Our topic today is choosing the right business structure for your start-up venture. Although there are three or four options to choose from, the real decision is between using a corporation or a partnership. For technology start-ups, the corporate structure is almost always the right decision. Why? There are several reasons.
Technology start-ups almost always require government assistance programs to get through the seed and early stages of development, and many government programs, whether in the form of grants, loans or investment tax credits (ITCs), are only available to corporations. For example, the ITCs available under federal and provincial SR & ED programs are only available to corporations, with enhanced ITCs being available to Canadian controlled private corporations (CCPC) under the Income Tax Act; and Manitoba’s Small Business Venture Capital Tax Credits are only available to eligible investors in respect of investments in eligible small business corporations.
Other advantages to using the corporate structure include the fact that, through stock options, founders can use company shares as currency for attracting key employees and directors; and founders of a CCPC may be eligible for the one time “750,000 capital gains exemption” under the Income Tax Act when qualifying shares are disposed of. As well, venture capital and private equity investors will only invest in the securities of a corporation.
Occasionally a client will have a business model that is service oriented, with one or more financial backers with high incomes and a desire for tax write-offs. In this situation a limited partnership can be effective. In a limited partnership, the liability of the general partner is unlimited, but the liability of the investor limited partners is limited to the amounts of their contributions of capital or property to the partnership. Income or losses of the partnership are determined, for tax purposes, at the partnership level, but are then allocated to the partners and are taxable in their hands, and the allocations need not be proportionate to the amount of capital invested by them. This allows the losses incurred by the partnership in the early years to be allocated to the investor limited partners, which then can be used by them to offset income from other sources.
A decision to proceed with incorporating will drive other decision-making, such as: Should you incorporate federally or provincially? What type of share structure should your corporation have?
The main advantage of a federal corporation is that when you get your company name reserved for federal use, you then have the right to use that name Canada-wide. Registering to carry on business in other provinces can also be a little easier with a federal corporation. Getting a federal name approved, however, can be more a difficult and time-consuming process than a provincial name approval. And a federal name approval is not an absolute guarantee that someone else has not established a prior right to use that name in another jurisdiction.
What type of share structure should you company have? You should keep it relatively simple. Down the road you may find yourself having to amend your share structure if a venture capital investor finds it too complicated. You should make sure, however, that your company’s articles meet the requirements of a “private issuer” for securities law purposes, so that the company can rely on the “private issuer exemption” for the sale of company securities without the need for a prospectus.
Next Up: We’ll look at the start-up’s capital structure, including the issue of shares to founders and employees.
About Jan Lederman:
Jan’s practice is concentrated in the area of corporate and commercial law with an emphasis on transactional work, including mergers and acquisitions, project development, venture capital, private equity investment transactions and public and private debt and equity financings. She has extensive experience in developing innovative development structures and strategically planning negotiations with multiple stakeholder groups. Jan also acts for co-operatives, non-profits and charities and teaches Charity Law at the Faculty of Law, University of Manitoba.
To find out more about Jan or to contact her, click here.
This post originally appeared in Jan’s Biz Law Blog. Check it out here.
With the benefit of more than 100 years of service to Manitobans, TDS has become one of the leading full-service business, employment and civil litigation law firms in the Province, with approximately seventy-eight lawyers. TDS has lawyers who provide services to its clients in both official languages and also in Spanish, Portuguese, Italian, Russian and Greek. Our professionals are assisted by a support staff of about 100, including paralegals, legal assistants, law clerks, accountants, systems and human resource personnel. We occupy four floors at Winnipeg’s premier business address, Canwest Place, in the heart of the City’s business district. We encourage our clients to make use of our facilities which include numerous well-finished boardrooms of various sizes.
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