NVBC Seminar 5. Corporate Structure
Tonight, the New Ventures BC seminar series presents Corporate Structure with Sean Hodgins of QC Docs and Steven Lukas of Fasken Martineau.
Steven Lukas, Fasken Martineau
When you put together a corporate structure, you’re bringing together a series of people for a common purpose. A company just sets out relationships of how they work together and what the responsibilities of them are.
A company is different from you. When you incorporate, you’re talking about being the owner of the business. As you bring in more shareholders, the company structure becomes more complicated.
The structural map of your company will include shareholders, directors, officers, employees and possibly an advisory panel.
Shareholders
Anyone can be a shareholder. Individuals, companies and partnerships can be shareholders. There is no limit on the number of shareholders.
There are rules on how people become shareholders and when you become shareholders. As well, the rules change once you bring in more than 50 shareholders.
The key to being a shareholder is that their liability is limited only to the money that they have invested. If the company goes under, shareholders are not responsible for those liabilities (though they may lose their investment).
There are an unlimited number of types of shares, classes, rights and restrictions. The key ones include, are they voting or non-voting, participating or non-participating, and coming with options, warrants or rights.
Shareholders have an exclusive right to elect directors, but by and large can’t make the company do anything. Shareholders rights are governed by very detailed contracts. Not all shareholder agreement contracts are equal.
Directors
Directors are elected by the shareholders. They can fill vacancies or potentially add a number of directors.
In practice, who makes the direction of who the director will be? Usually, it’s the CEO (though they don’t elect the directors).
There must be at least one director. In BC, there is no residency requirement and there are no qualifications for being a director.
If you’re looking at your exit involving sale to an American company, it may be easier to do it with a BC company, because of the lack of residency requirement for directors.
Directors have the power to manage the affairs of the company. They have a duty to the company and the shareholders as a whole to act fairly and diligently.
They may be personally liable for breaching duties, taxes or wages. For instance, they can be personally liable if they issue shares for less than what they’re worth. That said, you can be protected by doing due diligence and acting in good faith.
Officers
The power of any officer is set by the board of directors. They oversee the employees.
Employees
They do all the real work.
It’s important to understand the definitions of employee and contractor. An employee works for your company. A contractor works for themselves.
If the CRA second-guesses you determines that a contractor was actually an employee and he doesn’t pay his taxes, then the company can be liable for paying those taxes.
It can be complicated. One example — if you take twelve one month jobs, you’re a contractor. If you take a job and get fired after a month and that’s the end of it, you were an employee.
If the level of sophistication of the person representing themselves isn’t there, then the person is probably not a contractor (even if that is what they would like to be considered).
What does compensation look like? It can be cash, shares or options or any other combination thereof. There is no set model for paying employees.
The Advisors
These people advise the board or advise management from time to time, in their areas of expertise.
Officer Issues
Conflicts of interest ie. your role as a shareholder vs. director. These sorts of conflicts come up all the time in VC positions.
There are differences between being a private company and a public company. When you go public, you’ve got a whole new series of responsibilities.
Initial Corporate Structuring
Incorporation is favorable in Canada, because of:
Financing issues – investors don’t like offshore companies.
Government grants – in most cases, these are only available to Canadian companies
Taxation and employment issues are also simpler to deal with if incorporating in Canada.
Create a structure with unlimited common shares and unlimited “blank-cheque” preferred shares. If you don’t do it this way, you may have to go back to your shareholders to ask for permission.
Financiers dictate financing terms, such as debt vs. equity, price, preferences, terms of SHAG, etc.
If you can, avoid issuing secured debt, using shareholders’ loans, using multiple share classes and incorporating offshore.
NOTE: It’s almost impossible to start a business without creating shareholder loans. Before those investors come in, convert it to equity.
Founder Shares
Founder shares are large blocks of shares issued at a low price to position the founders. It recognizes their “sweat equity” contribution.
What class of shares should they be? Common shares. They can be preferred shares for sophisticated investors if you have a good reason (I’ve never come across one…).
Founder Shares should be issued to founders and senior officers, not employees or outside investors.
Common Mistakes in Allocating Founder Shares
* Not setting aside enough founders’ shares at time of incorporation.
* not setting aside some founders’ shares for future additions to the management team.
* Not vesting the Founders’ shares. In 2-4 years, or providing for “reverse-vesting”.
* Issuing them to the wrong people.
Preparing a Financing Plan
Determine a road map for financing
The company determines its developmental milestones. What are they? By when will they be met? How much funding is needed to meet them?
Sources of financing include government grants, friends and family, angel investors, VCs, investment backers, underwriters (ie. brokers). There’s money all over the place — it’s just a matter of who you can tap into and how.
If you distribute a security, you must file a prospectus or rely on exemption from prospective requirement.
There is no limit on the number of people you can approach for financing.
* What are stock options? The right to purchase a number of shares at a predetermined value.
* Companies must plan for growth an make a notional allocation of their options.
* Companies should vest all options within 2-4 years.
Don’t necessarily be afraid of reducing your percentage of shares so long as the value of shares keeps going up. It’s better to have a smaller percentage of a bigger pie than a bigger percentage of a smaller pie.
Your Capitalization Plan is your best guess, like a budget. Actual results may differ from your projections. If you figure out sooner what the end picture looks like, you can do better in picking the number of shares you need.
When VCs come in, they change the rules and apply new conditions. The easy part of the discussion is what is the value of your company. The hard part is dealing with contractual obligations while being able to do your job and manage your company.
Sean Hodgins, CA, CPA, Tandem Accounting Group Ltd., speaking on Financial Modeling
We deal day to day with a lot of technology startups. That’s our area of expertise.
In today’s presentation, we’ll look at structuring for success, BC Tech bootstrap structuring, Financial Modeling and a Case Study.
NVBC is a competition. To win, you need to be in a hot space, have huge potential and a great story! It’s a combination of timing and a few other things to hit and win the competition. Even for those who don’t win, businesses can learn a lot.
The Bootstrap Model
1 in 100 companies that apply get VC financing
2 out of 10 VC financed companies make it
Dragon’s den is entertainment, not to foster successful startups! (It pains me to watch that show). Listen and learn from what they’re saying, but I don’t know if it’s particularly healthy other than for that.
Focus on solving a real problem and making a profit.
If you only need one round of financing and can take home big paychecks and have a successful business, that’s where most enterprises are today.
Top 10 words of wisdom
1. Incorporate. Keep is simple and use reverse vesting common shares. It can be a disaster if this isn’t structured at the front end.
2. Raise your first $25,000 from friends and family. If you can’t raise money from those closest to you, how will you get financing from angel investors?
3. Get good at expense reporting (separate self from Inc.). For instance, you paid to travel here. Are you going to expense that to your company? Even if a company has no money and can’t pay you back, you recognize that the company owes you.
4. Register immediately to get your GST back!
5. Build real SR&ED and optimize Proxy rules. This is basically a tax incentive program for technology companies, allowing you to file a tax return, never having earned any money, and getting paid by the government for expenses for development of the product.
Proxy rules are an incentive to hire people as employees rather than contractors. You can gross up their salary and get a tax credit for the gross value. The Proxy comes in if you’ve incurred other expenses.
6. Register as an Eligible Business Corporation. This allows you to raise money from accredited or angel investors.
7. Leverage the NRC-IRAP and other Gov’t programs. NRC-IRAP is like pre-paid SR&ED. You get approved for a grant. Example, if you’re hiring youths, it’s definitely a place to look at.
8. Angel circuit-links to customers and maybe even money. They can develop great networks and create energy around what you’re building
9. Find “customers” who will “help” build your product.
10. Build partnerships and networks early.
Financial Modeling
What to include? (Historic + 3-5 year projection)
* Income statement (profit and loss). A year in time’s perspective.
* Balance Sheets – assets, liabilities and equity
* Cash flows and burn/runway
* Opportunity analysis
* List of assumptions. As you’re starting your business and are trying to develop your financial model, you must develop assumptions on how you are going to build your business.
* Capitalization table
Financial Modeling
* Focus on revenues
* Numbers are instrumental in telling the story
* Make it believable. Test using your network
* Test the angel networks and VC’s
* Costs should focus on R&D and sales and marketing.
Business Modeling
* Who’s going to buy what you’re selling?
* What price are you going to charge?
* How does this compare to competitors?
* When do the sales happen?
* Customer acquisition costs?
* Customer support costs?
Business Model (Eyeballs Model)
* Who’s going to visit your site and why?
* How fast is it going to grow?
* How does this compare to competitors?
* When do you get bought and by whom?
* Cost structuring for rapid growth?
* Customer support costs?
Business Model (Technical Model)
* What trend is hot?
* Who will acquire you and when?
* Need technical excellence!
* need investors in your field and with connections
* $1 Million+ per engineer
These types of companies are acquired for the people who are there.
Opportunity Analysis
* Calculate the size of your target market.
* Story to Market Take Ratio (how good is your story?)
* Rate of growth analysis – key metrics, customer acquisition costs (don’t guess)
* Valuation analysis – support your value
Case Study: QCDocs Systems Inc.
Numbers are a key to telling your story. Focus on the customer and generating revenue and don’t be afraid!
Tags: corporate structure, Fasken Martineau, New Ventures BC, QC Docs, Vancouver technology business