We frequently work with Canadian startups operating a U.S. (usually Delaware) company incorporated on their behalf by Stripe Atlas.  On the surface, Stripe’s assistance with incorporating this U.S. company seems convenient and an easy way to meet the U.S. entity requirements to use the Stripe payment processing platform.  However, a number of material issues are generated by Stripe when it incorporates a U.S. company on behalf of a Canadian startup.

Problem #1

It’s critical to understand that a U.S. company cannot operate out of Canada without registering as doing business in Canada (thus exposing the company to unnecessarily complicated Canadian/US dual taxation), which Stripe does not address in its standard documentation.

The common solution to this is to treat the U.S. company as a parent to (or as a subsidiary of) a new Canadian company and isolate each company’s tax obligations in their respective countries.

Problem #2

Your U.S. company formed by Stripe needs to transact with your Canadian company on an arm’s length basis, taking into account tax transfer pricing rules.  If you don’t engage in tax planning around the flow of cash and assets between the two companies, expect expensive tax problems in the future

These tax issues can typically be addressed through cross-border tax planning as documented in an Intercompany Agreement in which we address the flow of cash and assets between the two companies.  For example, in the agreement we can address which company books sales in which countries and how the cash from these sales moves between the companies.

While Stripe Atlas touts the ease and speed with which a U.S. company can be incorporated, it neglects the massive cross-border legal and accounting issues that forming a U.S. company abroad generates.  If these issues are understood before incorporating, Stripe Atlas can be a valuable tool but, if not understood and planned for, expect it to generate more problems than it solves for.

Many founders I speak with are concerned about where their startup is incorporated and how this could impact fundraising opportunities in the United States.  In reality, this concern is unfounded.

Any sophisticated investor considers the product/service, team, market potential and other commercialization factors before, if at all, considering where a startup is incorporated.  In some circumstances, an investor may request that the startup alter its jurisdiction of incorporation but whether or not they proceed with the investment is determined 90% by quality of the company over jurisdiction of incorporation.  As relayed to me by Canadian founders, “if an investor passes because you’re a Canadian company, that’s not the real reason for passing“.

Where an investor requires your startup to be incorporated in the U.S. there is a simple process for creating this structure that I discussed in a previous blog post – The Canadian-U.S. Swap: Moving an Early-Stage Startup to the U.S.

Canadian founders should focus on building a compelling product/service and not waste energy worrying about minutia of incorporation.  Sell investors on your company and any issues concerning where your company is incorporated can be worked out between your legal counsel and investors.

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!