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  • Writer's pictureSebastian Elawny

Understanding Share Structures

Updated: Jul 4


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Understanding your corporation’s share structure is an essential part of owning a corporation. The share structure has significant implications on corporate governance issues, such as control of the company and decision-making, as well as financial considerations (e.g. profit sharing) and tax consequences. The share structure is established in the corporation’s articles of incorporation, and an individual who owns shares in a corporation is called a shareholder.  

 

Classes of Shares

For shareholders, there are three primary rights under the applicable corporate legislation:


1.       the right to vote;

2.       the right to participate in the growth of the company; and

3.       the right to receive dividends.


Shares can be issued in classes, each having a different combination of these rights. Depending on jurisdiction, there is no limit on the number of classes of shares that can be outlined in the articles.  

 

Where a corporation only has a single class of shares, the number of shares owned is proportionate to the shareholder’s stake in the corporation. That class of shares will have all three of the rights described above.  

 

Where there is more than one class, different rights and privileges may be associated with each class. For example, one class of shares may be given voting rights, while another is not.  Both classes may be given the ability to participate in the company's growth.  A third class could also be fixed in value, and therefore, would not participate in the growth of the company. While each of the three rights mentioned above must be assigned to at least one class of shares, it is not necessary for one class of shares to have all three rights where more than one class of shares exists. 

 

There are three frequently used share class types: (1) voting common, (2) non-voting common, and (3) preferred shares. Where there is more than one class, it is common to name these classes with letters (e.g. Class A Common, Class B Common, Class C Preferred, or even Class A Voting Common, Class B Non-Voting Common, etc.) in order to be able to distinguish between them and to allow for the quick understanding of the likely rights of the class. 

 

The term “common” is generally used where the shares are expected to participate in the growth of the business.  Common shares may be voting or non-voting, regardless of their voting rights.  Voting common shares will have the right to vote on all matters relating to the shareholders of the corporation, including the appointment of the directors, whereas non-voting shareholders will only be entitled to vote on matters relating to their class of shares. Both voting and non-voting common shares will typically have a right to receive dividends from the corporation at the discretion of the directors, subject to any priority right of shares with preferential rights to dividends (see discussion of preferred shares below). One benefit of having multiple classes of common shares, is where shareholders hold different classes of shares, different dividend amounts can be paid to one shareholder (e.g. on Class A Commons) than to another (e.g. Class B Commons), even though the shareholders may hold the same number of shares of the corporation.     

 

The term “preferred” is generally used where the value of the share is fixed, and therefore not expected to participate in the growth.  Preferred shares typically have a preferential right to receive dividends from the corporation and a preferential right to receive assets of the corporation upon liquidation, thus giving them the name “preferred”.  Preferred shares are sometimes used as a proxy for debt and can also allow for the completion of tax efficient reorganization transactions.  A discussion of how this works is beyond the scope of this article.  

 

Where there is only one shareholder setting up a new corporation, the corporation will generally only need one issued class of common shares. From a planning perspective, however, it is generally recommended that at least one non-voting class of growth shares and one class of fixed value preferred shares be authorized by the corporation (even if not issued), in case they are needed in the future.   

 

Why is This Important? 

Each of the three rights discussed above are critical to consider when assigning shares. When it comes to voting, the concern relates to control of the corporation. For example, where X, Y, and Z are all shareholders of a single class of common shares of a corporation and X holds 60% of the shares, while Y and Z each hold 20% of shares, X will control the corporation. However, if X holds non-voting common shares and Y and Z hold voting shares, then Y and Z would have control, despite X having the greatest financial interest in the corporation. Where there is more than one shareholder of a corporation, it is strongly recommended that the shareholders consider entering into a Unanimous Shareholders Agreement, in order to reduce friction between shareholders and to ensure the smooth continued operations of the corporation.  

 

As mentioned above, the share structure will play a role in how dividends are distributed. When a dividend is issued, it must be paid out to the entire share class it is applicable to, and the shareholder receives it in proportion to their ownership percentage of that share class. For example, if a $100K dividend is declared and only Shareholder A and Shareholder B are in a share class that have the right to dividends, and they both own equal amounts of shares, the dividend will be split $50K each. However, if you wanted to reward Shareholder A with a higher amount and they hold a different class of shares than Shareholder B, the dividend could be split so that Shareholder A receives $70K and Shareholder B receives only $30K, despite owning equal amounts of shares.  

 

In all cases, you’ll want to consider whether a shareholder should be entitled to: (1) vote, (2) participate in the future growth of the corporation, (3) receive dividends from the corporation, and (4) participate in the assets of the corporation on wind up.   

 

Conclusion 

There are many considerations to keep in mind when setting up your corporation. Navigating share structures and their consequences is not clear-cut, and businesses of all sizes should seek professional advice when making these decisions. Outsiders Law is equipped with the knowledge to help guide you through this process. If you have any questions about what the share structure should look like for your business, contact one of our lawyers today!   

 

Disclaimer   

The information provided in this article is for educational purposes only. Nothing contained herein should be considered as legal, professional, or tax advice. Please contact us directly if you require legal assistance.  

 

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