No Maximum Number of Shares Authorized

[misc86]

Hello everyone,

I am just in the process of incorporating in BC, Canada. I have one question:

On the form, it asks "Maximum number of shares that the company is authorized to issue, or indicate there is no maximum number"

So I am incorporating with one other person. He will have 20% share, and myself 80% share. I heard it is beneficial to use the "no maximum option". If I do this, how can I allocate the 80/20 split between myself and the other co-founder?

Thanks for any insight!

[Business Attorney]

The maximum is just a cap on the total number of shares the corporation CAN issue. The percentages of ownership are measured by the shares the corporation ACTUALLY issues.

Even if you don't choose "no maximum," the two numbers are often not the same. For example, you could say that the maximum number of shares is 100,000 but if you only issue 800 to yourself and 200 to the other person, you still have 80% of the outstanding shares even though you only have 0.8% of the total shares that the corporation could conceivably issue.

[misc86]

Thanks for the advice Business Attorney,

So i guess setting no maximum doesn't make much of a difference, as long as the shares are not issued.

My next question then would be issuing preferred shares vs. common shares. I understand that issuing common shares means that the individual would have voting rights.

My situation is that I want to bring in an artist into my business, and give 5% of the company.

I want to not give her voting rights, she would not need to share in the costs of the company, and be given 5% of all future net income distribution.

Do I need to setup preferred shares then? How would I do so?

If I was issuing 10,000 shares, how do I make 500 (5%) of them preferred shares with the above features?

On the incorporation document (I have not incorporated), would I just say:

Class A - Common Shares - issue 9,500
Class B - Preferred Shares - issue 500, non-voting, non-convertible

Is that what I would do?

Thanks again!

[Business Attorney]

You should really consult with an attorney familiar with BC corporate law to make sure that what you are trying to do does not backfire on you.

Generally, "preferred" means that shares of that class have some sort of preferred position over the common shares. That preferred position can be many different things or even a combination of many different things. Sometimes the preferred shares come ahead of the common on liquidation proceeds; sometimes the preferred shares get a fixed dividend before the common receives anything.

It is true that preferred shares often have no voting rights unless there is a failure to pay the required preferred dividend, but I think that using preferred stock in the way you describe would be unusual. Typically, at least in most U.S. jurisdictions, you would issue non-voting common stock to achieve the result you are looking for. Whether that is the same in BC, I cannot say.

[misc86]

Ah, I see David. Thanks again, I will take your advice and consult further. It's just that I am really bootstrapped, and can't afford legal advice at this time.

If I could ask one more thing:

If I do issue 5% common voting shares to the artist, then would she need to be involved in all business decisions of the company? Or how does 5% affect the ability for me to manage the company?

[Business Attorney]

Again, let me emphasize I am not a BC lawyer or even a Canadian lawyer, so take all of this for just a suggestion to follow up on.

Shareholders do not directly participate in the management of the corporation. Their role is limited to a few actions, such as electing directors. Most shareholder actions require a simple majority. Some laws specify a greater that majority vote for certain actions, such as a merger or a sale of substantially all of the corporate assets. The percentage of shares voting in favor of an action, even in those cases, is usually two-thirds or three-fourths. I have never seen a corporate statute requiring 95%, which is what you would still own.

If the shares are non-voting, they would normally not even participate in those actions I have listed. Their voting rights, if any, are generally limited to actions affecting the non-voting shares directly, such as reducing their rights on liquidation or to receive dividends.

In short, the 5% shareholder has little or no ability to directly affect your ability to manage the corporation.

On the other hand (and this is an IMPORTANT point to note), once you have another shareholder, you have fiduciary duties to that shareholder. In other words, you may have the power to make all of the decisions without any input from the shareholder but your decisions must reflect the fact that they must be in the best interest of the company, not in your own best personal interest.

The best example is compensation. If you own the business outright, you can take as much compensation as you want (subject, in the U.S. at least, to IRS challenge if unreasonably high). If you have a 5% shareholder, then every dollar you pay yourself takes 5% out of the other shareholder's pocket. If you set your compensation above what an unrelated person would earn in that situation, the 5% shareholder can argue that you are breaching your fiduciary duty.

So, at least indirectly, even a non-voting shareholder can affect your ability to manage the business.

For that reason, our clients often settle on a phantom stock or contractual profit sharing arrangement where they get the economic benefits of ownership without actually becoming a shareholder. It does not usually carry the same psychological punch of being an actual owner, but it has less potential for problems.