have made no formal dec-laration of such a partnership. (See Sample1 for an example of a formal declaration.)This is because a partnership is created bythe relationship of the parties and not byany formal act or documents signed by theparties.

According to the Business Names Act(Ontario), you can register a proprietorshipor partnership with the Ministry of Gov-ernment and Consumer Services (MGSC) bycompleting a registration form availablefrom the Companies and Personal PropertySecurity Branch (CPPSB) and paying $80

1INTRODUCTION TO THE INCORPORATED BUSINESS

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SAMPLE 1BUSINESS NAME REGISTRATION FORM

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for registrations done by mail. (Electronicfiling is also available, for $60. Go towww.mgs.gov.on.ca.)

There is no established definition ofwhat constitutes a partnership, althoughthe following questions are a guide.

(a) Is there a sharing of net profits andlosses?

(b) Do any of the parties act as agentsfor the others?

(c) Is there any property held in jointtenancy?

(d) Is there any implication of partner-ship on your firm’s letterhead or inits correspondence?

(e) Is the nature of the work relation-ship that of a partnership?

2. The corporate entity and advantagesto incorporating

Many people prefer to carry on business asa corporation because a corporation is a dis-tinct legal entity, an artificial person quitedifferent from the people who are its share-holders. When you incorporate, you actu-ally create a new person in the eyes of thelaw. The assets and debts of a corporationbelong to it — not to the individual share-holders. Because of this, there are four majoradvantages for people who incorporatetheir business.

(a) There may be a greater source ofcapital available than in a partner-ship. Since the corporation is a“person,” separate from its share-holders, people may invest moneyin it without accepting any furtherresponsibility for conducting thecompany business, and withoutworrying about becoming liable forthe debts of the “corporation.”

(b) Since the corporation is a separate“person,” it does not expire whenthe shareholders die. Substantial es-tate planning benefits result fromthis aspect of incorporation.

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(c) The most advantageous and uniquecharacteristic of a corporation is itslimited liability, and this is why cor-porations are referred to as “limitedcompanies.” The words “Limited,”“Limitée,” “Ltd.,” or “Ltée”; “In-corporated,” “Incorporée,” or “Inc.”;“Corporation” or “Corp.” must ap-pear in the names of all corpora-tions.

This means that as a shareholder youare not liable for any act, default, obliga-tion, or liability of the corporation, withcertain exceptions. This is obviously an im-portant advantage. However, There arecertain practical considerations to make.The most important one being that, in manyinstances, creditors, particularly banks, willnot extend credit to a small corporationwithout your personal guarantee as a share-holder. However, if you do not personallyguarantee your corporation’s loans, thenyour liability as a shareholder is limited.

The following examples illustrate theforegoing principles:

Example 1

John Doe and Jack Doe carry on business as apartnership known as J&J Industries.

J&J Industries incurs debts of $25,200.

The assets of J&J Industries are $10,200.

A creditor successfully petitions J&J Indus-tries into bankruptcy or simply gets a judgmentagainst J&J Industries.

All the assets of John Doe and Jack Doe, asindividuals, including possibly their homes,cars, etc., may be executed against to repay the$15,200 debt incurred by the partnership overand above its assets.

Example 2

John Doe and Jack Doe carry on business as acorporation known as J&J Industries Limited,with John Doe and Jack Doe the only share-holders, each having purchased one share at $1 (although any number of shares can be purchased).

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J&J Industries Limited incurs debts of $250,000.

The assets of J&J Industries Limited areconsidered to have a market value of $100,000.

A creditor successfully petitions J&J Indus-tries Limited into bankruptcy.

The creditors can realize $100,000 on the as-sets of the corporation but they have no rightsagainst John and Jack as individuals, regardlessof the value of personal assets that John andJack may own outside the corporation. Thecreditors are creditors of the corporation, not ofJohn and Jack.

In arranging credit with a financial in-stitution, it may be advisable, if not neces-sary, to arrange for life insurance on thelives of the shareholders. Depending onhow the policy is arranged, different in-come tax consequences may arise, so pro-fessional advice should be sought.

(d) The tax advantages of incorporat-ing are so important that a wholechapter has been devoted to thesubject (see Chapter 2).

To summarize, there are three mainlegal forms an organization can take. Theseforms and their individual characteristics areoutlined briefly below for quick reference.

Proprietorship

• Unincorporated

• Owned by one person

• Creditors have a legal claim on boththe investment in the business andthe personal assets of the owner

Partnership

• Unincorporated

• Each partner has unlimited liabilityin a general partnership arrange-ment

• The acts of one partner in the courseof the management of the businessare binding on the other partners

• The partnership dissolves upon thedeath or withdrawal of any partner,or upon the acceptance of a newpartner

• Creditors have a legal claim on boththe investment in the business andthe personal assets of the owners

Corporation

• Incorporated in most provinces byMemorandum of Association or Ar-ticles of Incorporation, or federallyby Articles of Incorporation

• Exists as a separate legal entity

• Shareholders are not liable for anyact, default, obligation, or liabilityof the corporation, with certain exceptions

• May possess tax advantages

3. Disadvantages to incorporating

First, operating through a corporation doesentail extra paperwork. You have to main-tain minutes of your meetings and writtenresolutions, and keep registers. You have tofile two tax returns: one for your corpora-tion and one for yourself. There may be ad-ditional government paperwork to do fromtime to time, which could be avoided byoperating as a sole proprietor. Also, there isthe cost of setting up and maintaining aminute book and records office (see Chapter 5).

Second, any active business income inexcess of $300,000 per year does not enjoythe small business tax incentive; income atthis level attracts normal corporate taxrates. However, I assume that this situationapplies to so few people that further com-ment is unnecessary.

Third, there is the cost and bother ofdoing the incorporating. By the time youare finished, you will have spent approxi-mately $500 (in disbursement costs) and afew hours of your time. Is it worth it? Onlyyou can judge.

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b. FINANCIAL STATEMENTS ANDTHEIR IMPORTANCE

Regardless of what the law says and nomatter what legal form an organizationmay take, the preparation of meaningful fi-nancial statements is vital to any enterprise.This is because various people will have aninterest in the financial affairs of the organ-ization, namely, owners, managers, credi-tors, Canada Revenue Agency (CRA), andprospective buyers.

To illustrate, assume that you are abank manager and that J&J Industries Lim-ited, a medium-sized corporation in thebusiness of manufacturing, approachesyou for a $100,000 loan. The principal ex-plains that the funds are necessary for plantexpansion. As a prospective creditor youwould be interested in two things: the abil-ity of J&J Industries Limited to pay the reg-ular instalments of principal and intereston the loan, and the amount you — thebank — would recover if the corporationcould not meet its obligation. To satisfyyour curiosity, you would have to examinethe financial statements of the corporation.The annual income would be shown on theprofit and loss statement. This figure, ifcompared with the income from prior peri-ods, would indicate to you the rate of eco-nomic growth of the enterprise.

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In addition, you would be able to deter-mine whether or not enough total revenueis generated to repay the proposed loan.The balance sheet of the corporation wouldindicate any other long-term debt forwhich the corporation is liable. Further-more, you would be able to determinewhich assets (inventories, accounts receiv-able, etc.) are available as security for theproposed loan.

The corporation’s ability to pay its cur-rent obligations is another important indi-cator of the economic health of theenterprise. This ability to pay present debtswhen due can also be determined from thebalance sheet. This indicator is expressedas a ratio (called the “current ratio”) and iscalculated by dividing the total of the cur-rent assets by the total current liabilities.This is illustrated with the very simple ex-ample in Sample 2.

Current assets exceed current liabilitiesin the ratio of 2:1. In other words, the work-ing capital position of the corporation inthis case is healthy.

In summary, you would obtain much ofthe information vital to your decision re-garding the loan would be obtained bylooking at the financial statements of J&JIndustries Limited.

SAMPLE 2BALANCE SHEET

J&J INDUSTRIES LIMITED

March 31, 20--

Current Assets Current Liabilities

Cash $ 20,000 Trade payables $100,000

Accounts receivable 290,000 Wages payable 10,000

Inventories 90,000 Current portion oflong term debt 90,000

TOTAL $400,000 TOTAL $200,000

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This illustration shows how financialstatements can be useful to potential credi-tors. Furthermore, financial statements areuseful to anyone who has an interest (mon-etary or otherwise) in an enterprise. As ananalogy: just as certain medical imple-ments are the tools by which a doctor canget some indication of physical health, sofinancial statements are the tools by whichinterested parties can measure the eco-nomic health of an organization.

Below is a breakdown of the three majorfinancial statements: the balance sheet, theprofit and loss statement, and the state-ment of retained earnings. They are dis-cussed here to enable you to get some ideaof the function and contents of financialstatements.

1. Balance sheet

The balance sheet is a position statement,not a historical record, and shows what thebusiness owns and owes at a given date.There are three sections to a balance sheet:assets, liabilities, and owner’s equity.

(a) Assets

Current assets are those that will be used upwithin one year of the current balance sheetdate. Normal valuation of such assets is atoriginal cost or market value, which-ever islower.

Fixed assets are those that will providebenefits to the organization over a longerperiod than the one year from the currentbalance sheet date. Valuation is generally atoriginal cost minus accumulated deprecia-tion. The amount of depreciation is basedon the length of the useful life of the assetand the original cost of the asset.

To illustrate:

Building: original cost $20,000

Useful life: 10 years

Portion of asset cost that expires in eachperiod:

$20,000 = $2,00010

This type of depreciation is normallycalculated on a reducing balance basis, butfor illustrative purposes, I have used thestraight line method. The sum of $2,000 ischarged to the profit and loss statement ineach period and is accumulated on the bal-ance sheet as a reduction of the originalcost of the asset. Thus, five years after thebuilding was purchased, the balance sheetwould show:

Building, at cost $20,000

Less accumulated depreciation(5 x $2 000) $10,000

Book value of building $10,000

Because the asset may be sold for morethan the original cost, the book value doesnot necessarily indicate the amount the eq-uity-holders should receive for their own-ership of the building. (Note: “Equity-holders” in a corporation are shareholders.)

(b) Liabilities and owner’s equity

Liabilities are those things that are owed bythe company to others, both on a short-term and a long-term basis, and includethings such as accounts payable, bankloans, and unpaid taxes.

Owner’s equity is determined by sub-tracting liabilities from total assets and itrepresents the value of the owner’s share-holding for accounting purposes. Thisvalue may very well be different from thefair market value of the owner’s sharehold-ing because fair market value can only bedetermined from what an arm’s lengthpurchaser would be prepared to pay for theshareholdings, and not necessarily whatthe shareholdings are valued at for ac-counting purposes.

2. Profit and loss statement

This statement indicates the profit or lossby subtracting the total expenses of a period

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from the total revenue for that period.There are two ways of determining whenrevenue is earned and when expenses areincurred. They are —

(a) Cash basis — No revenue is recog-nized until cash is received. No ex-penses are recognized until cash ispaid out.

(b) Accrual basis — Revenue is recog-nized as soon as it is earned. Ex-penses are recognized as soon asthey are incurred. The date cash isreceived or paid out is irrelevant.

3. Statement of retained earnings

The statement of retained earnings showsaccumulated retained earnings from yearto year. Added to the opening balance of re-tained earnings for the year is the currentyear’s net profit (after income tax). Fromthat sum, dividends declared and paid aresubtracted to arrive at a closing balance forthe current year.

The closing balance is summarized onthe balance sheet in Sample 3 as the entryRetained Earnings and Partners’ Equity.

The closing balance for the current yearbecomes the opening balance for the fol-lowing year.

c. WHERE TO INCORPORATE

Since a corporation is an artificial person, itmust be created by someone. A corporationmay be incorporated or “born” by a certifi-cate of incorporation granted under eitherthe Canada Business Corporations Act orthe Business Corporations Act (Ontario).

The advantage of incorporating feder-ally is that the corporation has the capacityof a natural person and protection of itscorporate name on a nationwide basis. Aprovincially incorporated corporation hasthe capacity of a natural person only in theprovince of incorporation (although thereare provisions for registration in otherprovinces).

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For most “non-public” (i.e., small, pri-vate, family-owned and operated corpora-tions), it is much more convenient toincorporate a provincial corporation. Thisbook deals with Ontario corporations only.

d. PUBLIC VERSUS PRIVATECORPORATIONS

For purposes of Ontario corporation law,corporations can be of three types: listedcorporations, non-listed offering corpora-tions, or closely held (private) non-offeringcorporations.

1. Listed corporations

Under this category are included most ofthe well-known, large public corporationsthat have stock that is actively traded onone or more recognized stock exchanges.This book does not discuss this type of organization.

2. Non-listed offering corporations

Under this category are all corporationswith shares that are “publicly” held, but forone reason or another are not listed andtraded on a recognized stock exchange. Themost common example is the over-the-counter stock.

This book does not cover this type oforganization because such corporations are“public” as far as the Ontario SecuritiesCommission is concerned, and as such, arerequired to comply with the rules and reg-ulations of the Ontario Securities Commis-sion regarding issuing of prospectuses andother items.

3. Closely held (private) corporations

Obviously, not all corporations are incorpo-rated for the purpose of selling shares andraising large amounts of capital. The gen-eral advantages of incorporation are ex-plained earlier in this chapter. A differenttype of corporation was created by bothprovincial and federal legislation to give

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ASSETS

Current Assets

Cash on hand and in bank $720.12

Accounts receivable less allowance fordoubtful accounts $657.72

Merchandise inventory valued at thelower of original cost or market $3,212.63

Prepaid expenses $157.55

Total current assets $ 4,748.02

Fixed Asset — At Cost

Land $2,320.00Building $5,767.16Less: accumulated depreciation $1 727.92 $4,039.24

Store fixtures $3,726.12Less: accumulated depreciation $982.36 $2,743.76

Delivery truck $2,760.20Less: accumulated depreciation $513.60 $2,246.60 $11,349.60

$16,097.62

LIABILITIES & PARTNERS’ EQUITY

Current Liabilities

Trade Accounts payable $2,772.18Accrued wage $75.20Employees’ income tax payable $60.16Accrued real estate taxes $220.00

Total current liabilities $ 3,127.54

Retained Earnings and Partners’ Equity*

Jones’s share $6,484.84Smith’s share $6,484.84

$12,969.68

$16,097.22

*If the company was incorporated, this would read as follows:

CAPITAL STOCKSCommon stock, no par value, maximum selling price $1Authorized — 10,000 shares

Issued and fully paid for:Jones — 50 shares at $0.01 = $0.50Smith — 50 shares at $0.01 = $0.50

Retained earnings $12,969.68

You will note that Jones and Smith still have equity of a total of $12,969.68.

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SAMPLE 3BALANCE SHEET FOR UNINCORPORATED BUSINESS

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small businesses the advantages of incor-poration.

Private corporations can be thought ofas “incorporated partnerships” rather thanas corporations as we normally view thembecause they usually consist of one, two, orthree people who are close personal friends,business associates, or family members.

Another important distinction to keepin mind is that in public corporations thedirectors, officers, and shareholders areoften separate individuals. However, inprivate corporations, each individual mayhold two or three positions in the corpora-tion. For example, it is not unusual for oneperson to be, at the same time, a share-holder, officer, and director.

The directors on the board of a publiccorporation are usually a group of busi-nesspeople respected in the communitywho bring to the board a wide variety ofbusiness experience. Their function is to actas “watchdog” over the officers and to pro-tect the shareholders’ interest.

Most officers of large public corpora-tions are “hired professionals” and they arein charge of the day-to-day activities. Inmany instances they also wield the greatestinfluence on the overall operations of thecorporation.

Usually the two or three top officers ofthe corporation are also members of theboard of directors.

The last group in a public corporation,but certainly the largest in terms of num-bers, is the shareholders. In public corpora-tions this group is the “owner” of thecorporation, which in turn owns the assets.Shares represent ownership. However,ownership of shares does not usually vestin the shareholder the right or power to runthe corporation.

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In theory, the final authority for a cor-poration’s operation rests with the share-holders. In the reality of public corporations,shareholders may choose not to exercisethis right for many reasons.

Shareholders are often spread all overthe country, so very few attend the annualmeeting. Most shareholders want only a re-turn on their investment (dividends) andan increase in value of their shares; they donot want to run a corporation. If the corpo-ration does not perform satisfactorily, theshareholders may simply sell their sharesrather than call the management or direc-tors to task or replace them. Furthermore,many shareholders lack the competenceand business experience necessary to runthe business properly so they hesitate toquestion the activities of managing officersor directors.

Finally, the usual wide dispersal ofshareholders means that it would take agreat deal of time, money, and effort for agroup of reform-minded individuals toobtain enough support to seriously chal-lenge the management or directors of thecorporation.

If you were to visualize the hierarchy ofa public corporation, it would look like this:

XYZ LTD.

BOARD OF DIRECTORS

elect hire and fire protect interests of

OFFICERS

SHAREHOLDERS(owners of the company)

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All corporations must have directors,officers, and shareholders. One distinctionbetween public and private corporations isthat in public corporations these positionsare generally occupied by different persons.A vice-president in a public corporationmay not necessarily be on the board of di-rectors and will generally not own enoughshares of the corporation to affect corporatepolicy from a shareholder’s position. His orher effect on the operations of the corpora-tion will derive solely from his or her posi-tion as an officer of the corporation.

In a private corporation, these positionsare usually occupied by the same people.For example, if you have a “family” corpo-ration in which the husband has 50 percentof the shares, the wife 25 percent, and a sonthe other 25 percent, it is likely that thesepeople will be the sole directors.

You need at least one director and thedirector(s) may appoint officers and spec-ify their duties. Be careful not to confusethese positions, even though the people oc-cupying them are the same. In a privatecorporation, you are often wearing morethan one hat at the same time.

To illustrate, in the day-to-day activitiesof your small business, you are wearing thehat of an officer. If you decide, however, tobranch out into a new area or to purchaseor sell significant assets, you are wearingthe hat of a director. (Important mattersthat will have considerable effect on the cor-poration are usually referred to the boardof directors.) When you attend and vote atthe annual meeting, or buy or sell shares,you are acting as a shareholder. The share-holder always has the final say on any seri-ous issue because shareholdings representownership of the corporation.

You will find instances in which “part-ners” in a business, on a day-to-day level,are not 50/50 owners of a corporation on ashareholding basis. This is one of the greatdangers of incorporating a small business.

The minority shareholder (less than 50 percent) is usually in a precarious positionin relation to the majority shareholder(more than 50 percent).

I suggest that if you are in an incorpo-rated “partnership” with another personwho is not related to you, that you prepareand execute a shareholders’ agreement thatlays out the rules for the everyday manage-ment of the corporation.

You might ask what will happen whenthere is a basic disagreement over someissue and a deadlock results. The answer isthat either the assets are sold and the busi-ness is wound up or one party buys out theother. This reflects the basic nature of a pri-vate corporation, which is that of an incor-porated “partnership.”

We all know what happens when part-ners in a business have an irreconcilabledifference. The same is true in a small cor-poration. But a 50/50 split of the shares doesencourage co-operation. When this balanceis altered it will affect the personal relation-ship of the “partners.”

Remember, this book discusses onlythose corporations not offering securities tothe public. The distinction between corpo-rations that offer securities to the publicand corporations that do not is importantand must be kept in mind, particularly forgrowing organizations seeking alternativemethods of raising capital financing.

e. ONE-PERSON CORPORATIONS

Both the Canada Business CorporationsAct and the Business Corporations Act(Ontario) allow the formation of a one-person corporation. This means that oneperson may be the president, secretary, soledirector, and sole shareholder.

The evolution of one-person corpora-tions recognizes that many persons are inbusiness solely for themselves. (This is theso-called incorporated proprietorship.)

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The procedures for incorporation areessentially the same for the one-person cor-poration as for the two-or-more-personcorporation, but from a practical stand-point, the one-person corporation gener-ally approves corporate transactions bypassing a director’s resolution rather thanby holding a meeting (see Chapter 5 forfurther details).

f. HOW MANY SHARES SHOULDYOU ISSUE?

After the new corporation is incorporatedand organized, it will require financing inorder to begin operations. Capital flowsinto a business in two ways:

(a) By investing in shares (i.e., equitycapital)

(b) By lending money to the businessin some form or other (i.e., share-holder loans, bonds, debentures)

There are some definite advantages tocapitalizing a business through loans, asopposed to buying shares, especially ahigh-risk business such as a newly “incor-porated partnership.”

First, capital “loaned” to the corpora-tion, as opposed to “invested” in the cor-poration, can be repaid at any time taxfree. That is, a loan to the corporation re-paid to a shareholder is not income to theshareholder.

On the other hand, money invested inshares usually can’t be repaid without taxconsequences.

Second, if the new corporation has fi-nancial difficulties, a shareholder loan willgenerally rank equally with the other cred-itors when dividing up the remainder ofthe assets, and ranks ahead of repaymentto the shareholders for money invested inshares. Common shareholders rarely seeany proceeds when a corporation goesbankrupt or goes out of business.

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Third, by minimizing the number ofshares, you keep the initial capital invest-ment at a minimum.

There is simply no advantage in financ-ing the corporation only by issuing shares.In most simple incorporation situations,there is no real need to immediately issueall of the shares that you incorporated withto shareholders. The unissued shares re-main in the company treasury and belongto the corporation itself until it becomesnecessary to issue them to new sharehold-ers. Just visualize all unissued shares as sit-ting in a large pot labelled “Companytreasury” until directors’ minutes issuingthem to new shareholders are drawn upand filed in the minute book.

If a corporation is incorporated with anunlimited number of shares and there areonly two shareholders, then only one shareneeds to be issued to each of them. If theyeach have an equal number of the issuedshares, their interests are the same as if theyhad each taken 5,000 of the corporation’sshares.

If you look ahead in the book at themodel set of Articles of Incorporation (seeSample 9 in Chapter 3), you will see thatthe sample corporation is capitalized withan unlimited number of shares. Out of this“pool,” 10 shares have been issued to theincorporator, John Doe, for a price of $10,which should be deposited into the corpo-ration’s bank account.

As an alternative to issuing only 10shares, you may want to consider issuing 1,000 shares at 10 cents per share. This way,it will be easier to sell any of these shares toanother person because each share willhave a lower value than if only 10 shareswere issued. Similarly, it will be easier for anewcomer to your corporation to subscribefor shares from the company treasury, sinceeach share would have a lower value thanif only 10 shares had been issued initially.

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A final and most important reason forlimiting the number of shares you issue, isthat if your business is successful, you maywish to bring in other “partners” who wantto invest in the business. At that time a val-uation of the amount of “equity” you havein the business will have to be made byyour accountant.

Equity is defined as assets minus liabil-ities and represents the net worth of thebusiness. From the examples here you cansee that it makes no difference how manytotal shares are issued as long as your posi-tion in relation to other shareholders is notaltered. Also, by keeping most of the sharesin the treasury, you will be flexible enoughto meet new corporation developments.

Samples 4 and 5 are balance sheets for acorporation where the number of shares is-sued to shareholders is 10 and 10,000 re-spectively. I have purposely simplifiedmatters by deducting shareholders’ contri-butions in each case, because this is liketransferring money from one hand to thenext in a small, non-public corporation. Ihave also deliberately ignored the “goodwill” or capitalization of earnings factor,which merely serves to place a multiplefactor on the net earnings.

As you can see in Samples 4 and 5, JohnDoe’s business is worth the same on a netreturn basis.

Another common situation is where an-other shareholder is brought in. In such acase you have two alternatives to consider.

First, you may simply transfer a per-centage of each of the existing share-holder’s holdings to the new “partner.” Ifthe shares are sold for more than you paidfor them you will have to think about thecapital gains tax liability.

Another problem with this method isthat you frequently end up with a fractionalshare situation which is always annoyingto deal with.

For example, suppose John and JackDoe each own 50 shares. Their cousin,Helen, becomes involved and all partiesagree that she should be an equal share-holder. To do this, both Jack and Johnwould have to transfer 16 2/3 shares toHelen and each party would be left with331/3 shares, which is an awkward situation.

A better solution would be to issue 25more shares each to John and Jack Doe andthen transfer them to Helen. Again, capitalgains tax would have to be considered ifthe shares are transferred at a higher pricethan they were issued for.

On the other hand, if the shares were is-sued at, say, $5 per share and this amountwas paid into the corporation and theshares were then transferred for the sameamount, then no tax would be payable.

The other alternative is to issue addi-tional shares directly from the treasury toHelen at the price agreed upon. In this case,no capital gains tax would be payable be-cause the money simply flows into the cap-ital account of the corporation.

Of course, there would also be no directbenefit to John and Jack bringing Helen in,other than her contribution to the work ef-fort. In other words, the corporation wouldhave additional funds with which to fi-nance its activities, but Jack and John couldnot receive any financial benefit fromHelen’s purchase without paying tax.

In most cases, it is simpler to issue ad-ditional shares, either by issuing them di-rectly to the new shareholder, or by issuingthem to the existing members first and thentransfering them to the new partner, ratherthan get involved in complicated partialshare arrangements.

To recap briefly, there is no particularadvantage to issuing all the shares unlessyou are involved in a complicated sharecontrol problem, and there are several dis-advantages to capitalizing through share

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capital. Therefore, it is wise to issue a min-imum to begin with — for example, 100 to1,000 shares to each shareholder, dependingon the number of persons involved.

I have already covered the advantagesof financing the corporation through loansrather than equity. You lend the corpora-tion capital by simply writing a cheque andmaking a note on the cheque and bank de-posit slip that it is a shareholder’s loan. Youcan further record the fact that it is a share-holder’s loan by drawing up directors’minutes and a demand promissory note forits repayment. (See Chapter 5 on post-in-corporation procedures.) Your accountantor bookkeeper can make the proper entriesfrom your cheque stubs.

g. CLASSES OF SHARES

As most small private corporations haveno need for different classes of shares, youmay ignore this section unless you are curi-ous. Generally speaking, shares can havevarious rights and restrictions attached tothem. A class of shares can be any set ofshares that has attached to it rights thatmay or may not be different from the rightsattached to another set of shares.

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For example, when you start your busi-ness, you should incorporate with andissue “common shares” to all of the incor-porators, so that all the shareholders of thecorporation have equal rights to vote andreceive dividends. When your corporationbecomes successful, you might wish to cre-ate a different class of shares which, whenissued to shareholders, will give them theright to receive dividends before holders ofany other class of shares, or which have cu-mulative dividend rights, or rights to be re-deemed by the corporation. You mightrefer to the new class of shares as “pre-ferred” shares in order to distinguish themfrom the other shares that you first issuedfrom the treasury pool. Large public corpo-rations usually have different classes ofshares.

Remember, it is much easier to addrights and restrictions at a later date ratherthan attach them now and then have to buythem up or strip them. If you later wish tocreate classes of shares that have differentrights attached to them, you should see alawyer so you can carry out the alterationsof your Articles correctly and design yourcapital structure properly to minimizetaxes and maximize control.

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SAMPLE 4BALANCE SHEET

(Where 10 shares are issued)

JOE DOE & ASSOCIATES LTD.

ASSETS LIABILITIES

Cash $ 10 Note to the bank $ 2,000

Inventory $ 4,000 Shareholder loan $ 3,000

Building $ 5,000

Total assets $ 9,010 Total liability $ 5,000

NET WORTH

Capital stock authorized —unlimited shares

Issued 10 shares at$1.00 each $ 10

Retail earnings $ 4,000

Total liability and equity $ 9,010

Note: The corporation has earned $4,000 to date. Each share is worth $401 (total net worthdivided by 10) but as $1 of this amount is shareholders’ money and it is really a matter of trans-ferring it from one hand to the other, it really should not be included in determining the valueof the corporation from the shareholder’s point of view. Therefore, if the assets of the corpo-ration were liquidated tomorrow it would be worth $4,000 in net return to the shareholders.

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SAMPLE 5BALANCE SHEET

(Where 10,000 shares are issued)

JOE DOE & ASSOCIATES LTD.

ASSETS LIABILITIES

Cash $ 40,000 Note to the bank $ 2,000

Inventory $ 4,000 Shareholder loan $ 3,000

Building $ 5,000

Total assets $ 49,000 Total liability $ 5,000

NET WORTH

Capital stock authorized —unlimited shares

Issued 10 000 shares at$4.00 each to John Doe $ 40,000

Retail earnings $ 4,000

Total liability and equity $ 49,000

Note: If the business is wound up, John Doe’s shares are worth $44,000 but $40,000 of thisis John Doe’s own money. Therefore, the net return would again be $4,000.

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