Share Class Strategies for Start-Ups

Written by Christian Rossi
JD Candidate 2024 | UCalgary Law

When incorporating a business, filing the requisite documentation with the appropriate government authority and paying the associated fees is necessary. One critical document is the Articles of Incorporation (the “Articles”). Detailed requirements for the contents of the Articles have been outlined in a previous BVC blog post.[1]
 
Share Classes
 
Among the crucial considerations within the Articles is the corporation’s share structure. The Articles allow for one or more classes of shares. The Articles must set out the rights, privileges, restrictions and conditions for each class.[2] For start-ups, it is advisable to avoid complex share structures with too many classes. Typically, start-ups opt for two classes of shares: common and preferred. Amongst these classes, corporations grant shareholders three fundamental rights: the right to vote, the right to dividends when declared, and the right to property on wind-up or liquidation.[3] These rights do not necessarily have to be consolidated within a single class of shares; they can be spread out amongst classes, but it is a requirement that the corporation grants them. Furthermore, all shares of a particular class must have the same rights and obligations attached to them unless they were issued in different series.[4]
 
Common shares typically come with voting rights and are essential for maintaining control over the corporation. Preferred shares, on the other hand, offer an alternative financing avenue for companies to attract investors with differing objectives. External investors may prioritize fixed dividend rates and preferential treatment in the event of liquidation over voting rights. When considering preferred shares in the Articles, consider allowing for the issuance of preferred shares in series. This enables directors to establish multiple series of preferred shares with specific terms desired by shareholders without necessitating shareholder approval to amend the articles.
 
Equity Splits
 
A start-up must consider the equity distribution among its founders, as improper allocation can lead to long-term complications. One approach is to assign different equity amounts to reflect different roles and contributions. While a 50/50 ownership split might seem fair for a business incorporating with two founders, it may not be the most advantageous arrangement. An even split can pose hold-up risks for the corporation in the future. For instance, where founders disagree on significant decisions, barring any provisions in the bylaws to resolve ties, the indecision may stall the business's growth and potentially strain the business relationship between the founders. By issuing equity based on different roles and contributions, the corporation mitigates hold-up risks and ensures equitable compensation for each founder’s involvement in the company.
 
Conclusion
 
As a corporation grows, amending and repealing governing documents like the Articles becomes more difficult. Establishing appropriate share structures at the outset can help avoid these future complications. When drafting the Articles, start-ups should carefully consider the share classes they adopt, balancing simplicity with flexibility. Common shares often provide voting rights crucial for maintaining control, while preferred shares offer attractive financing options for investors. An equitable distribution of equity among founders can also be essential to prevent future conflicts and facilitate smooth decision-making processes. By thoughtfully designing share structures and equity splits, start-ups can establish a solid framework for success and pave the way for sustainable growth.


[1] Ali Abdulla , “Articles of Incorporation in Alberta – Beyond the Basics” (8 March 2024), online (blog): < http://www.businessventureclinic.ca/blog/articles-of-incorporation-in-alberta-beyond-the-basics>.

[2] Government of Canada, “Share structure and shareholders” (10 May 2023), online: <https://ised-isde.canada.ca/site/corporations-canada/en/business-corporations/share-structure-and-shareholders>.

[3] Ibid.

[4] Ibid.