- Anmol Trehin
6 Crucial Errors To Avoid When Incorporating (And What To Do Instead)
This blog post is not legal advice and is for general informational purposes only. Always speak with a lawyer before acting on any of the information contained herein.
A business is an exciting adventure and starting on the right track will help your long-term growth and success. Working for yourself means being responsible for every decision but it isn’t always easy to know if you are making the right one. Entrepreneurs will often decide to handle the incorporation process alone, which may present several issues before, during, and after the process has been completed. To help you dodge some of the same pitfalls, here is a list of the six most common errors and how you can avoid them.
Let’s jump in.
Error #1: Assuming Incorporating Will Protect Your Business Name
Error #2: Authorizing Inadequate Number and Classes of Shares (Or Omitting Them Entirely)
Error #4: Not Organizing Your Corporation After Incorporating
ERROR #1: ASSUMING INCORPORATING WILL PROTECT YOUR BUSINESS NAME
Your business name is a distinct element set out in your articles of incorporation used to legally identify the corporation. In Quebec, in addition to satisfying other legal requirements, the name must be French or bilingual (unless trademarked).
Most people mistakenly believe that if a name in the articles of incorporation is approved, it also has some degree of protection against others. However, this is not enough to safeguard against others using the same (or similar) name.
Choosing a strong name allows you to develop a brand and establish goodwill with the public. Protect your business name by conducting name searches, monitoring what is being used online, and by implementing a strong branding strategy. Once you have gone through these steps and decided on a name, strengthen its protection by ensuring you own the domain name and consider trademarking it.
ERROR #2: AUTHORIZING AN INADEQUATE NUMBER AND CLASSES OF SHARES (OR OMITTING THE SHARE-CAPITAL STRUCTURE ENTIRELY)
Authorized shares refer to the shares the corporation can issue. By contrast, issued shares are the portion of the authorized shares that have been issued (i.e., sold to people). Incorporators commonly confuse the two concepts and authorize only the shares they intend to own at the time of incorporation. For example, they will only authorize 100 class A shares, which is actually the amount they intend to own (confusing authorized and issued shares).
On the other hand, it's also common for entrepreneurs not to include a share-capital structure. Consequently, they will only have one authorized class of shares and the rights that can be associated with shares will belong to this one class. These rights include the right to vote, receive dividends, and receive a portion fo the property if the business liquidates.
Both situations are problematic. You want your corporation to authorize enough shares in the different classes to allow enough flexibility to have shareholders with different rights. This will structure your company's ownership and distribution of income and capital to shareholders. For example, as the founder of your company, you may want to subscribe to voting shares and ensure that all other shareholders only subscribe to a class of non-voting shares.
ERROR #3: SELECTING A FIXED NUMBER OF DIRECTORS
The number of directors are set out in the articles of incorporation. We suggest using a range with a minimum and a maximum number of directors (for example, between one and ten directors). This allows the corporation to maintain greater flexibility in its board of directors and changes in the directors (for example, such as the resignation or death of a director) will not impede the functioning of the corporation. Regardless of the range selected, in a privately-held corporation there must be at least one director, and in a public company at least three. Additionally, for a federal corporation, at least 25% of the directors must be Canadian residents and if there are less than four directors at least one must be a Canadian resident.
ERROR #4: NOT ORGANIZING YOUR CORPORATION AFTER INCORPORATING
Most clients believe the work is done when the incorporation documents are filed and accepted. But, this is when the work begins. You must organize your corporation once you receive the certificate of incorporation. During the first board meeting and the first shareholders' meeting, the company will establish a structure to govern its activities. The Board can take certain measures, like adopting the by-laws and appointing officers. Meanwhile, the shareholders can elect directors, approve the by-laws, and handle other corporate affairs. Depending on the type of business, this is also an opportunity to make other key decisions, like making sure any permits needed to operate are obtained.
ERROR #5: FAILING TO CREATE OR MAINTAIN YOUR MINUTE BOOK
A minute book is a record of your corporate history that is stored either in a physical binder or online. Maintain your minute book to ensure you are keeping track of your company’s important documents and decisions. This allows you to provide records to shareholders, creditors, and other stakeholders like potential buyers if you decide to sell your business. Beyond being necessary for key stakeholders, having a minute book is a legal requirement. Failing got maintain your corporate records can result in various consequences, such as penalties or tax issues, or other disruptions to your activities.
ERROR #6: ASSUMING A DIY INCORPORATION WILL SAVE YOU MONEY
While it is possible to incorporate by yourself, seeking the assistance of a professional will help you do it right the first time. This will save money as it costs a lot more to fix an incorporation that is not done properly. Most people underestimate the importance of budgeting for a lawyer in the early stages of business. The initial cost of consulting a lawyer before incorporating may seem steep, but it will cost less in the long run. Issues like amending the articles of incorporation, fixing or creating a minute book, and bringing the corporation back into regulatory compliance can give rise to legal issues and may affect the smooth functioning of your company.
These were some of the most common errors encountered when companies incorporated without the right guidance. While incorporating by yourself is possible, we strongly recommend meeting with a professional to make sure you are on the right track. If you found this blog helpful, share it with your fellow entrepreneurs so they can avoid making the same mistakes.