Prior to reading this article see the previous articles on How to Organize your Ontario Business and on How to Incorporate in Ontario.
Once a corporation has been incorporated and organized, entrepreneurs that cannot fund things on their own often turn their minds to how to finance the company. Broadly speaking a corporation can procure financing either by borrowing money (debt) or by issuing and selling shares (equity). There are also hybrid debt/equity instruments that take on characteristics of both, like preference shares
1. Debt
If the incorporator has good credit and collateral a simple bank loan from a chartered bank could be the solution. When a corporation has few assets and no revenues the bank can be expected to require that both the corporation and individual be jointly and severally liable for the amount borrowed and to require security on an asset (such as a house). This means that if the corporation can’t pay the individual will be on the hook and vice versa.
Another option is procuring debt financing from an entity other than a chartered bank like an individual or company. This would involve finding a person willing to make the loan (angel investors, investment clubs, venture capital firms and investment banks might help) and then entering into a loan agreement with the creditor(s). When security is being provided (guaranteeing the debt with an asset) a security agreement is also entered into.
Established firms will sometimes sell a debt instrument via an offering. Generally this requires a credit-worthiness, reputation and scale that newer companies do not have, however.
2. Equity
Common Shares
Common shares are generally shares with equal voting rights, rights to share equally in dividends and rights to an equal proportion of proceeds upon the winding up of the company. This can be considered to be a proportionate ownership of the corporation. The characteristics of the common shares for a given company can be found in the Articles of Incorporation and can vary.
Common shares can be issued and sold to investors in order to raise funds for the company to carry out its business plan. When a company issues new shares of a given class to new investors it will dilute the percentage of ownership held by existing shareholders. If the shares are voting shares this could even lead to a shift in control of the company.
Preference Shares
Preference shares can have many different traits but generally speaking they are non-voting shares that pay dividends and are senior to common shares upon the distribution of assets when winding up. They are used when a company wants to raise money but existing shareholders do not want to dilute control by issuing common shares and the company does not want to show a liability on the balance sheet by borrowing funds.
If meant to replace debt financing preference shares might be non-voting, callable (the corporation can buy them back) and cumulative (outstanding dividends accumulate if not paid).
It is not uncommon for investors in start-up or venture companies to request convertible preference shares (or, in the alternative, convertible debt) rather than common shares. Convertible preference shares can act like debt until the company becomes profitable, at which point the preference shares can be converted into common shares.
3. Equity Offerings
Usually a company’s founder(s) provide the initial funds to set up business. Shares are usually issued in consideration for the money and uncompensated labour invested and for the value of the business concept. If additional funds are required to develop and operate the business an equity offering may be made.
When a company makes an equity offering of its shares it must be compliant with all applicable securities laws and regulations. The general rule is that a prospectus must be filed and a registered dealer used to broker the transactions. In order to make it easier for start-up and growth stage companies to finance growth via an offering numerous exemptions to these requirements are permitted.
The documents required can vary depending on the nature of the offering. Exempt offerings for a start-up company might use an offering memorandum a subscription agreement and an acknowledgment of obligation binding the new shareholder to the shareholders agreement, if any.
This blog and the contents herein are for informational purposes only and do not constitute legal advice. Readers are advised to seek legal counsel prior to acting on any matter discussed herein. I take no responsibility for any third-party sites linked, nor is the presence or absence of a link an indication of my endorsement of views expressed.