Prospective clients often ask to incorporate “federally” or that they want a “Canadian incorporated” company. In most cases we recommend a provincial incorporation instead – here’s why:

1. Federal Falsehoods

At the start, it’s critical to dispel federal incorporation falsehoods:

First, federal incorporation does not allow the company to operate Canada-wide. Like a provincially incorporated company, a federal company must register in each province in which it does business (see separate nexus test), which involves paying an extraprovincial registration fee to each province (except Ontario, which is free for federal companies). Similarly, provincial companies must pay an extraprovincial registration fee in each province.

Second, federal incorporation does not protect a company name across Canada. The federal government uses the “NUANS” name reservation system, which has been adopted by some but not all provinces (British Columbia, for example, does not use NUANS) such that a federal company name is only protected in NUANS provinces. If you’re looking to protect a company name Canada-wide, the correct approach is to file a trademark.

2.  Residency.  Federal corporations are required to have a board of directors containing 25% Canadian residents or, if four or fewer directors, 1 resident director.  Conversely, certain other provinces do not have director residency requirements, for example British Columbia, Alberta, Ontario and Nova Scotia. As most startups receive foreign (often U.S.) investment, federal residency requirements quickly become a problem.

3.  Extra Provincial Registration. Since federal corporations are effectively foreign in all provinces (except Ontario), a federal corporation must immediately pay an additional extraprovincial registration fee based on the first province in which it does business. For example, a federal corporation based in British Columbia must pay roughly $450 in extraprovincial registration fees immediately upon incorporation, which for a cash-strapped startup is an unnecessary expense.

For all the above reasons, consider incorporating in your home province rather than federally (with some exceptions). Before taking the step to incorporate, be sure to speak with your legal advisors to determine which jurisdiction fits your particular needs.

It seems Canadians are still wrestling with whether to incorporate their startup in Delaware.  I wrote about this question back in September 2014  and since then the post has racked up over 1,000 views.  Back then, I concluded with this piece of advice, which I still stand by:

Don’t lock yourself into Delaware before you know where your investment comes from.  Based upon the cost and complexity of operating a Delaware startup from Canada, I recommend that you incorporate in Canada at the start.  Where a future U.S. investor requires you to incorporate in Delaware (or another state) your legal advisors can assist with this transition.  Conversely, Canadian investors may prefer to invest in a Canadian company!

Tip:  your product/service is important, not the place of incorporation.

In addition to the legal, accounting and immigration reasons I raised in support of initially incorporating in Canada, I wanted to revisit this question and point out the various incentive programs only available to Canadian companies:

1.  BC EBC Tax Credit.  This tax credit grants investors in eligible business corporations (EBC) a 30% refundable tax credit for their investment (up to $60,000 annually).  This program is only available to BC or federally incorporated companies.  BC angel investors quite like this program and it can often serve as an incentive for investment – an incentive that is lost should you incorporate in Delaware.

2.  Industrial Research Assistance Program.  Otherwise known as IRAP, the program provides companies with non-refundable funding under 4 different arms, including grants that can cover substantial portions of your company’s labour or R&D costs.  This program is only available to provincial or federally incorporated companies.  Again, if you incorporate in Delaware you lose access to IRAP funding.

The above are two examples among many programs, both federal and provincial, that require recipients to be Canadian companies.  When choosing where to incorporate, consider the benefits that are available to Canadian companies that are lost if you incorporate a Delaware company.  While I’m not averse to incorporating in Delaware, I am averse to incorporating in Delaware for the sake of emulating other successful U.S. startups without considering the costs/benefits of this decision.

As I concluded two years ago:  incorporate in Canada first.  If your jurisdiction of incorporation needs to change this can be easily accommodated in the future.

Canadian startups are frequently influenced by U.S.-centric blog posts concerning startup company structure.  Relying on these posts ignores some fundamental differences in how Federal and British Columbia corporations can be incorporated compared to a Delaware corporation.  Indeed, Canadian startups should not ignore such differences as they permit a more lenient corporate structure from which to grow a company.

To start, here is an overview of the Delaware corporate structure typically recommended to startups:

1.  Authorize 10,000,000 shares.  Delaware corporations must authorize a fixed number of shares at the time of incorporation.  This number can be altered in the future but will require shareholder approval.  The large number is used as: (a) it avoids fractional shares; and (b) looks expensive.
2. Issue around 5,000,000 shares.  Shares are issued to founders but at least a 1/3 of authorized shares remain unissued for option pool grants and investment rounds.
3. Allocated shares to option pool.  A certain number of shares are allocated to the option pool.  The art of structuring the option pool, especially in regard to finance rounds, will be discussed in a future post.

Once complete, assuming a 10% pool, 6,000,000 shares (5m founder shares and 1m pool) have been issued or allocated.  The remaining 4 million shares, or 40% of the company, will be reserved for future investment rounds and expansion of the option pool (if needed).

Conversely, Federal and British Columbia corporations are NOT required to authorize, and thereby set a cap on the number of, shares.  Instead, shares can be unlimited, thereby granting the Canadian startup great leeway in granting shares in the future without having to worry about running into the authorized share limit that Delaware corporations face.

Here is what the same startup, incorporated Federally or in British Columbia, would look like structurally:

1. Authorize an unlimited number of shares.
2. Issue about 5,000,000 shares.
3. Allocate the option pool, fixed or rolling.  Given that shares are unlimited, you are not forced to set a fixed number of shares to constitute the option pool, although you could.  Instead, you can set the option pool size as a rolling % of issued shares creating an automatically adjusting pool size regardless of the number of shares issued in the future.

Ultimately, the Federal/BC startup is not faced by the same rigid share structure, governed by the authorized share requirement, that a Delaware startup is, thereby taking away a few of the corporate structure challenges that U.S. startups often face.  With unlimited shares, the Canadian startup’s future share grants are only restricted by the corporation’s constituting documents, agreements with shareholders or third parties and BC corporate law.  Conversely, the Delaware corporation needs to review how a share grant will reconcile with the number of authorized shares and, if needed, increase that number and seek shareholder approval to do so.

Of course, if you want to structure the company exactly like a U.S. startup, you certainly can authorize a fixed number of shares in your Canadian startup!

I frequently encounter a misconception that non-voting shares in British Columbia companies do not have a right to vote.  Unfortunately, this is not the case as, in certain circumstances, non-voting shares DO have voting rights.

The obvious circumstances where non-voting shareholders can exercise a right to vote are, for example, alterations to company articles that impact rights held by non-voting shareholders or a company’s decision to amalgamate.

The often forgotten voting right held by all shareholders, including non-voting shareholders, is the annual right to vote on whether the company appoints an auditor and, separately, whether the company produces and publishes annual financial statements.  This vote can be made through a consent resolution (by all shareholders) or through a majority vote at the company’s AGM.   Barring a Shareholders’ Agreement or other voting trust that takes control of how each non-voting share votes, your company will need to seek the approval of non-voting shareholders on an annual basis.

When you sell non-voting shares it is important to understand that these non-voting shareholders do have certain, limited, voting rights to exercise in relation to the company, its structure and direction.  Therein, contrary to the mistaken belief of some founders, the non-voting share class is not entirely passive and can, in fact, take a limited active role in the company.