Content Type, Legal Insights | December 13, 2016
Written By: Shane Murphy, Law Scout
Early-stage small businesses are always looking for ways to cut costs. But no matter how lean you plan to run your business, you don’t need an expert to tell you there are some costs that shouldn’t be cut. Cutting too deep can lead to very expensive problems that even a thriving business will struggle to fix. In this blog post, we outline one such cost: the cost of having a lawyer properly incorporate your business. We’ll let you know the future costs and downsides of having a business improperly set up.
It’s no secret that any Canadian entrepreneur can login to the federal government’s Online Filing Centre and file the documents to create a corporation. It costs about $200 and takes only one business day to fill out and process the incorporation documents. Simple enough, right?
What the government website does not explain is that incorporating a company is a two-step process. First, you fill out the mandatory documents with the government. Next, you need to structure the company by appointing directors and officers to manage the business, and most importantly, you distribute shares to the company’s owner or owners. The government’s website does not provide any guidance with the second step, and unfortunately too many entrepreneurs underestimate the importance of issuing shares.
You’re probably wondering if it really matters for a small, early-stage company to be formally structured with shares issued to shareholders. Can I wait until my company grows before this becomes an issue? As the example below demonstrates, the way you structure your business can have a huge impact on the future growth of your business, and putting it off will only lead to excessive costs, complications when raising external investment, and could harm your reputation as a savvy entrepreneur.
Take Gill, for example. Gill is a software developer who has recently launched an innovative mobile application for food delivery called Pluto. Prior to launching his app, he incorporated his own company online, Pluto Delivery Inc., using the federal government’s website. The government sent Gill a Certificate of Incorporation, and Gill assumed the incorporation process was complete and successful. He only paid the $200 government filing fee and did not speak to a lawyer or accountant about the corporate structure or shares of his corporation.
Two months later, Gill hired his first employee, Chelsey, and agreed to give her 10% equity of Pluto Delivery Inc. They signed a short agreement that Gill prepared himself and continued to work together on the business.
By the next year, Pluto was really taking off. A group of investors offered to invest $500,000 in exchange for 20% of the company shares. Before making the investment and transferring the funds to the company, the investors asked to see the Minute Book (A Minute Book is a collection of documents required to set up the corporation and document important meetings and changes, which every corporation is legally required to keep) for Pluto Delivery Inc. and proof that Gill was the majority shareholder.
All Gill could show the investors was the Certificate of Incorporation sent by the government and the short agreement he signed with Chelsey to give her 10% of the shares. He had no Minute Book containing the company’s organizational documents and he had nothing to prove that he actually owned the remainder of the company’s shares.
The investors were not impressed with Gill’s record keeping for Pluto Delivery Inc., and they didn’t understand how Chelsey could receive shares in the company when Gill himself had nothing to show he was a shareholder. They told Gill to go see a lawyer to get his documents organized, or the investment offer would be cancelled.
The cost and complexity of this work could have been greatly reduced if Gill hadn’t cut corners in the legal department. Had he presented the investors with a Minute Book to prove he owned the company, the investment would have been much easier to finalize. Also, Gill would have looked far more professional and credible when the investors were conducting their due diligence.
The lesson here is simple. Legal and accounting fees are an inevitable cost of building your business. Think of your business like a new home. You need to make sure its foundation is strong before you move in. Even if your home looks fairly humble to start, you need a professional’s input if you’re ever going to expand.
Your legal needs likely won’t be complex at an early stage, and the cost of hiring a lawyer should not be prohibitive. The long-term cost savings and professional advantages of engaging a lawyer to incorporate will far outweigh the initial savings of attempting to incorporation a company yourself. It doesn’t need to be expensive. There are plenty of lawyers, firms, and online legal tools that will help you build the foundation of your company the right way and limit the risk of things going wrong while staying within budget.