Incorporating Your Business? | How to Create the Best Share Structure For Your Business

hey everybody joe here from avalon accounting and today we're talking about shares and share structure for corporations so often we do get asked about share structures when people are incorporating their new business but even more often we get asked about what went wrong with their share structure and trying to fix that share structure later i'm hoping that you're pre-incorporation but if you're not and you've incorporated that's okay you can go to a lawyer and get things redone but we'll give you some common share structures that we see both good and bad and what we often recommend especially in a scenario where you have multiple owners so we'll get into all the details around what different aspects two shares there are and some of the considerations around accounting we won't get into too much legal stuff so try to keep it nice and accountanty for you but all that and nothing else coming right up all right so i'd like to start at the start and that is what is a share of a company so a share is exactly how it sounds it's the share of a company um you know if there are a hundred shares of a company and you own one share you have one out of a hundred or one one percent share of the company so it really depends on how many shares there are and how much you own but it's simple calculation from there on the percentage that you own of the company but we will get into how that is made more complex by different share classes and some of the attributes that come with each share class so we'll get into all of that next all right so i'll get into there that there can be different share classes so you can have within your corporation a number of different share classes not all the shares uh are issued at all times but you may have in your incorporation articles that you can have a number of different share classes with different attributes for each so you'd see class a's that might be one uh one set of characteristics class b's class c's class d's class e's and so on and so forth all the way through the alphabet and beyond that just means that there's going to be it's not a simple calculation of one share a share class and how many shares are owned in it you're going to have to do some more thinking around how each share class makes up a total number of shares but we'll get into that don't worry about that too too much yet just good to know that there are multiple classes of shares all right so next we'll get into the characteristics of a share class so you may have class a's and they may have voting rights attached to them so you may have class a's with voting rights but class b's that are non-voting so all that means is that who has a say in the decision making and essentially this means who gets to vote members to the board of directors that can actually enact decisions on behalf of the company so that's kind of where that comes from voting versus non-voting and each share class may either have voting rights attached to it or non-voting characteristics attached to that share class all right so the second characteristic that i'll go through is participating versus non-participating and this is an accountants where we play a lot in is because participating versus non-participating means whether these share classes can take dividends or they cannot take dividends so you may have a class a share and as we're sort of building up class a shares of voting non-participating shares those are two characteristics of that share class it it can't take any dividends so you cannot issue dividends to that class a then you may have class b's that are non-voting no votes attached to them but they're participating shares which means we can issue dividends to this class and that's a really important characteristic to understand when you are incorporating your business and you're creating these share classes with different characteristics so next up is common versus preferred so common shares are what you typically see what we've been talking about so far the voting uh maybe voting participating shares if you just had one share class those would be common shares preferreds generally would have a value attached to them that they could be redeemable for or there's some aspect to a fixed either dividend that they get but the idea around a preferred share is that they are a preferred class above the common shares in the event of a dividend payment so they get paid dividends before common shares for example or on the wind-up of a company if all the assets are sold you know all the all the liabilities are settled preferreds would come next and common shares would be the last what's advantage of common shares is they tend to be the most appreciable uh part of the company so if you own common shares most of the increase in value will go to common shares whereas preferreds might have a fixed value um that's uh either redeemable or they can be retracted or something like that so it's just good to know there's not it's kind of beyond the scope of this video going into details on that but just knowing that there are common and preferred and they have different slightly different characteristics there as well the next thing you need to understand is about authorized versus issued shares so when we talk about authorized versus issued authorized would be how many shares in the articles of incorporation are there to be issued sometime in the future they may not all be issued but they are authorized so you may have you know issued a hundred shares of class a's but you've authorized a thousand to be issued and you may sell more of that that class of share later to an incoming investor and send those rate from the company so they're newly issued shares but they've been authorized in the articles of incorporation so that's just good to know for a number of reasons number one when you're purchasing shares it is good to know whether you can be diluted and what diluted means is that you know you buy 100 shares of this company but do you have any understanding of how many authorized shares there are to be issued later and you can think back to the movie the social network what happened to one of the shareholders early on is that he got you know a billion shares or something and he was you know excited about that but he found out later that there was an unlimited number of shares that were authorized to be issued and he got diluted to something like some really low percentage of the company later because the um the company issued a lot more shares so his percentage ownership went way down just because of how many shares were issued later so just something to understand there about authorized versus issued and a good uh you know scenario to avoid is the social network scenario that i just mentioned all right so what does share structure actually mean for your business so there's two aspects that we like to cover here and number one and number one is it always comes first is the legal aspect so you need to know kind of the legal background of uh what share or structure you need and require for the type of business that you are and it is good to have a full understanding of the legal implications of your share structure what we're talking about here in this video is really more around the accounting and tax structure and how different share class structures would affect how you can pay dividends for example and what some of the tax implications of those might be so from an accounting and tax perspective the share structure really does come into effect when we're looking to pay dividends because of the characteristics of each share class that we have we are able or not able to pay dividends based on that share structure so what we end up seeing is we'd like to really set up early on when a business is just incorporating a structure that's going to allow flexibility in timing and amount of dividend payments to the different shareholders according to the scenarios that they may see come up and what's really critical to understand here is that dividends are paid to share classes not to individual shareholders so if you have class a's that are 50 50 owned by two owners and you issue a dividend of say a thousand dollars then that class will take the thousand dollars and each owner 50 50 will have to take 500 they're forced into that dividend taking based on the dividend that was issued to the class of shares so that'll become a little more clear in the scenarios that i'm about to do but just really good to know when you're going to set up your share structure that dividends are paid to dividend classes not to individual shareholders all right so let's go through three common share structure scenarios and you can build on these i think each one of these kind of builds on each other and you can kind of see from these different share structures common share structures where you might fit and where you might be able to adapt if you have a little more complexity in your ownership so number one is the 100 owner always will be so in this scenario we have a simple ownership structure 100 and it's always going to be that way likely unless they sell the company but it's usually going to be just them we can go with a simple share structure in this scenario so 100 owner takes maybe 100 class a's and the characteristics we would want with these one class of shares class a's are voting and participating shares that's just a straight up way to do it if you don't foresee any future scenario where you're going to take on another business owner another shareholder within the corporation one thing of note for this though is that we used to always include a spouse in this when we could because we were allowed to split income with dividends so we would have a spouse have a separate class of shares issue those dividends once in a while if it made overall tech sense for the family but recent rules have sort of clamped down on that tax planning opportunity by requiring the spouse to be either active in the corporation so working more than 20 hours per week in the company or they have significant investment in the company so they've put up the funds to get this business started and have really a an investment role in the company so we don't typically see those two scenarios very often although it does come up and it's something we we definitely want to talk about before incorporation um but the typical scenario where we would give suppose some dividend uh shares is sort of clamped down on by the tax on split income rules that came in 2019 2018 something like that um that uh limits us to be able to do that these days so how we typically pay dividends in this scenario is that the the the business owner maybe takes draws throughout the year they take out some money but they're also putting some money back into the company when it's needed so we take the net amount of withdrawals for the year and then that becomes the dividend for the owner nice and simple structure you kind of get paid you know you get your income is based on what you've taken out of the company throughout the year and we can treat those as dividends and just do that tally at year end but one thing to note in this scenario is that very little tax has been paid the corporate corporation has paid some tax on this money but you're gonna have to pay the excess in personal taxes um at come tax season so just something to keep in mind when you are withdrawing money without paying withholding tax through wages that you are going to have to pay some tax on these dividends that you've taken out all right so number two scenario number two is the classic multiple owner pitfall and we see this quite a bit and i'll go through sort of a 50 50 scenario where you have two owners that own 50 50 in the company um and what they do a lot of times is have that same share structure that we went through in scenario one one class class a's of voting participating shares that each owner owns fifty percent in maybe there's a hundred shares they each own fifty and this is a pitfall because it is completely limited our tax planning opportunities because what what happens here is because all the votes and all the uh dividend amounts have to be locked into one share class when we do issue some dividends to one of the owners both owners are forced to take those dividends so because we maybe it's a thousand dollars of dividends that we want to get into owner number one's hands we have to issue a dividend for two thousand dollars to the class a's and the second owner is forced to take that thousand dollar dividend as well uh and so this is a problem because often what we see for tax planning is that number one uh owners don't always have the same even though they have the same ownership they may not have the same level of involvement in that profit so may not want to take the same amount of dividends maybe they are splitting their divide their dividends a little bit differently based on different performance indicators or something like that but you also may have this scenario where an owner has a lot of income in one year maybe they sold a piece of property and are in a high tax bracket and they say yeah i want my dividend but i don't want my dividend until next year or i'm going to be taxed with the no's because my marginal tax rate is so high this year and the other owner is saying well i need to put a down payment on a house right now and my income's been low this year so i want that dividend we're not able in this scenario to really plan around those two things that are happening and one owner is going to win out and one owner is going to lose in this scenario or we're going to be forced into doing bonuses which you know it can work but can be a little bit of an issue for for some owners when they're trying to plan and it's you know maybe we're doing it in january or something like that they need to take this bonus earlier all right so scenario number three is our uh preferred method when you have multiple owners on share classes so we'll take the same scenario those two 50 50 owners and you can you know you can expand this example to as many owners as you like and i'll show you how to do that essentially what we're going to do is set up a new structure where we have flexibility in paying the dividends but we also have voting sort of carved out and whoever is controlling the company carved out into one share class so what we would want to see in this scenario is a class a share with voting non-participating characteristics so we keep the votes contained into our class a's and we may have that 50 50 structure where they're 50 50 or maybe someone's 51 and someone's 49 that's all cool then what we're going to do is create some class b's that are non-voting and participating shares that can take dividends but have no votes attached to them and we're going to have and we're going to have owner number one own 100 of those and then we're going to have class c's again we're going to have owner number two own 100 of those and that's their dividend class of shares so what we can do with the votes is assign sort of dividends between those two um those two different classes and as you have multiple owners you could create further and further classes of shares that can take these dividends and you can do a lot of tax planning around that it will break down as you get more and more owners but for the typical sort of maybe two to five owner sort of structure um this works really well and can allow for a lot of tax planning so now what we see is that you know owner owner number one they sold some property this year they have a high marginal tax rate they do not want to take a dividend this year but they want equality over time in dividends with their second owner so we will issue a dividend to owner number two on their class cs and they can make their down payment on the house um and uh you know take advantage of their low tax rate because their other income has been lower this year and we're gonna wait till next year to issue a dividend to the class b's because of that high tax rate in that particular tax year so now we've got that flexibility and we can pay those two owners at different times so that's the classic example the structure that we like to see and if you are incorporating yourself we do have a link to a program called owner so you can go online incorporate yourself use this sort of structure make sure you have the legal side sort of taken care of although they do help with that and you get a bit of a discount using our link and it really helps out this channel but overall i just want to say really a big big thank you to everyone who's given us so many positive comments has encouraged me to start doing some more videos i really enjoy them and i really appreciate all the positive feedback that we got that we get all the time which is fantastic really if you have any questions please post them below we'll be setting up more q a sessions coming up so we do take a tally of all those questions that you send through and uh want to do some more youtube lives with that as well so again thank you so much for watching and really appreciate the support and if you want to get notified for all those future things you know to do and if you like this video you know what to do thanks again so much for watching and hopefully this video has been helpful until the next one see you later

Channel: Avalon Accounting

Views: 18,886

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Id: lPeWt3FdZHE

Length: 18min 46sec (1126 seconds)

Published: Wed Sep 29 2021