Business Venture Blog
This is where we post about business ventures, law, and business venture law.
Anything interesting, really.
Anything interesting, really.
Business Venture Blog
Sole Proprietor to Incorporation & Section 85 Rollovers
Frequently, small business owners will initially operate as a sole proprietorship in the early stages of business development. This can be beneficial as it facilitates the deduction of business losses against other personal income and reduces legal, accounting, and administrative costs until the business’ viability has been demonstrated. As a business grows, however, the desire to limit liability, facilitate raising funds through the sale of shares and the ability to defer taxes by retaining corporate profits within the corporation and pay dividends in lieu of salary often make incorporation preferable.
Unfortunately, the sole proprietor learns that if an asset has gained in value and then is transferred it attracts capital gains tax. Fortunately, the Government recognized it would be unfair to not encourage businesses to grow properly. Thus, when a sole proprietor incorporates his or her business, section 85(1) of the Income Tax Act (the “Act”) allows the business owner to transfer business assets out of the sole proprietorship and into a corporation without triggering tax liabilities due to a disposition of property. This is known as a Section 85 rollover.
Section 85 Conditions:
There are 5 primary conditions for determining the applicability of a section 85 rollover, these include:
4.Consideration consists of at least one share of capital stock; and
5.A joint election must be filed by the prescribed deadline.
An eligible transferor includes individuals (i.e. a sole proprietor), trusts and corporations. An eligible transferee must be a taxable Canadian corporation (i.e. the newly incorporated business) A corporation is a taxable Canadian corporation if it was incorporated in Canada (and therefore deemed to be a resident of Canada by section 250(4) of the Act) or a resident of Canada from June 18, 1971and is not tax exempt under the Act.
Eligible property is defined in Section 85(1.1) of the Act and includes:
Section 85(1) transfer requires that, in exchange for the eligible property, the eligible transferor must receive at least some share consideration. The eligible transferor may also receive a non-share compensation in exchange for the eligible property, but the total compensation package must include shares in the corporation and must not exceed the fair market value of the property transferred.
The joint election is a filing that must be made with the Canada Revenue Agency using the prescribed form (T2057) in order for Section 85(1) to apply to a disposition of property.
Section 85 Elected Amounts:
When filing a joint election, the transferor and transferee must choose an elected amount, which represents the proceeds of disposition for the transferor and the cost to the transferee corporation. The actual value exchanged must be FMV (i.e., the corporation must pay the sole proprietor FMV for the transfer) but the elected amount is the deemed value for the tax purpose of avoiding capital gains tax. The Act prescribes the following upper and lower limits on the elected amount:
If a Section 85 rollover is warranted, it is common to transfer assets from the sole proprietorship to the corporation at FMV (but elect at cost and take back shares equal to FMV). The individual (shareholder) takes back shares from the corporation equivalent to the FMV of the assets transferred into the corporation. So, for example, if an individual transfers $50,000 worth of assets, they would take back $50,000 worth of shares (preferred or common shares).
It’s important to have a valuation done or at least a reasonable attempt made to understand the value of assets transferred, including intangible assets such as ‘goodwill’ (brand, customer lists, etc.). More often than not, goodwill is an asset that is transferred.
In this scenario, there is no immediate tax consequences. If the shares or assets of the corporation are sold at a future date, tax is paid then (if the transaction includes a gain on the sale of shares or assets).
It is important for business owners to take note that a Section 85 rollover provides only a deferral or postponement of tax. It does not amount to tax avoidance. Any increase in value of the assets that was not realized when the transfer occurred will be taxed at the time the assets are sold or otherwise disposed of by the newly incorporated business. The Section 86 rollover can be an important election that can help small businesses lower their tax burden when they want to expand or make changes in their business structure. Use this if you want to convert your sole proprietorship business into a corporation but ensure you seek qualified advice from a lawyer and your accountant before doing so.
 Income Tax Act, RSC 1985, c 1 (5th Supp). [ITA].
 Ibid at s 85(1).
 Ibid at s 89(1).
 ITA, supra note 1.
 Ibid at s 85(1)(f).
 Ibid at s 85(6).
 Ibid at ss 85(1) (a), (b), (c).
Sole Proprietorships – A Closer Look
Sole proprietorship is the simplest form of business organization. It is also by far the most popular structure amongst business founders, as 64% of new Canadian businesses chose to register the onset of their business in the form of sole proprietorship. This blog post aims to take a deeper dive into sole proprietorships in Alberta by providing 1) an overview of sole proprietorships, 2) legal requirements of operating a sole proprietorship, as well as 3) briefly evaluate its advantages and disadvantages.
Sole proprietorships come into existence when an entrepreneur start to carry on business for his or her own account without taking the steps necessary to adopt other form of organization, such as a corporation.
A sole proprietor has sole ownership of the business and there is no separation between the sole proprietor, as the individual owner, and its business. This means that the individual owner of the sole proprietor assumes total responsibility over the management and the business’s assets, profits, and losses. The sole proprietor is also exclusively responsible for all torts committed by him or her personally in connection with the business and will be vicarious liable for all torts committed by employees in the course of their employment. Most crucially, a sole proprietor bears unlimited personal liability. As a result of this unlimited liability, the sole proprietor’s personal assets, as well as assets contributed to the business, may be sized in fulfillment of the obligations of the sole proprietor’s business.
2. Legal Requirements and Registration Process
There are two main legal requirements associated with the use of a sole proprietorship: 1) trade name registration and 2) licensing requirements.
The sole proprietor may either use the sole proprietor’s given name or trade name as their business names. Carrying on business under the sole proprietor’s given name does not require registration, unlike operating under a trade name. Under the Alberta Partnerships Act, using a trade name to run a sole proprietorship does require registration. According to Partnerships Act section 110, “[e]ach person who...
(a) is engaged in business for trading, manufacturing, contracting or mining purposes,
(b) is not associated in partnership with any other person or persons, and
(c) uses as the person’s business name
(i) some name or designation other than the person’s own, or
(ii) the person’s own name with the addition of “and company” or some other word or phrase indicating a plurality of members in the firm, shall sign and file with the Registrar a declaration in writing of the fact.”
Trade name registration is a straightforward process. All that the sole proprietor has to complete a Declaration of Trade Name Form (found here) and file it at one of the Alberta Corporate Registry service providers. Note that despite the requirement in Partnerships Act section 110(2)(d) that the Declaration be “filed within 6 months after the time when the business name is first used,” section 110(3) suggests that no penalty will be imposed if the sole proprietor were to file the Declaration over the 6-months limit.
Unlike a corporation, a sole proprietorship does not have perpetual existence. A sole proprietor who wishes to cease carrying on business of the trade name can do so by filing a Cancellation Declaration (found here).
The other requirement for sole proprietorships, which applies equally to all forms of business organizations, is licensing. Licensing requirements will vary from different business types and the levels of government, whether it be federal, provincial, or municipal. The BizPal permit/licensing finder filter can be found here.
3. Advantages & Disadvantages
As mentioned earlier, one of the main characteristic that makes a sole proprietorship attractive to business founders is its simplicity. Unlike incorporation, which comes with certain paperwork requirements, such as filing of articles of incorporation pre-incorporation and bylaws and minute books post-incorporation as well as annual returns in subsequent years, sole proprietorships has virtually no paperwork that needs to be done save for a trade name registration.
Sole proprietors may also be attractive if the businesses incur losses in its early start-up years. This loss may be applied against the income received by the entrepreneur from other sources. If the losses cannot be used in the current year, it can be carried back for three years to recover taxes previously paid or it can be carried forward 20 years to offset future earnings.
On the flip side, a chief disadvantage of the sole proprietorship is unlimited personal liability. All of the sole proprietor’s personal assets may be taken by third parties in satisfaction of obligations of the business. As the scale of the business and related liabilities increase, this exposure to personal liability makes sole proprietorships increasingly less attractive. By comparison, incorporation provides protection against personal liability. While it is true that a sole proprietorship could manage liability risks through insurances or contractual provisions, incorporation is cheaper and in most cases, more effective.
Another problem with sole proprietorship is raising capital. As a business grows, it will require additional investment. Since it is impossible to divide ownership of the sole proprietorship, the only financing option available is debt. Not only that, non-friends and family investors will also be interested in acquiring an ownership interest in the business without being exposed to the venture’s liabilities. In that case, a sole proprietorship could provide neither the liability protection or the equity mechanism.
To conclude, it is the legal nature of the sole proprietorship as an unlimited liability and unincorporated entity that is determinative of its relative advantages and disadvantages as compared to a corporation. While sole proprietorships have its simplicity and loss-offsetting tax advantages to boast at the beginning of a venture, incorporation may provide further capital raising avenues and better protection against liabilities as the business matures and develops. For more information on the registration process of a sole proprietorship or how it compares to a corporation, contact the BLG Venture Clinic for further details.
 Bryce C. Tingle, Start-up and Growth Companies in Canada 4th ed (Lexis Canada Inc, 2018) at page 36.
 Anthony J. VanDuzer, The Law of Partnerships and Corporations, 3rd ed (Toronto: Irwin Law Inc., 2018) at page 6.
 Ibid at page 8.
 Partnership Act, RSA 2000, c P-3 [Partnership Act], s 110.
 Partnership Act, s (110)(2)(d).
 Business Corporations Act, RSA 2000, c B-9, s 21.
 Income Tax Act, s. 111(1)(a).
 Supra note 1 at page 36.
Can I Patent That?
What Exactly Is A Patentable Creation?
What is Intellectual Property?Before discussing patents specifically, it is helpful to first have a general understanding of what exactly is intellectual property (“IP”). IP, stated broadly, is a “creation of the mind”[i] and includes things like logos, inventions, literary works, and designs.[ii] IP is a type of intellectual asset which, though intangible, plays a crucial role in providing businesses with a competitive advantage so that they can succeed in today’s increasingly knowledge-based economy.[iii] As a result, it is important for entrepreneurs to be able to identify their business’s value-creating IP and understand how to protect it.
There are various forms of IP protection in Canada, with each form focused on protecting a specific range of subject matter. Patents fit into this Canadian IP protection framework as being the form of protection that can be used to protect inventions… provided that those inventions meet certain criteria.
Defining Patents: The Criteria for PatentabilityAs mentioned above, patents are the form of IP protection concerned with protecting inventions.[iv] Inventions are defined in the Patent Act[v] as “any new and useful art, process, machine, manufacture or composition of matter, or any new and useful improvement in any art, process, machine, manufacture or composition of matter”[vi].
For an invention to be “new” it must distinctly demonstrate its novelty or ingenuity over a previous patent.[vii] This novel or ingenious use can includes a new use of an existing substance, such as discovering a new application for an existing drug.[viii] For a patent to be “useful” it must have a demonstratable utility or a sound prediction that it works at the time the patent application was filed. This can be a single or recurring use.[ix]
In addition to being new and useful, the subject matter of an invention must have not been obvious to a person skilled in the art or science to which the subject matter of the invention pertains at the time the patent application was filed.[x]
An Art is a broad category of subject matter which includes new and inventive methods of practically applying skills or knowledge to create commercially useful results.[xi] A Process is a mode or method of operation where the end product is produced from the application of physical or chemical action, element or power of nature, or of one substance to another.[xii] A Machine is a physical or mechanical embodiment of a process which, when used, can deliver a desired effect.[xiii] A Manufacture is the action or process of making articles or material through the application of physical labour or mechanical power.[xiv] And a Composition of Matter is a substance formed by a combination or mixture of various ingredients.[xv]
With these criteria of what constitutes a patentable invention in mind, lets now turn to some examples of subject matter that can fall within these parameters.
What Is and Is Not Patentable Subject Matter?If the subject matter of an invention meets the above the criteria, it is typically patentable. Consequently, patentable subject matter can range from door locks[xvi] to genetically modified cells[xvii]. However, there are some notable exclusions and areas of contention with respect to what can and cannot be patented. Some key examples of these are discussed below.
Unpatentable Subject Matter
Scientific principles and abstract theorems cannot be patented.[xviii] Moreover, creations of nature, like cross-bred plant species, cannot be patented since they are not deemed to have been invented by the discoverer.[xix] Presently, forms of energy such as electromagnetic and acoustic signals are not considered patentable either.[xx]
Broadly speaking computer programs are not patentable subject matter.[xxi] However, if the software is imbedded in a computer – such as in the form of algorithm tied to a physical, read-only computer chip – then it may be patentable.[xxii] It is also important to note that if a computer program is used to make an otherwise unpatentable discovery, the fact that a computer program was used to make the discovery does not change that unpatentable discovery into a patentable one.[xxiii] For example, the fact that a computer was used to discovery a new scientific principle does not make that scientific principle patentable.
Professional skills such as novel ways to describe and lay out land in a subdivision are also not patentable,[xxiv] nor are high life forms such as mice[xxv]. Medical and surgical methods are not patentable in Canada,[xxvi] however the medical products used in those processes can be patented.[xxvii]
Possibly Patentable Subject Matter
A business model can be patentable subject matter, however for a business model to be patentable it must meet all the criteria described in the above “Defining Patents” section and have physicality.[xxviii] This physicality requirement demands that the business model somehow physically exist beyond manifesting its usefulness through the application of a physical tool.[xxix] How this can be done exactly is not clear, however there is some United States case law which suggests that if a business model were imbedded in a software of some kind that it may be patentable.[xxx]
Alternatives to PatentingPatents are just one example of the intellectual property protections available in Canada. Copyrights, Trademarks, and Industrial Designs are other examples of other IP protection available in Canada. Protecting IP through keeping it as a trade secret is also an option for business, and is an IP protection strategy commonly used by start-ups and growth companies.[xxxi] As a result, if you cannot patent your invention, you may want to review the Clinic’s other blogs about IP or book an appointment with the Clinic to learn more about these other forms of IP protection!
Duncan Pardoe is a caseworker at the BLG Business Venture Clinic and a second-year law student at the Faculty of Law, University of Calgary.
[i] World Intellectual Property Organization, “What is intellectual property” (February 21, 2021) online: World Intellectual Property Organization < https://www.wipo.int/about-ip/en/> [WIPO: Defining IP].
[ii] WIPO: Defining IP.
[iii] Government of Canada, “Intellectual assets” (February 21, 2021) online: Canadian Intellectual Property Office < https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr03585.html?Open&wt_src=cipo-ip-main>.
[iv] Government of Canada, “What is a patent” (February 21, 2021) online: Canadian Intellectual Property Office < https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr03716.html?Open&wt_src=cipo-patent-main> [CIPO: What is a patent].
[v] Patent Act, RSC 1985, c P-4 [Patent Act].
[vi] Patent Act, at s 2.
[vii] Whirlpool Corp v Camco Inc, 2000 SCC 67, at paras 64-67.
[viii] Apotex Inc v Wellcome Foundation Ltd, 2002 4 SCR 153.
[ix] AtraZeneca Canada Inc v Apotex Inc, 2017 SCR 943 at paras 46; 53; 55-56.
[x] Patent Act, at s 28.3.
[xi] Progressive Games v Canada (Commissioner of Patents), 177 FTR 241, at para 16.
[xii] Canada, Government of Canada, Manual of Patent Office Practices (2020) online: Canadian Intellectual Property Office < https://s3.ca-central-1.amazonaws.com/manuels-manuals-opic-cipo/MOPOP_English.html#_Toc57035319>, at s 17.01.02 [MOPOP].
[xiii] MOPOP¸ at s 17.01.03.
[xiv] Harvard College v Canada (Commissioner of Patents), 2002 SCC 76 [Harvard College v Canada].
[xv] Harvard College v Canada.
[xvi] CIPO: What is a patent, at “What you can patent”.
[xvii] Monsanto Canada Inc v Schmeiser, 2004 SCC 34, at para 22.
[xviii] Patent Act, at s 27(8).
[xix] Pioneer Hi-Bred Ltd v Canada (Commissioner of Patents), 1989 1 SCR 1623.
[xx] MOPOP, at s 17.03.04.
[xxi] Schlumbereger Canada Ltd v Canada (Commissioner of Patents), 1982 1 FC 845 (CA) [Schlumbereger Canada Ltd v Canada].
[xxii] Re Motorola Inc’s Patent Application No 2,085,228, 1998 86 CPR (3d) 71 (Pat App Bd & Commissioner of Patents).
[xxiii] Schlumbereger Canada Ltd v Canada.
[xxiv] Lawson v Commissioner of Patents, 1970 62 CPR 101 (Ex Ct).
[xxv] Harvard College v Canada.
[xxvi] Tennessee Eastman v Canada (Commissioner of Patents), 1974 SCR 11.
[xxvii] Cobalt Pharmaceuticals Company v Bayer Inc, 2015 FCA 116.
[xxviii] Canada (AG) v Amazon.com Inc, 2011 FCA 328 [Canada (AG) v Amazon.com Inc].
[xxix] Canada (AG) v Amazon.com Inc.
[xxx] Alice v CLS Bank International, 573 US 208 (2014).
[xxxi] Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (Canada: LexisNexis Canada, 2018) at 140.
Should Your Start-up Consider an Innovative Equity Model?
Choosing the right structure and equity allocation for a new venture can create stress for a lot of entrepreneurs. Unfortunately, the equity issue usually comes at a time when there are many other things that the founders are dealing with. Disparity in finances, hours being put in, connections, and any other possible resources can create problems when people are trying to decide how to divide their start-up and allocate equity. Slicing pie, a concept by Mike Moyer, aims to solve this initial hurdle entrepreneurs often face in his book, The Slicing Pie Handbook: Perfectly Fair Equity Splits for Bootstrapped Start-ups.
Moyer teaches Entrepreneurship at Northwestern University and the University of Chicago Booth School of Business. He is a staunch advocate of slicing pie, enthusiastically pointing out all of the problems it can solve and the opportunities it may create. However, solutions to the problems within slicing pie itself are much less plentiful and without an exuberant spokesperson.
The slicing pie concept itself is fairly simple. Implementing it in Canada however, as opposed to the United States where slicing pie originated, is a lot more uncertain and complicated.
The idea is that everyone is compensated for their specific contributions to the company. This means that when someone invests with time, money, ideas, relationships, supplies, equipment, facilities or anything else someone provides without full payment that they are then allocated ‘slices’ of the pie. The pie represents the company, and the slices are a proxy for the individual shares of each person who the pie is split among. The model is dynamic because it adjusts every day as the contributions are made by those working on business. The idea is that if you contributed on a given day, your piece of the pie should reflect that immediately.
The formula is an individual’s % share = individual's Slices ÷ all Slices. This applies until the company starts to break even or they raise enough capital to pay the equity holders for their contributions. When one of these events happens, the pie would ‘bake’ or the split would be frozen and the allocation at that time would determine the distribution of dividends or proceeds of a sale.
The reason for slices and not shares in the traditional sense is the defence mechanisms the concept has built in. With equity, if someone were to leave the company, they maintain that equity. With slices of pie, the idea is that anyone who leaves would be forfeiting their contributions. This is billed as an advantage of slicing pie because it is supposed to keep people committed and bought in to the business’ success for a longer period of time.
However, Canadian courts may not uphold this type of arrangement. In Canada, the principle of equitable relief, such as that referenced in section 16 of the Alberta Judicature Act, means that courts may find anyone who left a company with slices, and not shares, is entitled to the value of those slices anyways. Since the solution slicing pie is offering is to essentially force someone to give up all contributions they have made to a company if they do what is within their rights to do and leave, it is quite logical to think courts will deem that to be unfair. If the courts felt it was unconscionable for the person leaving to receive nothing from their work, it could fundamentally eliminate one of the reasons to use slicing pie.
At this point there is not case law in Canada dealing with the issues slicing pie presents for Canadian law so we cannot be certain as to how the common law and equity would handle a slicing pie dispute. The important thing is that it is a potential issue, and one which is not mentioned or addressed by the very limited slicing pie literature. As time passes and the model is not so new, hopefully there will be answers from the courts and from the relevant tax authorities on how the slicing pie model will be treated.
Another issue with the legally absent equity allocation slicing pie temporarily creates is that the division of the pie may not be honoured. When it comes time to bake the pie, there isn’t a guarantee that everyone will get the share they had with the slices. Everyone involved must trust each other that they will get what they were supposed to. This leads to the second potential issue. Slicing pie claims that because there is no formalized equity until an event that bakes the pie, and therefore terminates the model, there are no potential tax consequences. If one were to try to get around the risk of someone not honoring the slicing pie arrangement by legal agreement, they would be defeating the whole purpose of the model by effectively setting an equity arrangement. This could possibly catch the attention of the Canadian Revenue Agency which may determine equity was held much earlier on, before the pie was officially baked, than claimed.
Slicing pie also theorizes that it will incentivize people into staying committed to the business longer. However, since the slices convert to equity once the company sees success, someone could simply wait until that event and then leave. Alternatively, if the company never returns value then the equity they gave up by leaving had no value anyways, rendering the threat slicing pie implies empty. In the meantime, if they are truly disinterested in the company, they have no reason to contribute more to the pie. They may not officially break off the relationship but could for all intents and purposes stopped adding value of any kind. To think someone that would otherwise leave a venture will stay and work hard for that business’ success because of slicing pie seems to be an untested and flawed theory.
While the slicing pie model advertises that it solves the issue of conflict during equity allocation, and it very well might, it may also just shift the problem. Similar to competing interests wanting different equity decision, there still needs to be negotiation and agreement about what contributions result in slices. For example, one party may have more financial resources while the other has much more time to put into the business. How to properly weight cash contributions compared to an hour of someone’s time must still be agreed upon. In a sense, slicing pie may just be shifting around where the difficult negotiations points exist.
Unfortunately, as with most things slicing pie in Canada, there is a lack of information or certainty. Since the theory was formed by Mike Moyer, and the information on it is contained on his slicing pie website (https://slicingpie.com/) and in his books, there is a deficit of objective and critical information dealing with the challenges the model may face. This is especially true for jurisdictions that are not the United States.
While slicing pie is an exciting and innovative model for helping start-ups deal with equity distribution, there are still many unknowns. Anyone considering the model should take careful consideration of the potential tax and legal uncertainty while also thinking about whether the model will add value to the business or if it will cause as many issues as it solves.
Common Negotiation Terminology
Negotiations are common and important for entrepreneurs, as any start-up business will require negotiating financing rounds, board decisions and salary for employees, among many other things. In our last negotiation centered blog post, we discussed interest-based negotiations and how they are effective (link in footnotes). In this negotiation-based post, I will outline many common negotiation tactics and present some useful tips on how to use them.
Best Alternative to a Negotiated Agreement (“BATNA”)
Zone of Possible Agreement (“ZOPA”)
 “Interest-Based Negotiation” (23 December 2020), online blog): Business Venture Clinic <http://www.businessventureclinic.ca/blog/december-23rd-2020>.
Katie Shonk, “6 Bargaining Tips and BATNA Essentials” (19 January 2021), online (blog): Program on Negotiation Harvard Law School < https://www.pon.harvard.edu/daily/batna/bargaining-tips-batna-essentials/>.
 Katie Shonk, “How to Find the ZOPA in Business Negotiations” (10 August 2020), online (blog): Program on Negotiation Harvard Law School < https://www.pon.harvard.edu/daily/business-negotiations/how-to-find-the-zopa-in-business-negotiations/>.
 Katie Shonk, “What is Anchoring in Negotiation?” (19 May 2020), online (blog): Program on Negotiation Harvard Law School https://www.pon.harvard.edu/daily/negotiation-skills-daily/what-is-anchoring-in-negotiation/.
 David Wright, Law 508 – Negotiation (Faculty of Law, University of Calgary, 2020).
Should Your Canadian Start-Up Become a Benefit Company?
Effective June 30, 2020, British Columbia became the first Canadian province in the country to enact legislation regarding a new corporate form known as a 'benefit company'. The concept originated in Maryland in the United States and has since been adopted by 35 other states.
The amendment to the British Columbia Business Corporations Act [BCBCA] was introduced as a private member’s bill with the aim to support companies who choose to pursue social and environmental goals at the heart of their mission. However, the question remains if entrepreneurs and start-ups should adopt this new for-profit structure and if more provinces will adopt the legislation considering the success the United States has seen.
What Is a Benefit Company?To become a benefit company in British Columbia, your start-up must include a 'benefit statement' and 'benefit provision' in its notice of articles. The benefit statement must make clear its commitment to conducting business in a sustainable and responsible manner while also advocating one or more public benefits. The benefit provision needs to detail the 'public benefits' it intends on promoting. The BCBCA broadly defines a 'public benefit' as having a positive effect on communities, organizations, the environment, or a class of persons other than shareholders of the company. This positive effect can be artistic, charitable, cultural, economic, educational, environmental, literary, medial, religious, scientific, or technological in nature. In the benefit company’s articles it also needs to explain the company’s commitments to conducting business sustainably and responsibly as well as highlight its specified public benefits.
What are the Benefits?
In 2004, the Supreme Court of Canada expanded a director’s fiduciary duties to include social morals by not enforcing a shareholder primacy rule.  This means fiduciaries may choose to pursue broader matters beyond increasing profits for its shareholders. Despite these rules, there are still some advantages of transitioning to a benefit company. For example, it can provide clarity and certainty regarding a company’s purpose, even if the founders decide to move on at a later date. This type of entity can also help attract capital from ethically motivated investors who wish to make a positive impact.
The amendment even restricts who can sue the company in relation to its duties and allows shareholders to bring an action against a benefit company’s directors if a member of the board chooses to disregard the start-up's primary purpose and is in violation of their duty relating to its purported public benefits.
What are the Disadvantages?
Despite the success in the United States, critics of the amendment have many questions about the benefits to a start-up from both a business and legal perspective. From a business perspective, it is unknown how attractive becoming a benefit company is to investors, consumers, and potential new employees. It is also yet to be established which industries should consider exploring this type of entity. Legal experts are wondering how directors will balance their duties of the new amendment with their existing fiduciary responsibilities. There is also a question of how a benefit company will measure the well-being of people impacted by its efforts. It is also unclear what happens if benefit expectations are not met.
How to Find Out if You Should Become a Benefit Company?While some questions remain to be answered about benefit companies, it is worth discussing with a legal professional if this avenue is worth exploring or if the existing legislation is sufficient in supporting your social purpose.
The BLG Business Venture Clinic can assist in answering your legal questions as well as provide advice on how to start your new venture. Get in contact with us today and find out how we can help.
 Business Corporations Act, SBC 2002, c57 [BCA].
 Mondaq (2020, 7 2) Canada: Benefit Companies Arrive in B.C. Retrieved from mondaq.com: https://www.mondaq.com/canada/shareholders/960856/benefit-companies-arrive-in-bc.
 BCA, supra note 1, s. 1.
 Ibid at s. 51.992 (1).
 Ibid at s. 51.991 (1).
 BCA, supra note 1, s. 51.992(2).
 Peoples Department Stores Inc. v Wise 2004 SCC 68.
 Lexology (2020, 6 5) In a First for Canada, Benefit Companies Are Coming to British Columbia. Retrieved from lexology.com: https://www.lexology.com/library/detail.aspx?g=d18e8fb6-c356-4a16-96ea-cc80c267cabe.
Moving Online: Virtual Considerations for Start-ups
For many small businesses, COVID-19 has likely brought about a shift toward virtual operations. This post outlines some considerations for start-ups in Alberta as they navigate the trend toward virtual and electronic operations.
The COVID-19 pandemic created a need for many Canadian corporations to host virtual meetings in order to avoid risks presented by in-person meetings and obey public health orders. Although some challenges remain, virtual meetings can present various benefits for companies, especially in current circumstances, and they may be here to stay.
Alberta corporations are required to hold annual shareholder meetings within specified time ranges. Recently-incorporated Alberta corporations must also hold an organizational meeting of directors. Due to COVID-19, the provincial government suspended these statutory requirements to hold in-person meetings for a limited time in 2020. However, this suspension is no longer in effect and companies may need to consider virtual platforms and other options for holding required meetings as well as other company business.
Companies that would like to host corporate meetings virtually may need to check their corporate documents to ensure they are able to do so. Shareholders of Alberta corporations can participate in shareholders’ meetings electronically, as long as all participants are able to communicate with each other, but only if allowed under the corporation’s bylaws or by the consent of all of the shareholders entitled to vote at the meeting (subject to the bylaws). Similarly, an entire shareholders’ meeting may be held electronically if provided for in the bylaws. Shareholders can also vote electronically if the corporation makes electronic means of voting available, and as long as the bylaws do not prohibit electronic voting. Corporations legislation also allows directors to participate in board meetings electronically, but only if this is allowed under the corporate bylaws or where all of the directors provide consent. Additionally, certain communications related to corporate meetings, such as notices to shareholders or directors, may be sent by electronic means.
As an alternative to holding meetings, matters can generally be passed by a resolution signed in writing by all directors or shareholders entitled to vote on the resolution, as applicable, and this will be as effective as passing the matter by a vote at a board meeting or shareholder meeting.
Alberta law provides for the use of electronic documents in business settings, which may help facilitate companies’ transitions to virtual operations.
“Functional equivalency” rules provide that legal requirements for information to be in writing can generally be fulfilled by using or providing information electronically, as long as it is in an accessible form and can be further referenced and/or retained by the people receiving it. Requirements for records to be signed can be satisfied with electronic signatures, although additional considerations may apply to ensure reliability of the signature.
Agreements and contracts can also be formed online by providing information in electronic form, or by taking actions “intended to result in electronic communication” (for example, clicking an icon can show a person’s intent to electronically communicate acceptance of a contract offer).
Companies that execute signed contracts virtually may consider whether contracts include a “counterparts” clause. These are standard clauses that may be used where parties to a contract do not sign the document while together. A counterparts clause generally provides that the agreement may be executed in separate parts that are electronically circulated, and those parts together will be considered to form the same agreement.
Companies shifting toward virtual operations may begin to share more documents electronically and use electronic document storage and sharing platforms to manage files. This can raise considerations for companies related to privacy law and data breach concerns.
Under Canadian privacy laws, organizations remain responsible for personal information (any information that can be used to identify an individual) that they transfer to third parties. This may apply for organizations using online platforms or “cloud computing services” to share, store, or back up files containing personal information. Privacy commissioners suggest that organizations review the terms of service for cloud computing providers to ensure personal information is handled by the provider in a way that is meets the organization’s privacy obligations. Federal privacy law, where applicable, specifically requires organizations to use “contractual or other means to provide a comparable level of protection” for information being processed by a third party. Companies considering transitioning files and sharing information using online service providers may consider conducting a review of these and other privacy law obligations to ensure they are prepared for virtual business operations.
Additionally, businesses transitioning files, meetings, and communications online may consider the risk of data breach when using virtual platforms. Movement of business operations online often involves use of virtual private networks and cloud computing and raises concerns of increased cybersecurity risk. As noted by the Canadian Centre for Cyber Security, “the more Internet-connected assets an organization has, the greater the cyber threat it faces”. Businesses may consider their information security policies and how to manage risk of data breach and meet any obligations in the event of a breach. Under privacy laws, organizations must protect personal information by using “security safeguards” or “reasonable security arrangements” to prevent unauthorized access and other risks. If there is a breach of an organization’s security safeguards and it is reasonable in the circumstances to think there is a “real risk of significant harm to an individual”, then the organization must report the breach to the relevant privacy commissioner, and it may be required to notify the affected individuals. A previous blog post from the Business Venture Clinic discusses data breach preparedness in more detail.
 See, e.g., federal government recognition of the risks of corporate meetings in Corporations Canada, “Annual meetings of federal businesses, not-for-profits and cooperatives during COVID-19 in 2021” (last modified 30 December 2020), online: Government of Canada <http://www.ic.gc.ca/eic/site/cd-dgc.nsf/eng/cs08888.html>.
 See Dan Healing, “More corporate meetings to go virtual after success during pandemic” (3 August 2020), online: <www.ctvnews.ca>.
 Business Corporations Act, RSA 2000, c B-9, s 132(1) [ABCA].
 Ibid, s 104(1).
 Service Alberta, Ministerial Order no. 009/2020 (9 April 2020), s 5(1), available online: <https://open.alberta.ca/dataset/ministerial-order-no-sa-009-2020-service-alberta>.
 ABCA, supra note 3, s 131(3).
 Ibid, s 131(3.1).
 Ibid, s 140(4), (5).
 Ibid, s 114(9).
 Ibid, s 255(5), see also s 258(2).
 Ibid, ss 117, 141.
 Electronic Transactions Act, SA 2001, c E-5.5, ss 10-13.
 Ibid, s 16.
 Ibid, s 27.
 Personal Information Protection and Electronic Documents Act, SC 2000, c 5, Part 1, Schedule 1, ss 4.1, 4.1.3 [PIPEDA]; Personal Information Protection Act, SA 2003, c P-6.5, s 5(1) and (2) [PIPA]. For the definition of personal information, see PIPEDA, s 2(1); PIPA, s 1(1); Office of the Privacy Commissioner of Canada, “Summary of privacy laws in Canada” (last revised January 2018), online: <https://www.priv.gc.ca/en/privacy-topics/privacy-laws-in-canada/02_05_d_15/>.
 Office of the Information and Privacy Commissioner of Alberta, Office of the Privacy Commissioner of Canada, and Office of the Information & Privacy Commissioner for British Columbia, “Cloud computing for small and medium-sized enterprises” (June 2012), online: <https://www.priv.gc.ca/en/privacy-topics/technology/online-privacy-tracking-cookies/online-privacy/cloud-computing/gd_cc_201206/>.
 PIPEDA, supra note 15, Schedule 1, s 4.1.3.
 See, e.g., Canadian Centre for Cyber Security, Cyber Threat Bulletin: Impact of COVID-19 on Cyber Threat Activity (last modified 10 June 2020), online: Government of Canada <https://cyber.gc.ca/en/guidance/cyber-threat-bulletin-impact-covid-19-cyber-threat-activity>; Canadian Centre for Cyber Security, CYBER THREAT BULLETIN: Impact of COVID-19 on Cyber Threat Activity (2020) at 4, online (pdf): Government of Canada <https://cyber.gc.ca/sites/default/files/publications/COVID_19_Continued_Impact_Threat_Bulletin_TLPWHITE-1.eng_.pdf>.
 Canadian Centre for Cyber Security, National Cyber Threat Assessment 2020 (2020) at 21, online (pdf): Government of Canada <https://cyber.gc.ca/en/guidance/cyber-threats-canadian-organizations>.
 PIPEDA, supra note 15, Schedule 1, s 4.7; see also PIPA, supra note 15, s 34.
 PIPEDA, ibid, s 10.1(1); PIPA, ibid, s 34.1; Federal privacy law also requires notification to the individual (PIPEDA, s 10.1(3)) and Alberta privacy law may require notification at the discretion of the privacy commissioner (PIPA, s 37.1).
 “Preparing for the (Inevitable) Data Breach” (23 February 2020), available online: BLG Business Venture Clinic <http://www.businessventureclinic.ca/blog>.
Articles of Incorporation Basics
If you have the opportunity to start your business off on the right foot, why not capitalize on it? Having an effective and well thought out legal structure is not only conducive for business growth, but it can also save a lot of headaches and future problems down the road. Articles of Incorporation is going as far back, legally, as possible. Understanding what these documents are is critical to understanding how the law can directly impact your business.
Articles of Incorporation are part of a legal document that is submitted to either the provincial, territorial, or federal government which registers a business as a corporation within Canada. For the purposes of this blog post, we will be examining two jurisdictions. The first is Alberta-based corporations which is governed by the Business Corporations Act (Alberta). The second is federally incorporated companies which are governed by the Canada Business Corporations Act.
As a refresher, operating under a corporate entity separates the business from its owners. The liability attributed to the corporation is only in regard to the corporation’s assets, not the assets of the owners of the corporation. This is important if the business is being subject to any legal action or debt recovery; it limits shareholder and director liability.
What is included in the Articles?
Articles of Incorporation include specific information for all corporations. Requirements of the Articles are found in S.6(1) of the ABCA and CBCA. The legislation mandates the inclusion of the name of the corporation, the corporation’s share structure, the number of directors of the corporation, and restrictions. Found on the legal Articles document is the corporation’s address and date of filing.
A business name is always included in the Articles. Often, you will see companies named ###### Alberta Inc., or ###### Canada Inc. This would be the legal name of the business, but the Articles allow you to have a named corporation as well like ABC Company Inc. To make sure there are no other companies with your business’ chosen name, you will have to do a NUANS report to confirm that no duplicates exists.
Directors and Officers
All directors’ names and their addresses must be included in the Articles. Federally, if there are only one or two directors in the company, at least one of them must be a Canadian resident. In Alberta, there is a similar rule, but the Alberta corporation only mandates that one in four directors must be resident. Non-Canadian residents can also be directors of the corporation, however, and in most instances, provinces will still require the company to have an attorney for service or someone in the province to be able to receive mail and more, on behalf of the corporation. When this is not the case, most provinces will require an attorney for service or someone in the province to be listed. Residential addresses for all directors are required to confirm residency status.
Although officers are not legally mandated in corporations, in a small owner-operated business, it is common for the shareholder(s), director(s), and officer(s) to be all the same. For example, if Bryce is the CEO of 123456 Canada Inc, Bryce can also be listed as a director and a shareholder on the Articles. However, officers manage the operations of the business and therefore, the decision to select them should not be taken lightly.
The Articles must include the corporation’s head office address. The head office of the corporation needs to be located in the province or territory in which the business is being registered.
Any restrictions that apply to the business must be included in the Articles. Restrictions generally relate to the company’s share structure and share transfers. Restrictions on share transfers allow shareholders to control who can become a shareholder in the corporation. Having this embedded in the Articles makes sure that changes cannot be made without updating the Articles with the government. In order to update the Articles, shareholders must vote to pass the amendments with a two-thirds vote.
 Business Corporations Act, RSA 2000 c B-9 (ABCA).
 Canada Business Corporations Act, c C-44 (CBCA).
 Ibid at s 105(3.3).
 ABCA, supra note 1 at s 105(3).
Incorporating a Business – A Tax Perspective
As the business grows, entrepreneurs at some point may need to consider, or at least have heard of, the idea of incorporating their business. This is a complex decision that involves several legal, financial and tax implications. This blog will provide a brief overview some of the important consequences of incorporation from a tax perspective.
An informative summary of the legal considerations can be found on the Business Venture Blog here.
A corporation is one of three basic types of business organization, with the other two being sole proprietorships and partnerships. There are two basic differences between corporations from the other forms: [i]
1)Corporations have a separate legal existence. The corporation, rather than the owner, operates the business and bears all the rights and obligations that come with that business.
2)The owners and managers of the corporation become separate and have distinct rights and obligations.
This has an important consequence – the income earned by the corporation running the business and the income earned by the shareholders of the corporation are separately taxable. Because there are two levels of taxation, the differences in the way they are taxed create advantages and disadvantages for the business owner. Some advantages include the ability to reduce taxes by claiming tax credits only available to corporations, controlling the timing of income, or splitting income (to a limited degree). Some disadvantages include the restriction against deducting business losses against personal income, the additional costs of maintaining a corporation such as registration and accounting fees, and the complexity of winding down the corporation when the business ends.[ii]
Taxable Income – Corporations vs Unincorporated Businesses
There are some differences between the tax treatment of business income earned through a corporation and business income from a sole proprietorship or partnership. For a more thorough overview of the tax treatment of business income, see our blog posting here.
In short, the amount of taxes owed from a business is based on Taxable Income, which is calculated as:
1)Net income (or “profit”) based on accounting rules,[iii] then
2)Adjustments are made to calculate Net Income for Tax Purposes,[iv] then
3)Additional deductions are made to arrive at Taxable Income.[v]
This calculation applies to both corporations and individuals with unincorporated businesses. However, there are different kinds of deductions available to each type of business, or the deductions may be treated differently. Deductions available to individuals but not corporations include:[vi]
Deductions that are treated differently include:[viii]
Tax Incentives Specific to Corporations
Several tax incentives available to support incorporated businesses include:
1)Small business deduction – ITA s 125(1)
The federal small business deduction allows Canadian-controlled private corporations (“CCPC”) reduce their taxes payable based on a limited amount of active business income earned in Canada. The business must be a CCPC, which is a private Canadian corporation that is not controlled by one or more non-resident persons or corporations whose shares are publicly traded or listed on a stock exchange.[ix]
Income from an “active business” includes most kinds of business income except for income from a “specified investment business” or “personal services business”.[x] These terms have complicated meanings, but it essentially means that active business income excludes passive income earned merely by owning property (for example, stocks and bonds), and income earned by providing what could be reasonably seen as an employee service.
The deduction is calculated as 19% of active business income (for the 2020 tax year) earned during the year up to $500,000.[xi] This amount would then be deducted from your federal tax payable.
2)Investment tax credits – ITA s 127(5) through s 127.1(4)
Canada offers specific tax credits to support corporations investing into their business. These include credits for scientific research and experimental development (“SR&ED”), employing an eligible apprentice, and purchasing property to run a business in Atlantic Canada.[xii]
3)Foreign tax deduction – ITA s 126
Both individuals and corporations may claim a tax credit to offset foreign taxes paid on business and non-business income earned outside of Canada. The main difference is that, for foreign non-business income, the amount of credit an individual can claim is limited to the lesser of:
a)15% of foreign non-business income, and
b)Another limit based on a formula.
There is no 15% limit for corporations – they may instead claim up to the total foreign taxes paid on foreign non-business income or the formula limit, whichever is lower.[xiii]
4)Manufacturing and processing (“M&P”) profits deduction – ITA s 125.1
The federal government offers a tax reduction based on 13% of profits earned (for 2020) from “manufacturing and processing” activities in Canada. There is no precise definition of manufacturing and processing, but the tax rules exclude activities such as logging; construction; extracting minerals; and producing industrial minerals, natural gas, and heavy crude among many other exceptions.[xiv]
Note that there may not be any actual tax benefits from claiming the M&P profits deduction as any income not included in that deduction is eligible for the general rate reduction, which creates another deduction using same percentage and applies to all other income. However, Ontario, Quebec, and Saskatchewan offer their own tax credits based on M&P activities.[xv]
5)Provincial small business deductions and tax credits
All provinces provide small business deductions to CCPCs like the federal deduction above. Each province also provides tax credits for corporations performing specific activities. For example, Alberta offers the Innovation Employment Grant (beginning January 1, 2021) and tax credits for scientific research and development, foreign taxes paid, capital expenditures, and production and labour costs for film and television productions.[xvi]
Salary vs Dividends
In the case of an owner-managed business corporation, owners have the option to pay themselves a salary, dividends, or a combination of both. This decision depends greatly on the individual circumstances of the owner and their business. Some important considerations are listed below:[xvii]
1)Provincial tax rates and credits
While all Canadian corporations are subject to the same federal tax rates, different provincial tax rates and credits could weigh in favour of salaries or dividends depending on where the business is incorporated. Generally, individuals taxed at higher rates would likely prefer dividends as their tax effects are offset by dividend tax credits. Salaries of course receive no such credit.
2)Types of dividends received
Corporations can pay either eligible or non-eligible dividends, each of which have their own tax treatment. Eligible dividends typically receive (are “eligible” for) more generous tax credits than non-eligible dividends. However, whether a dividend is eligible or not depends on the tax treatment of the corporate income from which the dividends were paid, and the tax credit is intended to offset that difference. Given that and the differences in the provincial tax treatment of dividends, there is no clear answer to whether salaries or dividends should be preferred.
3)CPP and EI contributions
Being paid a salary allows an owner to continue making contributions to the Canada Pension Plan (“CPP”) and Employment Insurance (“EI”), whereas dividends do not. Being paid in dividends will have the effect of lowering the amounts the owner is eligible for under either plan.
Salary payments are used to determine how much an owner can contribute to their Registered Retirement Savings Plan (“RRSP”). RRSP contributions enable individuals to defer taxes by allowing them to deduct their contributions from income. Dividends received are not factored in and so would not increase their total contribution room.
5)Childcare expense deductions
Salary is also used to determine how much an individual can deduct in childcare expenses.[xviii] Dividends do not count towards this limit and so could reduce the amount an owner may claim for this deduction.
A goods and services tax (“GST”) is charged on most goods and services in Canada and is paid by consumers. With some exceptions, the suppliers of these items (including business corporations) are responsible for collecting and remitting GST to the Canada Revenue Agency. For an overview of a business’s GST obligations, please see our blog post here.
Transferring Business Assets to a Corporation
It is often the case that business owners will have worked at and grown their business long before they consider incorporation. If they do decide to incorporate, owners may transfer their business assets to the corporation. However, under normal tax rules this transfer could result in the owner paying additional taxes (through capital gains and CCA recapture).[xix]
Section 85 of the Income Tax Act[xx] provides a solution to this. The owner must notify CRA that he or she intends to transfer their assets to the corporation and elect to have Section 85 apply by filing certain forms. There are many detailed rules around how to properly perform the transfer, including what kinds of assets are eligible for transfer, what the owner should receive in return for the transfer (for example, shares in the corporation), and how the assets should be valued. In essence, this election may prevent owners from facing needless tax liabilities in growing their business.
[i] J Anthony VanDuzer, The Law of Partnerships and Corporations, 4th ed (Toronto, Ontario: Irwin Law Inc, 2018) at 13-16.
[ii] Clarence Byrd, Ida Chen & Gary Donell, Byrd & Chen’s Canadian Tax Principles: 2020-2021 Edition, Volume 2 (North York, Ontario: Pearson Canada Inc) [Byrd and Chen] at 725-727.
[iii] For an explanation of “profit”, see “Basic Tax Implications for Canadian Entrepreneurs”, (30 December 2020), online (blog): Business Venture Blog http://www.businessventureclinic.ca/blog/december-30th-2020.
[iv] Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA], s 9(1).
[v] ITA, supra note iv at s 110(1).
[vi] Byrd and Chen, supra note ii at 585.
[vii] In 2019, the Government of Canada proposed changes to the current treatment of employee stock options, where there will be a $200,000 limit on stock options that qualify for the stock option deduction. Employees with options over this limit would not receive the deduction on those options and include the entire excess benefit in income when the options are exercised. Instead, the employer will be able to deduct the amount that would have been eligible for the deduction. CCPCs and non-CCPC corporations with annual gross revenues of $500 million or less would not be subject to the new rules. The Government’s goal was to “ensure that start-ups and emerging Canadian businesses that are creating jobs can continue to grow and expand and attract key talent, while limiting the benefit of the employee stock option deduction for high-income Canadians who work in mature companies.” The new rules are expected to apply to options granted on or after July 1, 2021. See Department of Finance Canada, “Supporting Canadians and Fighting COVID-19: Fall Economic Statement 2020“ (2020) at 113-114, online (pdf): Her Majesty the Queen in Right of Canada https://www.budget.gc.ca/fes-eea/2020/report-rapport/FES-EEA-eng.pdf
[viii] Byrd and Chen, supra note ii at 585-586.
[ix] ITA, supra note iv at s 125(7).
[x] ITA, supra note iv at s 125(7).
[xi] ITA, supra note iv at s 125(1.1)(c) and 125(2).
[xii] See Canada Revenue Agency, “Line 41200 – Investment tax credit” (date modified: 18 January 2021), online: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-41200-investment-tax-credit.html
[xiii] Byrd and Chen, supra note ii at 615.
[xiv] See ITA, supra note iv at s 125.1(3) for definition. See also Canada Revenue Agency, “Income Tax Folio S4-F15-C1, Manufacturing and Processing” (last modified: 15 February 2017), online: https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-4-businesses/series-4-businesses-folio-15-manufacturing-research-development/income-tax-folio.html#N101DD
[xv] Byrd and Chen, supra note ii at 609.
[xvi] See Government of Alberta, “Corporate income tax” (date accessed: 30 January 2021), online: https://www.alberta.ca/corporate-income-tax.aspx#deduction
[xvii] Byrd and Chen, supra note ii at 753-758.
[xviii] ITA, supra note iv at s 63(1)(e)(i).
[xix] Byrd and Chen, supra note ii at 775.
[xx] ITA, supra note iv at s 85(1).
The “agency problem” arises whenever one person (the “Principal”) entrusts another person (the “Agent”) with the power to make decisions that affect the Principal. This could involve entrusting property to the Agent to deal with on behalf of the Principal, or it could involve delegating decision-making power to the Agent that affects the legal rights of the Principal. The core of the agency problem is that the Agent has the authority to act on behalf of the Principal and yet the interests of the Agent may diverge from the interests of the Principal. For example, the Agent may not negotiate as hard as the Principal would on the price of the Principal’s goods unless there is something in it for him. This is a prime example of an “agency cost”.
In Canadian common-law, the essence of an agency relationship is that the Agent can affect the legal rights and obligations of the Principal with the outside world. For example, the Agent can negotiate, enter into contracts, or dispose of the Principal’s property. The list of agency relationships is not closed, but trustee-beneficiary, employee-employer, solicitor-client, and business partners all give rise to certain agency problems. In a corporation, an agency relationship exists between the corporation's shareholders (Principals) and its management (Agents).
The common-law’s solution to the agency problem is the fiduciary duty. The fiduciary duty holds the Agent to a strict standard of conduct. It requires the Agent to exercise reasonable care and diligence (duty of care), and to exercise his authority in the best interests of the Principal, not to obtain a benefit for himself to the detriment of the Principal (duty of loyalty). Courts are reluctant to impose fiduciary duties, particularly in commercial contexts because it is thought to be a “blunt tool” in that it imposes serious legal duties upon one party without much regard for circumstances. To find a fiduciary duty at least three elements must exist (although the presence of all of them or the lack of one of them is not determinative):
(1) The fiduciary has scope for the exercise of some discretion or power.
(2) The fiduciary can unilaterally exercise that power or discretion so as to affect the beneficiary's legal or practical interests.
(3) The beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the discretion or power.
In a corporation, it is the directors and officers who make decisions about the corporation’s business, and it is the shareholders whose property is at stake. As a result, both the common-law and legislation impose fiduciary duties on directors and officers to act in the best interests of the corporation. This public-law solution is good, but as mentioned above, it is “blunt” and not very proactive. There are several other ways that shareholders can protect themselves contractually i.e., structuring the enterprise in a way that aligns the interests of management, with the interests of owners.
In a corporation, agency costs are the costs incurred by the shareholders (Principal) to supervise and control management (Agent). Traditionally, economists point to three ways to effectively control and oversee management:
The market for corporate control, like the fiduciary duty, is criticized as being “blunt” and only really applies when management has seriously failed. It does not proactively prevent mismanagement. The market correction also relies heavily on an efficient market where these kinds of inefficiencies can be addressed immediately. But, transaction costs, market regulations, asymmetric information, and the fact that other firms are not always in a position to acquire make the market for corporate control less efficient.
Similarly, empirical research has shown that board independence is not actually very effective at reducing agency costs or improving firm performance. Boards of directors are rarely truly independent, and even if they are, they are often influenced by management and are less effective at disciplining management and representing the interests of shareholders than one might think. Regardless, in a start-up company, it is unlikely that an independent board of directors is possible.
In very early-stage companies the founder often holds 100% of the company’s capital and manages 100% of the affairs of the business. When the company needs to grow, it needs to attract some form of venture capital. The moment that outside capital is involved, there are going to be agency problems. What you end up with is a company with shareholders who are particularly vulnerable to the control of a single founder or group of founders, and founders who are particularly vulnerable to shareholders who want their money back. Not to mention that both the founders and the shareholders are particularly vulnerable to going out of business. So naturally, agency costs are significant in start-up companies. This partially explains why start-up companies and investors make use of relatively complex investment instruments and shareholder agreements.
Capital structure, shareholder agreements, bylaws, and employment agreements all play a significant role in controlling agency costs in a start-up company. The table below provides a few examples of the legal tools corporations can use to address agency problems. This table is not authoritative and the boundaries between independence, equity, and corporate control are not clear-cut, but hopefully, it gives the reader a sense of the motivation behind certain contractual provisions and rules.
 Dalton et al, “The Fundamnetal Agency Problem and Its Mitigation: Independence, Equity, and the Market for Corporate Control” in James P Walsh & Arthur P Brief, The Academy of Management Annals: Volume 1, New York: Taylor & Francis Group, 2008) 1 [Dalton].
 Trophy Foods Inc v Scott, 1995 NSCA 74 [Trophy Foods].
 Guerin v The Queen, 1984 CanLII 25 (SCC).
 Trophy Foods, supra note 2.
 Lac Minerals Ltd v International Corona Resources Ltd, 1989 CanLII 34 (SCC).
 Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (Canada: LexisNexis Canada, 2018) [Tingle] at 328.
 Dalton, supra note 1 at 3.
 Dalton, supra note 1 at 27.
 Dalton, supra note 1 at 10.
 Tingle at 329.
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.