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Financing the Start-up Company
Written by Viviana Heather Securities regulation in Canada is a matter of provincial jurisdiction, where it governs every issuance of securities by a growth company. The legal requirements concerning securities offering are substantially the same between the provinces. As a result, there are two bedrock principles in the Canadian securities regime: (a) no one may buy or sell shares unless a registered dealer (in other words, an investment bank) is involved in the sale; and (b) a prospectus must be used every time a corporation distributes its shares to investors.[1] However, growth companies will unlikely raise early financing under this system due to the high costs associated with a prospectus and retaining a registered dealer.[2] This blog post provides an overview of the exemptions from prospectus requirements. The Private Issuer Exemption This exemption is invariably the exemption applied to startups and small issuers for the initial distribution of shares to their business partners. The private issuer exemption requires the following:
This exemption is similar to the Private Issuer Exemption. Eventually, a company will cease to be a private issuer because they have too many shareholders or they distribute shares to the public (which violates the requirements under 3 and 4 of the Private Issuer Exemption).[4] The individuals that fall under this exemption include:
This exemption is usually used by angel and venture capital investors. While there are different categories of accredited investors, the most commonly used ones are as follows:
This prospectus exemption is available in every province, but there are significant differences in how it operates.[11] The general concept is that the exemption allows a company to raise money from any person so long as that person is provided with an offering memorandum in a prescribed form prior to agreeing to purchase the security.[12] The offering memorandum discloses basic information about the issuer, its business, financial status and management, terms of the offering, and it describes the securities that are to be sold.[13] The Employee Exemption This exemption is typically not used as a financing mechanism, but NI 45-106 provides an exemption for trades by an issuer with its employees, directors, senior officers and those consultants that spend a “significant amount” of time working with the company.[14] However, these individuals are also covered in other exemptions such as the Private Issuer Exemption and the Family, Friends and Business Associates Exemption. The Minimum Amount Investment All provinces subscribe to this exemption, which provides for an exemption from prospectus requirements where an investor acquires more than $150k worth of securities.[15] Conclusion To make an offering of securities in Canada without using a prospectus and involving a registered dealer, a growth company must rely on a prospectus exemption in order to finance their enterprise. Viviana Heather is a member of the BLG Business Venture Clinic and is a 3rd year student at the University of Calgary Faculty of Law Footnotes [1] Securities Act (Alberta), s 75; Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (LexisNexis Canada, 2018) at 252 [Tingle]. [2] Tingle, ibid. [3] Prospectus and Registration Exemptions, NI 45-106, s 2.4 [NI 45-106]; Ibid at 254. [4] Tingle, supra note 1 at 255. [5] NI 45-106, supra note 3. [6] It is a rebuttable presumption. See Securities Act (Alberta), s 1(1). [7] NI 45-106, supra note 3. [8] See e.g. Re Brittain, 1993 CarswellSask417 (WL Can), 2 CCL 109 (SK Securities Commission). [9] NI 45-106, supra note 3. [10] Ibid. [11] Tingle, supra note 1 at 258. [12] Ibid. [13] Ibid. [14] Ibid at 260. [15] Ibid at 261.
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CSA Regulatory Sandbox
Written by Nikolas Kalantzis If your start-up is in the business of trading or advising securities you are subject to Canadian securities laws and must register under the Alberta Securities Commission (ASC). Securities may include stocks in a company, corporate bonds, profit-sharing agreements, shares in an investment fund, or investment contracts. And yes, according to CSA Staff Notice 21-327, when cryptocurrencies are traded on a platform they are also considered a security. Spurred into action by the QuadrigaCX fiasco, securities regulators across Canada have now stepped up their game to more closely regulate financial technology (fintech) start-ups and cryptocurrencies (crypto) while still allowing some innovation and experimentation in the market. In doing so, the ASC has created a Financial Innovation in the Capital Markets unit in partnership with the Canadian Securities Administrators (CSA) and have released a regulatory Sandbox to exempt fintech start-ups from certain securities regulations. What is the Sandbox? The Sandbox is a coordinated relief initiative to allow fintech start-ups the chance to apply their ideas and test their products on the securities market. The CSA allows relief across Canada subject to local regulators. It is also in collaboration with international fintech networks allowing international testing of their innovative product or service. A regulatory sandbox can be defined as a “safe space” that allows start-ups to work in “a limited capacity and receive regulatory relief from traditional rules” such as waivers or no-action letters (Clements 2019, 8). This provides the necessary regulatory oversight that promotes start-ups to work more precisely than the traditional Silicon Valley tech start-ups of the “move-fast-and-break-things” ethos (Clements 2019, 9). As such, financial markets and consumers are still protected while allowing Canadian start-ups the chance to innovate and grow. Who’s Allowed In? Applicants must be a fintech start-up or business with an innovative product, service, or application. Fintech itself has a wide net that covers processes, products, technology, and innovations that materially effect financial markets, business transactions, or financial systems (Clements 2019, 3). This may include more efficient ways to trade securities, promote financially underserved markets, enhance customer-user experiences, and reduce transaction costs. While the CSA is not explicit in defining fintech, your start-up should likely fit into this area to operate within the Sandbox. To date, crypto and crypto trading platforms makeup the majority of the Sandbox. The ASC defines crypto as generally referring to coins or tokens that are digitally represented assets produced by cryptography or blockchain technology. The CSA puts out an online decisions list of the various decisions or recommendations to applicants of the Sandbox. Before applying, interested fintech start-ups may want to consider these decisions to see the types of relief previously requested and the responses that the regulators gave. The Rest of the Playground Fintech is a new an exciting place with many growing start-ups. But outside the safe space of the Sandbox, fintech start-ups are likely subject to many regulatory requirements under Alberta’s Securities Act. This may include filing a prospectus, dealer registration, continuous disclosure, and market manipulation conditions among others. Fintech start-ups who are not registered with the ASC or another jurisdiction’s regulator may not have the normal safeguards in place such as trustworthy record keeping, confidentiality protections, fair pricing mechanisms, disclosure of fees, and risk warnings. Hop-in! If you have more questions about the Sandbox or just want to discuss the legal options for your fintech start-up please contact the BLG Business Venture Clinic. You can also contact the ASC directly at: regtechsandbox@asc.ca Nikolas Kalantzis is a member of the BLG Business Venture Clinic and is a 2nd year student at the Faculty of Law, University of Calgary. Sources: Clements, Ryan 2019. “Regulating Fintech in Canada and the United States: Comparison, Challenges and Opportunities”: View of Regulating Fintech in Canada and the United States: Comparison, Challenges and Opportunities (ucalgary.ca) CSA Regulatory Sandbox - Canadian Securities Administrators (securities-administrators.ca) Financial innovation in the capital markets | ASC (albertasecurities.com) Securities Act, RSA 2000, c S-4, <https://canlii.ca/t/5541x> retrieved on 2021-10-25. The Problem with Using Shares as Compensation for Future Services
For growth companies, offering shares as compensation to employees and contractors can be effective early-stage strategy. This is especially true for companies still waiting to see revenues coming through the door. However, there are important considerations to keep in mind when using shares as compensation. This article will outline the issues with using shares as compensation for future services, and then discuss two possible solutions to this problem. When can shares be used as compensation? Both the Alberta Business Corporations Act and the Canada Business Corporations Act outline that shares cannot be issued until the consideration for the share is fully paid.[1] This presents a problem when a corporation wishes to issue shares for future services. Based on the wording of these Acts, a share issuance given for future services would be an improper issuance. What can happen if shares are improperly issued as compensation for future services? There are currently two different views in the case law on what results when shares are improperly issued. The first line of cases has found that an improper issuance results in the shares being a nullity, while the second line of cases has instead used what is known as the "contextual" approach and allowed the courts to fashion the remedy to the situation. According to the line of cases which follow Javelin International v Hillier, if shares are issued for inadequate consideration, the issuance is considered a nullity.[2] This case, and the others which followed in its footsteps have noted that the legislation outlines that shares shall not be issued until consideration for the shares is fully paid. According to these cases, the use of the word "shall" signifies that without proper consideration, the issuance must be considered a nullity. In Alberta, the nullity stream of cases appears to have been rejected by the Alberta Court of Appeal in favour of the contextual approach. In Pearson, The Court of Appeal highlighted that corporate legislation does not spell out what should result if an improper issuance occurs.[3] The case expressly outlines that an improper issuance of shares under section 27 does not automatically make the shares void.[4] Other courts have come to a similar conclusion as Pearson, and determined that in the absence of guidance from the legislation, it is up to the courts to determine the proper remedy in situations where shares are improperly issued. In this situation, courts have typically taken one of three positions: (a) The shares are a nullification; (b) The directors are liable for the improper issuance; or (c) The shareholder is permitted to pay the subscription price to validate the issuance.[5] While this approach does offer the potential for an improper share issuance to be remedied, corporations will not want to rely on the discretion of the courts to validate their share issuances. Instead, two potential solutions are proposed below. Potential Solutions There are two potential avenues that a corporation may take that may allow it to issue shares as payment for future work. One Canadian scholar has suggested that the shares may be issued as consideration for entering into an employment agreement with the corporation.[6] However, if a corporation wishes to do this, it must keep in mind that section 27(3) of the Alberta Business Corporations Act requires that the consideration for the shares be "the fair equivalent of the money that the corporation would have received if the share had been issued for money."[7] Therefore, the value of having the employee join the company must equal the fair market value of the shares being issued. This will typically only be possible in the early stages of a corporation's life. The other strategy that a corporation may use requires further foresight. This strategy involves an existing shareholder transferring a portion of their shares to the contractor or employee. In this scenario the shares will have already been issued to the founder for good consideration. The founder is then free to deal with her shares as she sees fit. In order to execute this type of plan, it can be wise for a corporation to issue a founder extra shares when the corporation is founded for the purpose of later transferring those shares to new employees or contractors. Alternatively, the founding shareholders may agree to transfer shares to a new employee or contractor on a pro-rata basis. Conclusion Granting shares to potential employees and contractors in exchange for future work may be something a growth company wishes to do in its early stages. If it does do this though, it must ensure it does not run afoul of corporate legislation. The shares should either be transferred from the holdings of a current shareholder, or the shares must be issued in consideration for entering into an agreement with the company. ________________ [1] Business Corporations Act, RSA 2000, B-9, s 27(3); Canada Business Corporations Act, RSC 1985, c C-44, s 25(3). [2] Javelin International Ltd. (Receiver of) v Hillier, 1988 CarswellQue 28, 40 BLR 249, para 24. [3] Pearson Finance Group Ltd. v Takla Star Resources Ltd., 2002 ABCA 84, para 9. [4] Ibid, para 22. [5] Marshall Haughey, "Issuing Shares for a Promissory Note", (2014) 24:8 Can Current Tax 85, at 87. [6] Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (LexisNexis Canada, 2018), at 154. [7] Supra Note 1, s 27(3). How to Protect your Billion-Dollar Idea: An Overview of Copyrights, Patents and Trademarks
Written by Skylar Caldwell So you've finally thought of the next billion-dollar startup idea. Before you book the next available spot on Dragon's Den or let the Facebook, Amazon, and Apple shaped-stars in your eyes cloud your vision, you may be wondering what steps you can take to protect the information that is valuable to your future-unicorn company. Canadian legislation provides several options to protect intellectual property and other information that is valuable to a business. This blog post provides an overview of three of the most common ways businesses protect their information; copyright, patent, and trademark. Copyright: For Creative Works A copyright is the right a person holds in a creative work. Do you intend on building a literary empire à la Stephen King? If yes, copyright is for you. Copyright provides protection for literary, artistic, dramatic, musical works, computer programs, and other subject matter known as performer's performances, sound recordings, and communication signals.[1] In general, copyright means the sole right to produce or reproduce a work or substantial part of a work in any form. In order to successfully apply for a copyright, a work must be original, creative, and recorded in some way. Creative, in the context of copyright, does not exclusively refer to artistic works. It simply means that the copyrighted work must be the product of knowledge and judgement. Haven't been able to find a publisher willing to take on your literary masterpiece? Don't sweat it- unlike trademark protection, copyright protection under the Copyright Act applies to works that have not been published or otherwise made known. In fact, copyright includes the right to publish a work or a substantial part of a work. Registering a copyright is not necessary. However, copyright gives the creator the presumption of ownership in any legal disputes that may arise surrounding the copyrighted material, as well as precludes a person who infringes on the copyright from claiming innocence.[2] It should be noted that not every incidence of copying copyrighted material is considered to be a violation. For example, section 6 of the Copyright Act specifies that exceptions are made in instances of copying for the purpose of "research, private study, education, parody or satire".[3] Additionally, the copyright must be monitored by the copyright holder.[4] This means that the onus is on the holder of the copyright to recognize any infringements on their copyright and bring forth an action against the individual infringing on the copyright. A copyright is typically valid for the entire creator's life, and extends to 50 years beyond the year of the creator's death.[5] Copyrights can be registered through the Canadian Intellectual Property Office (the "CIPO"). The process involves filling out an online form and paying a $50 fee. Patents: For Inventions Patents exist for the protection of inventions. Does your future-unicorn startup involve the invention of a product to protect dog's ears to solve the incessant problem of not being able to bring your pup along to concerts? I have bad news, Animal Ear Protectors have already been patented. If you have another invention, defined under the Patent Act 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"[6], a patent may be the right option for protecting your business. Patentable inventions must be new, useful and not obvious to an individual working in the relevant field or industry. Unlike copyright, there is no automatic protection for creators of the patented material. In order to legally protect your invention, a patent must be granted. Patent protections are typically stronger than copyright protections, as they give the holder the right to exclude others from making, using or selling the invention, even in instances where another person developed the patented invention independently. Patents last for 20 years, and cannot be renewed.[7] The first step in obtaining a patent is to file an application. The patent application fee is $204 for small entities and $408 for other businesses.[8] Once the application has been filed, the applicant must request an examination, which can take up to two years to occur. During the examination stage, an application may be granted, or the examiner may object to all or part of the application. In instances where there is an objection, the applicant must respond to the objection or else the application will be considered abandoned. If the applicant responds to an objection, there may be additional objections made by the examiner or the application may be denied in whole. If an application is rejected, the applicant can appeal the decision to the Commissioner of Patents. If an application is granted, the owner of the patent must pay maintenance fees every year to maintain the patent. The maintenance fee for the second, third, and fourth years following the filing date of the patent is $50 for small entities and $100 for other businesses.[9] The maintenance fees increase the longer you hold the patent for. On the fifth, sixth, seventh, eighth and ninth years following the filing date of the patent, the maintenance fee is $100 for small entities and $204 for other businesses.[10] Trademarks: For Business Names, Slogans and Logos The word "Tesla" is inextricably associated with innovation and the quirky, visionary leadership of its founder Elon Musk. If you foresee your billion-dollar startup obtaining a similar type of powerful brand recognition, you should consider filing a federally registered trademark under the Trademarks Act.[11] Trademarks can be any "combination of words, sounds, or designs used to distinguish the goods or services of one person or organization from those of others".[12] Trademarks can include business names, logos, and slogans, and can be important components of ensuring continuity in brand recognition. After all, where would Nike be without its association with the intensely inspirational and instantly recognizable "Just Do It" slogan? When registering a trademark, a person is granted "the sole right to use the mark across Canada for 10 years".[13] The holder of a trademark is also provided the option to renew the trademark every ten years. A trademark is not required to be registered. This is because, if the use of a trademark has persisted for a certain length of time, the trademark may be protected under common law. [14] The two most common types of trademarks in Canada are ordinary trademarks and certification marks.[15] An ordinary trademark includes words, designs, tastes, textures, moving images, modes of packaging, holograms, sounds, scents, three-dimensional shapes, colours, or a combination of these used to distinguish foods or services of one person or organization from those of others.[16] A certification mark can be licensed to many people or companies for the purpose of showing that certain goods or services meet a defined standard with respect to: (a) the character or quality of the goods or services; (b) the conditions under which the goods have been produced or the services performed; (c) the class of persons by whom the goods have been produced or the services performed; or (d) the area within which the goods have been produced or other services performed.[17] Certification marks are trademarks that serve as a guarantee that the goods or services with which the mark is associated conform to a particular standard. The owner of a certification mark is responsible for establishing the defined standard indicated by the mark. The owner may adopt the mark and register it with the Canadian Trademarks Office so long as it does not itself manufacture, sell, lease or hire the goods, or perform the services, in association with which the certification mark is to be used. Instead, the Trademarks Act provides for a licensing scheme under which the owner of the certification mark may license others to use to mark in association with their own goods and services, so long as those goods or services meet the owner's defined standard.[18] A trademark application may be filed on the CIPO website. There is a $336 base application fee if a business submits their application online through the CIPO website, and a $438 base application fee if a business submits through another channel.[19] An application for a trademark may be refused if it is confusingly similar to a previously filed trademark.[20] This is bad news for you if your billion-dollar idea involved a soft drink company called "doca dola". In order to expedite the process of filing a trademark, a business can search the Canadian Trademarks Database to look for similar trademarks before submitting their trademark application to determine whether their proposed trademark is confusingly similar to an existing one. The Trademarks Act deems a trademark to be adopted once it has been filed for registration in Canada. The filing date of an application is the date that the Registrar received an application meeting all its filing requirements. Once you've taken all the necessary steps to protect the valuable information involved in your startup, you can start building your entrepreneurial empire. So get out there, maybe get a small loan of $1 million from your father, and use your copyrighted, patented, or trademarked billion-dollar idea to build your unicorn startup! __________________ [1] Copyright Act, RSC 1985, c C-42 s 2. [“Copyright Act”] [2] Ibid at section 53(2). [3]Ibid at section 29. [4] Ibid at section 35(1). [5] Ibid at section 6. [6] Patent Act, RSC 1985, c P-4 [Patent Act]. [7] Ibid at section 44. [8] Government of Canada, “Patent Fees” (1 February 2021), online: Canadian Intellectual Property Office <https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr00142.html>. [9] Ibid. [10] Ibid. [11] Trademarks Act, RSC 1985, c T-13. [12] Government of Canada, “What Are Trademarks?” (3 July 2019), online: Canadian Intellectual Property Office <https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr03718.html>. [13] Government of Canada, “A Guide to Trademarks” (24 July 2020) online: Canadian Intellectual Property Office < https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/h_wr02360.html?Open&wt_src=cipo-tm-main&wt_cxt=learn> [TM Guide]. [14] Ibid. [15] Ibid at "Understanding Trademarks". [16] Ibid. [17] Ibid. [18] Ibid. [19] Canadian Intellectual Property Office, “Complete list of fees for trademarks” (28 April 2017) online: Canadian Intellectual Property Office <http://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr04194.html>. [20] Ibid.  LEGAL PERSONALITY
The Default StructuresSo, you want to start a business and can’t wait to build that new prototype of your ground-breaking, market-disrupting product. Maybe this is a joint effort, and you get together with some tech savvy friends, and borrow some seed money from yet more friends to get started. So, what’s the problem here? When you start a business by yourself (a Sole Proprietorship), there is no distinction in the eyes of the law between yourself and the business. Taxes are filed together, money earned is considered personal income, and most importantly, obligations of the business are your personal obligations. You are personally on the hook for everything the business does or does not do. This is the first default way of doing business. When you get together with others to “carry on a business in common with a view to profit” you’ve triggered the second default way of doing business, by entering into a Partnership. Like the previous default structure, there is no distinction made between the business and the partners. Partnership income is the same as the partner’s income, but with the added catch that if no agreement is made between the partners, that income (or loss) is to be divided equally among the partners. The Partnership Act governs some of the key elements, but the interpretation of the above underlined terms is found in the case law. In addition, partners owe to each other stringent fiduciary duties that compels them to act in the best interests of the partnership. In practice this includes: not competing with the partnership, the sharing of any benefits accrued from the partnership, full disclosure of information pertaining to the partnership, and confidentiality, among others. Liability incurred by the partnership for wrongs committed against a third party is also joint and severable between the partners[1]. This means that an injured third party may claim against any partner for the full quantum of damages. There surely are some benefits for using these default structures but that is a topic for another time. However, one of the biggest risks is the personal exposure to liability. The Corporate Form A popular alternative to the above default structures is the corporate form. This is not a default way of doing business because it requires positive procedural steps to trigger its formation. A corporation does not arise automatically from indirect actions of the involved parties. To start a corporation, you must follow procedures in a Business Corporations Act[2]. There is both a federal and provincial version of this act with a large degree of similarly (albeit there are some differences too). Incorporation can be done under either of them, but not both simultaneously. The main benefit of the corporate form is that it effectively splits ownership from management in the eyes of the law. This gives the corporation “legal personhood”, sometimes also called a “juridical person”. A corporation therefore is considered a separate entity that files taxes, declares income, borrows money, and incurs liability on its own, separate from the true owners[3]. The owners in this case are the “shareholders”, and the management of the corporation is led by the “board of directors”. The trick here is that the owners are protected from liability above the amount they have invested in the corporation. This protection is known as the “corporate veil”. Only on very limited and extreme occasions is the corporate veil breached by a Court to hold the owners personally liable for an action of the corporation. Ownership of a corporation is therefore comparatively less risky, which facilitates activities such as obtaining new investment from people looking to buy shares or from institutions looking to lend capital. Another benefit is that ownership does not preclude the individual from also being a manager or employee[4]. However, unlike the owners, individuals acting as managers do have to contend with other legal duties and potential liability. The shareholders maintain control over the board of directors by using statutory mechanisms in the Business Corporations Act and also through provisions in the “articles of incorporation”. The articles are akin to a corporate constitution, and it will govern the relationship between the owners and managers. It does this through restrictions on what the company can and cannot do, and through the rights associated with the shares that a company can issue. The distribution of liability between the managers depend on the scope of their relationship to the company. The board of directors will carry the largest burden because they are ultimately responsible and in charge of making strategic decisions for the corporation. In addition, they owe a fiduciary duty of loyalty and care to the corporation itself[5]. In practice, this often means that they attempt to maximize benefits for the shareholders. To attract and retain competent directors, a corporation will typically indemnify directors for liability that they could personally incur so long as they were acting in good faith and did not breach their fiduciary duties. Senior officers include managers that are hired and appointed directly by the board of directors. Officers owe a fiduciary duty to the corporation because their influence over the affairs of the company are analogous to that of the directors[6], and because they are included alongside directors under the fiduciary provision in the Business Corporations Act[7]. Other managers of a corporation may also owe a fiduciary duty to the company, but the scope of the duty will be circumscribed by: 1) the degree of influence they exert over the daily operations, and 2) the terms in their employment contract. As a general rule, the more senior and influential a manager is, the more likely they will owe a fiduciary duty and the greater the scope of that duty. Finally, the employees of a corporation generally do not owe any additional duties to the corporation beyond those that arise from general principles under the common law, and through their employment contract. This often means that any non-competition, non-solicitation, and confidentiality restrictions on an employee are spelled out in a contract. _______________ [1] Partnership Act s.15 [2] Alberta Business Corporations Act [“ABCA”] and Canada Business Corporations Act [“CBCA”] [3] Salomon v Salomon & Co. [4] Lee v Lee’s Air Farming Ltd. [5] ABCA s.122 [6] International Corona Resources v Lac Minerals [7] ABCA s.122 Shareholder Agreements vs Unanimous Shareholder Agreements
When incorporating, the question of whether or not to establish a shareholder agreement, or a unanimous shareholder agreement for that matter, should be considered. This blog will cover the major benefits and drawbacks of each while attempting to clarify in what situation each type of agreement is most suitable. Purpose Shareholder agreements outline the expectations and guidelines on how to resolve specific problems that may arise between shareholders. Essentially, these agreements allow shareholders to address any situation in the manner in which they choose. Often, the agreements will establish how corporations make decisions, and how shareholders dispose of or acquire additional ownership interests. In small, closely held corporations, shareholder agreements are paramount as any change in ownership is typically of great interest to the company and its remaining shareholders. Change in ownership could even result in a material event. Without any such agreement, provincial or federal statute will govern shareholder relationships. Applicable laws tend not to be the most comprehensive and often leave unforeseen situations wanting. Shareholder Agreement vs. Unanimous Shareholder Agreement In Canada, there are two types of shareholder agreements, regular shareholder agreements (“SA”) and unanimous shareholder agreements (“USA”). Scope SAs will only be applicable or bind those who sign it. In order for the agreement to apply to a specific shareholder, that shareholder must be a party or a signatory to the agreement. Note, that shareholders can become a party to the SA at any time. Conversely, USAs bind all shareholders provided that notice is given. No signature required. The USA will apply to any shareholder regardless of when the shares are acquired. Objective SAs are a form of commercial contract. It may provide rights and obligations to shareholders, resolutions to specific disputes and good management or governance practices. A USA is a combination of a commercial contract and a constitutional document similar to the articles of incorporation. A USA can override the common law rule against fettering the discretion of the directors.[1] This means that it can withdraw or restrict a director’s power and transfer it to the shareholders.[2] Important Points of Distinction USAs involve withdrawing or restricting decision-making power from the director and placing that power onto the shareholders. By doing so, directors can no longer be held liable for the rights or liabilities that have been fettered by the USA. Additionally, USAs should be flexible enough to allow minority shareholders to have a say in the direction of the company, but it should also permit the majority of shareholders to make corporate decisions without being blocked or restricted by the minority.[3] Choosing the Right Structure Prior to incorporation, one must first characterize the venture. Consider a growth company and a small privately-owned corporation. A growth company is defined by its rate of change.[4] Rapid growth inevitably leads to instability in the corporation’s composition including the number of investors and frequent management changes among other things. Such changes lead to varying corporate and legal needs that are difficult to anticipate.[5] As a result, greater flexibility is needed to avoid impeding growth and development. Small privately-owned corporations have different needs. This type of company opts for stable growth with the ultimate goal of remaining small and closely held. Predictability is key in these organizations. Growth Company A SA suits a growth company’s need for flexibility. SAs allow for effective management while the number of passive shareholders tends to increase. USAs are inappropriate for companies that seek rapid growth and anticipate a larger number of investors or shareholders.[6] Essentially, a SA will protect the company from a wide range of shareholders while staying attractive to investment as it doesn’t transfer a disproportionate amount of power to founders as is typical of USAs.[7] The distinctive characteristics of the USA present challenges to growth companies should a disgruntled founder or shareholder aim to hold up the business’ activities. Further, passive investors won’t want to bear the risk of liability resulting from the transfer of rights and obligations from the directors onto the shareholders.[8] Finally, USAs are part of the constating documents. As such, a growth company is likely to quickly outgrow an agreement written at incorporation. The ability to amend or withdraw a USA requires a unanimous vote as per the Alberta Business Corporations Act, which could be difficult to acquire with a large number of shareholders.[9] Small Privately-Owned Corporation USAs are ideal for small, privately-owned corporations. The distribution of shares can be controlled. Shares can therefore remain closely held. For corporations that intend to stay small, USAs can control shareholders and founders in the event of diverging opinions. The agreements allow for all shareholders to have a say in how the business is run. A USA can be drafted to include provisions ensuring the continued operation of the company regardless of founder or shareholder disagreements. Application to a New Venture Provisions that are appropriate for a small, privately-owned company may be harmful for a growth company. In particular, USAs are generally inappropriate for growth companies whereas SAs are well-suited for such companies. Prior to incorporation, founders should consider which type of venture is anticipated. Early consideration of the nature of the venture will inform the breadth of desired legal agreements. ___________________ [1] Mihai Gheorghe Cioc, Why should you have a shareholders’ agreement in Canada? Online: LexStart <https://lexstart.ca/en/legal-articles/why-should-you-have-a-shareholders-agreement-in-canada/>. [2] Brian Graves, Shareholder Agreements (2005) online: McCarthy Tetrault LLP <https://marcomm.mccarthy.ca/pubs/insight_paper_ver_two.pdf>. [3] Mihai Gheorghe Cioc, Why should you have a shareholders’ agreement in Canada? Online: Lex Start <https://lexstart.ca/en/legal-articles/why-should-you-have-a-shareholders-agreement-in-canada/>. [4] Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 2nd ed (LexisNexis Canada, 2013) at 2 [Tingle]. [5] Ibid at 4. [6] Ibid. [7] Ibid at 107. [8] Ibid at 106. [9] Business Corporations Act, RSA 2000, c B-9, at 146(8). 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.[1] 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: 1.Eligible transferor; 2.Eligible transferee; 3.Eligible property; 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.[2] An eligible transferee must be a taxable Canadian corporation (i.e. the newly incorporated business)[3] 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.[4] Eligible property is defined in Section 85(1.1) of the Act and includes[5]:
Section 85(1) transfer requires that, in exchange for the eligible property, the eligible transferor must receive at least some share consideration.[6] 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.[7] 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.[8] 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:[9]
Example: 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). Conclusion: 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. ________________ [1] Income Tax Act, RSC 1985, c 1 (5th Supp). [ITA]. [2] Ibid at s 85(1). [3] Ibid at s 89(1). [4] ITA, supra note 1. [5] Ibid. [6] Ibid. [7] Ibid at s 85(1)(f). [8] Ibid at s 85(6). [9] 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.[1] 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. 1. Overview 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.[2] 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.[3] Most crucially, a sole proprietor bears unlimited personal liability.[4] 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.”[5] 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,”[6] 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,[7] 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.[8] 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.[9] 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. ____________________ [1] Bryce C. Tingle, Start-up and Growth Companies in Canada 4th ed (Lexis Canada Inc, 2018) at page 36. [2] Anthony J. VanDuzer, The Law of Partnerships and Corporations, 3rd ed (Toronto: Irwin Law Inc., 2018) at page 6. [3] Ibid at page 8. [4] Ibid. [5] Partnership Act, RSA 2000, c P-3 [Partnership Act], s 110. [6] Partnership Act, s (110)(2)(d). [7] Business Corporations Act, RSA 2000, c B-9, s 21. [8] Income Tax Act, s. 111(1)(a). [9] 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. |
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