Calling shares “confusing” would be putting it lightly. Many of us, especially those of us who own small businesses, got where we are simply because we are good at what we do. Even so, it’s critical to understand how shares function.
With that in mind, we’ll start with a brief overview of shares before diving into a few reasons you might want to restructure your shares.
What Are Shares?
It’s common to see the words stocks and shares used interchangeably, especially in the cases of common stock and preferred stock. That’s because they are the same. The only real difference is that brokerages typically use the word stocks to refer to a portfolio of investments in multiple companies, and it’s more common for Canadian private companies to refer to ‘shares’ and US private companies to refer to ‘stock’.
The phrase capital stock refers to the entirety of an individual corporation’s shares.
A share, meanwhile, is a single piece of a company’s stock. If the company is publicly traded, each share has a dollar value assigned to it, which can go up or down depending on the business’s success. Here’s where it gets a little confusing.
In broad strokes, there are two primary categories of shares.
- Common shares allow the shareholder to vote on certain actions by the company.
- Preferred shares don’t afford voting rights, but are given priority for repayment if a company goes bankrupt.
There are also multiple classes of shares, usually categorized based on their voting rights. A single share from one class might be worth five votes, while a share from another might be worth ten. Different share classes also have different sales charges where mutual funds are concerned, but this isn’t something we need to examine in-depth here.
What are Qualified Small Business Shares?
There’s one other type of share that’s worth mentioning here – or rather, a subtype. A qualified small business share (or qualified small business corporation share, as defined by the CRA) is any share in a qualified small business. A qualified small business, meanwhile, is any small business that meets the following criteria:
- Registered corporation.
- 90% or more of the “fair market value” of its assets must be:
- Used primarily within Canada by either the corporation or the corporation’s owner.
- Shares or debts of other connected small business corporations.
In order for a share to be considered a qualified small business share, a few conditions must be fulfilled:
- At the time of sale and for two years before and after, it must have been a share in the capital stock of a small business corporation.
- At the time of sale and for two years before, it must have been owned by the founder, a spouse or common-law partner, or a partnership of which the founder was a member.
QSB shares are favorable to a business owner primarily because they’re treated favorably where the capital gains tax is concerned. Selling QSB shares can also qualify your business for a capital gains deduction.
Category aside, the most important detail of a share is who owns it. Whatever person or entity owns the majority of a company’s shares is said to have a controlling interest in that company. And here’s where share restructuring enters the picture.
How Does Share Restructuring Work?
Share restructuring is precisely what it sounds like. You’re basically changing how your shares work. This can take a few different forms.
- Introducing a new class of shares.
- Modifying your company’s ownership structure.
- Transferring a large volume of shares from one principal owner to another.
Why Restructure Your Business’s Shares?
There are multiple circumstances in which you might restructure your shares. In some cases, a share restructuring can also make your company a more attractive prospect for buyers or investors. An acquisition or merger may also trigger a restructuring.
As a small business owner, however, the likeliest reason to restructure your shares boils down to reducing liability and creating tax efficiencies.
How to Benefit from a Share Restructuring
There are a few ways you might choose to restructure your shares to your own benefit.
Holding Companies Can Save You Money
Holding companies are created to buy and possess shares belonging to other companies. These organizations don’t typically create or maintain their own assets, but rather ‘hold’ assets from other operating companies. In addition to shares, a holding company might hold real estate assets or an investment portfolio.
Per Vancouver business lawyer Steve Parr, there are four reasons to use a holding company with your small business corporation.
- Asset protection: By transferring the money not required for day-to-day operations from operating company to holding company, you ensure that money is no longer subject to liability from lawsuits if something goes wrong with your business.
- Eligibility for the Lifetime Capital Gains Exemption: Every Canadian is entitled to $880,000 of a lifetime capital gains exemption on the sale of qualifying small business shares – as mentioned, 90% of the assets of your operating company must be actively employed in your business, or else you won’t qualify.
- As an investment vehicle: A holding company allows you to invest money into real estate, investment portfolios, etc. Money invested in this way will be subject to the corporate tax rate instead of a personal tax rate.
- Better timing of dividend payments: In companies that have multiple shareholders, ensuring each shareholder has a holding company means each of these shareholders can receive dividend payments when they need them rather than all at the same time.
Family Trusts Offer Significant Tax Breaks
As noted by Parr, a family trust distributes proceeds from the company to a list of beneficiaries. This distribution is the responsibility of a named trustee, who is also responsible for managing the funds. As you may expect, the beneficiaries of a family trust are typically immediate family, such as your spouse or children, but could also include a holding corporation.
Generally, a family trust is meant for scenarios where you have more money than you’ll need in your lifetime and wish to distribute that money to the next generation. However, a trust also provides significant potential tax benefits. If, for instance, you insert a family trust as the shareholder of your operating company, each beneficiary will be able to make use of the LCGE.
Even if you only have four beneficiaries, this increases the total exemption from $892,218 to approximately $3.56 million.
An Estate Freeze Can Reduce the Hit of Taxes on Inheritance
Per Parr, if you want to transfer your business to the next generation, an estate freeze is the best way to do so. This is because if you set a nominal share price of your business before you sell it, the CRA will assess the value of those nominal shares at their actual fair market value. They will then order the seller to pay a capital gains tax on each share, but the value of the purchaser’s shares will not change.
And so, the purchaser will be required to pay a massive capital gains tax if and when they decide to sell. Instead, Parr advises combining an estate freeze with a family trust. This achieves a few things.
- Allows you to transfer your business without incurring capital gains taxes.
- Allows you to retain control over the business.
- Ensures you have a steady stream of income for retirement.
The process is as follows:
- Establish a family trust.
- Exchange the existing common shares through a Section 86 Rollover for Preferred Shares.
- Issue new common shares to the family trust, allowing it to receive dividends from the operating company.
A Better Share Structure Starts With Better Planning
We wouldn’t blame you if, even after reading all this, you’re still a little confused. Managing the finances and structure of your business can be complicated, even overwhelming. But it doesn’t need to be.
As Vancouver’s leading financial planner, SaaS Wealth Insurance has helped countless Canadians attain better financial control in the present, and better financial security in the future.
Our certified professionals also stay on top of trends, provide comprehensive financial support, and help you plan and execute calculated risks. And we don’t just provide support for business owners, either – we also offer wealth management, group benefits, retirement planning, insurance planning, and estate planning.
Contact us today, and we’ll help you achieve true peace of mind.