Incorporation & Corporate Structure Planning with Ted Maduri | E001
The fundamentals of business legal structure.
Summary:
In the first episode of Financial Planning for Canadian Business Owners, Jason Pereira, award-winning financial planner, university lecturer, writer, and host of the podcast Fintech Impact, welcomes Ted Maduri, Partner at the law firm DLA Piper, to talk about how to establish a strong business structure from the start, challenges people may face along the way, and more.
Episode Highlights:
● 01:53: – From a legal standpoint, the easiest way to start a business is through a sole proprietorship or a general partnership if you have a business partner.
● 02:50: – Registering as a business allows you to have a brand and a name, allows you to enter into contracts and then sue on the basis of those contracts, and allows you to deduct business expenses.
● 03:50: – You are not locked into a business structure forever; you can begin as a sole proprietorship and become a corporation later when the time is right.
● 05:40: – In either of these options, taxes are still done individually, on the personal level.
● 06:00: – The plus to a corporation is that it exists in perpetuity and offers limited liability, so if someone sues they are suing the company, and not you as an individual.
● 07:43: – A business doesn’t have to start thinking about HSD or GSD until they are worth $30,000.
● 08:40: – As a corporation you are able to take advantage of Canada’s small business tax rates.
● 12:20: – The simplest way to tell whether it’s the right time to add complexities to your business structure is that you can afford it.
● 14:10: – It’s better to put together an abbreviated shareholder agreement that’s more like a term sheet than it is to move forward with nothing just because it’s too costly or laborious to establish one.
● 16:04: – Ted strongly advises against combining your real estate investments with your operating company because it complicates your ability to later sell your business.
● 19:02: – Ted points out that it’s often more appropriate to have separate legal entities for each of multiple locations of a business or different divisions of a business.
● 20:42: – Ted suggests a family trust so that the business owner can remain the sole trustee and then make family members beneficiaries of that trust.
● 24:55: – Another benefit to proper corporate structure planning is tax deferral.
● 26:22: – The ideal way to set up your corporate structure is to best position it for eventual sale.
● 26:40: – You have to have a corporate structure in place for 24 months before you qualify for a tax exemption.
● 30:15: – The same record-keeping and best practices that Ted recommends for the eventual successful sale of a business are also helpful for raising funding to grow your business.
● 33:16: – You should adjust your team if you outgrow it or it’s no longer a good fit.
3 Key Points
1. There are pros and cons to choosing both a sole proprietorship/general partnership or a corporation, as well as to establishing a corporation at the beginning of your business or later in its growth.
2. It’s crucial to create some form of a shareholder agreement as soon as there is more
than one shareholder in the business.
3. Ideally, establish your business structure with the long-term view of its eventual sale.
Tweetable Quotes:
● “Anytime you do have more than one shareholder, you should have a shareholder agreement... I sometimes describe it as a prenuptial agreement for business owners.” –Ted Maduri
● “I think what sometimes people forget about is once you put shares into someone’s hands, they own those shares.” –Ted Maduri
Resources Mentioned:
● Website – Jason Pereira’s Website
● Facebook – Jason Pereira’s Facebook
● LinkedIn – Jason Pereira’s LinkedIn
● DLA Piper – https://www.dlapiper.com/en/canada/people/m/maduri-ted/
● Ted Maduri’s Linkedin – https://ca.linkedin.com/in/tedmaduri
Full Transcript:
Speaker 1: Welcome to the Financial Planning For Canadian Business Owners podcast. You will hear about industry insights with award winning financial planner and entrepreneur Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business and life. And now, your host Jason Pereira.
Jason Pereira: Hello. Welcome to the very first episode of the Financial Planning For Canadian Business Owners podcast. I'm your host, Jason Pereira. This is a podcast that will explore any number of facets of being a Canadian business owner and entrepreneur. If you are one, you know that essentially your life is split into two: your personal and your business life, and they tend to merge with each other quite often, but the rules and regulations surrounding one are very different from the rules and regulations surrounding another.
Jason Pereira: So we're going to explore all kinds of issues. For more structural ones, like today where we're going to talk about corporate structure, to softer ones like how to find purpose once you're ready to start retiring. So for my first episode, I welcome Ted Maduri, partner at DLA Piper.
Jason Pereira: DLA Piper is a large, multinational law firm catering to basically every form of law known to man. Ted's specialization specifically is a corporate lawyer, and I brought him on the show to talk about how to structure your corporation and how to structure holding companies' trust and whatever else may be involved in your corporation structure for the best, optimal outcome. And with that, here's my interview with Ted.
Jason Pereira: Hello, Ted.
Ted Maduri: Hey, Jason.
Jason Pereira: Thanks for coming in today.
Ted Maduri: Oh, my pleasure. Long time listener, first time guest I guess.
Jason Pereira: Long time listener of the other podcast, right?
Ted Maduri: To the other podcast.
Jason Pereira: To the other podcast.
Ted Maduri: Big fan of the other podcast.
Jason Pereira: Good, good. Excellent. For those of you who don't know yet, the other podcast is Fintech Impact, and that is already more than 100 episodes in so please check that one out.
Jason Pereira: So Ted Maduri of DLA Piper, I brought you in to talk about fundamentals of business structure in corporation, corporate structure planning. So let's talk about that. So someone wants to start a business. What are the options for how they structure that business from a legal [inaudible 00:01:58]?
Ted Maduri: Yeah, I think the most basic option is to set up a sole proprietor shift where it's just an individual, maybe register a business name, you carry on business through that sole proprietorship. There's no difference between you as an individual and the business. Another option is if there's more than one person involved in the business you would set up a partnership. That can be just a regular, limited partnership. There are certain kinds of partnerships that service providers have, such as a limited liability partnership. And then of course there's the corporation that I would say most businesses operate as.
Jason Pereira: So most people when I talk to them about wanting to start a business, they always seem to leap to a corporation first, right?
Ted Maduri: Yeah.
Jason Pereira: So let's talk about the first two. As you said, there's no difference between the individual and the business, but what you've done as a sole proprietor, you've registered a business, and then what does that permit you to do?
Ted Maduri: Well, it permits you to have a brand. Usually you would register under a statute to have a name that you carry your business under. You can enter into contracts. You can, if the contracts don't go well, you can sue under those contracts so long as you're registered. And you're right. I think most people do jump to a corporation, and sometimes perhaps more quickly than they need to.
Jason Pereira: Yeah, and I mean the other thing is it allows you to duck those business expenses, right? So now you're, and for people who don't realize this, the way it works is essentially you are the business. Whatever money you make in that business or elsewhere is your top line income, and your deductions for the business get subtracted from your income on your personal income tax statement. So I mean, tell me about the costs of setting up a structure like this.
Ted Maduri: Just a sole proprietorship?
Jason Pereira: Just a sole proprietorship.
Ted Maduri: Yeah, it's just $100-200 with the government or with your lawyers to register your business name. Of course, there will be accounting fees at the end of the year, but I think one thing to keep in mind is that you're not stuck with that structure for the rest of your existence. You can carry on a business as a sole proprietorship, and when the time's right you can convert. Whether to a partnership if you bring on someone to run the business with you or convert to a corporation down the line.
Jason Pereira: Okay. So before we jump to the corporation part, we're just going to spend most of the time ... So I mean, clear advantage there is in my mind simplicity, right, and cost. Whereas when we go to a corporation, there's additional costs involved. So let's talk about that first. Then we'll come back to partnership. So what are the costs of running a corporation and the complexity added to one's life?
Ted Maduri: Yeah, it's not onerous. Most services would charge you a few hundred dollars in a government fee to incorporate. There's some legal fees involved with that. There would be a separate accounting fee to do a separate tax return or a separate set of financial statements. So you're talking all in a couple or a few thousand dollars.
Jason Pereira: Yeah, I mean one of the big frustrations I see, especially people starting off with a corporation, is realistically any decent accountant I know is not going to do a corporate tax return for less than $3,000. In addition to that you have the bookkeeping burden. Whereas before you could just keep your receipts and then deduct them all at the end of the year, here you've got to actually have tangible books, right?
Jason Pereira: So yeah, the ongoing maintenance of that and filing those tax returns, you're looking at at least three grand for even a simple case. So that's a pretty big difference. Less than $200 to get going in one case, and in the other case basically-
Ted Maduri: Thousands.
Jason Pereira: Thousands, right?
Ted Maduri: Yeah.
Jason Pereira: Now, one of the things ... So let's go back to partnerships before we move onto corporations and a couple other questions I have. So partnership. How does that differ from a sole proprietorship?
Ted Maduri: Well, it is involving a separate person who just joined your company. So it could be the case that you have a business partner, and essentially you'd enter into a partnership agreement. You'd register that partnership with the government, and the two of you would enter into an arrangement whereby you carry on your business.
Jason Pereira: So essentially it's almost like a multiple of the sole proprietorship.
Ted Maduri: Correct.
Jason Pereira: So you're still deducting taxes, they're still paid personally, income is still taxed on a personal level. You're just repeating it across multiple people.
Ted Maduri: Correct.
Jason Pereira: All right. Now, let's talk about ... So the advantages, I mean, are clearly simplicity I think and cost. What are the disadvantages of having a sole proprietorship or partnership?
Ted Maduri: I think you can flip it and say, "What are the advantages to incorporating?"
Jason Pereira: Fair enough. Exactly [crosstalk 00:06:01].
Ted Maduri: And so I think a corporation exists perpetually. It continues beyond your existence. There's limited liability attached to a corporation that you don't see with a partnership or [crosstalk 00:06:15]-
Jason Pereira: So someone sues the business, you're suing the business, they're not suing you.
Ted Maduri: Correct.
Jason Pereira: Yeah.
Ted Maduri: Correct.
Jason Pereira: Now I also caution people with this is that typically when we're talking about lending, you want to get a loan for the business. Any business starting off, the bank is going to want a personal guarantee anyway. So you're not protected there, and also depending on what you're doing on the sole proprietorship side, frankly you should have insurance in place.
Jason Pereira: But it is nice to have that extra layer of protection knowing that as long as you conduct business ethically, that corporation's getting sued, not your personal assets.
Ted Maduri: You're right. There are lines that are blurred. For example, a guarantee with the bank or an indemnity under release. Your landlord may require you to sign personally. So in that case the lines are blurred, and you're not fully protected by the corporate. But all else being equal, I think it is an additional layer of protection.
Jason Pereira: Yeah, and so it is nice. Especially if you get bigger, right? Then it becomes less and less likely you'll have to provide those guarantees, right?
Ted Maduri: Correct.
Jason Pereira: So at that point, you would have that protection. Whereas, you don't have that with the sole proprietorship and the partnership, right? You don't have a separate entity that basically gets to conduct itself. You mentioned specifically it lives on forever. So I die, I own a corporation. Even if I was the only one working at the corporation, technically it still lives, right?
Ted Maduri: Correct.
Jason Pereira: Yeah, and those shares can be transferred by the will. So before we move on with ... I want you to dive more into corporations.
Ted Maduri: Sure.
Jason Pereira: But before we do that, let's talk about one issue that we all have to face in Canada, and we'll get into that in the corporations later, but HST. So HST or GST regardless, depends on what province you're in, at what point does a business have to worry about taking care of HST or GST?
Ted Maduri: I guess I should caveat all that I'm saying with the caveat that I'm not a tax lawyer. I'm just a lowly corporate lawyer. My understanding is at $30,000 ...
Jason Pereira: Yeah, that's about right.
Ted Maduri: ... is when you need to start charging and collecting HST.
Jason Pereira: So it basically, if I start off and I am selling handmade widgets from whatever I'm doing in my basement, whatever it is, and I basically only make $10,000 in a year, I really don't have to worry about an HST number, filing those registrations, anything like that. So then let's talk about you're not a tax lawyer, but let's talk about what the other advantage to corporations are is that's potentially access to the small business tax rate. So how freely do you want to, or can you, speak about that being a lowly corporate lawyer?
Ted Maduri: I do know that there are huge benefits to having a corporation from a tax perspective, in addition to the perpetual existence and then limited liability. So being a corporation does have certain benefits.
Jason Pereira: So I'll speak to that because I do this all the time. So depending on the province, we're looking at tax rates that are ... Let's call them anywhere around 10-15% on small business income which, again, depending on the province, is roughly about half a million dollars. So the corporation makes half a million bucks, you're looking at a tax bill that's probably in the neighborhood of $50,000-75,000 for the corp.
Jason Pereira: However, when you take money out of the corporation you're then going to pay tax on it either as income or dividends, and it ends up being when you add up the tax bill paid by the corporation and the tax bill paid by yourself, it's the same thing. The advantage though is that the business now has more money to reinvest, and grow, and do all those wonderful things.
Jason Pereira: But in terms of anything beyond that, you'd then enter the general tax rate which is 26%, and that's a big difference in contrast to the top personal rate which depending on the province, I think half the provinces have tax rates over 50% when you get to $200,000-220,000, and then some of them are ... the other half are very close.
Jason Pereira: So we will bring someone on to talk about corporate taxation at a later date, so we'll get more into that, but let's talk now about having the corporation. So typically when people set up a corporation, they typically set it up usually sole shareholders or if they have a partner and they have everybody's got classes of shares. Talk to me about the need for planning at that time, specifically around partnership agreements. What needs to be done there to make sure that things are going to go smoothly in that category?
Ted Maduri: Yeah, so I think a couple of things. You do need to think about how you hold the shares in your company. So it's often the case that you do just hold the shares personally or you register the shares in the name of your spouse, but there is some planning opportunities there into how you hold the shares, and maybe I'll come back to that in a minute.
Ted Maduri: Any time you do have more than one shareholder, you should have a shareholder agreement. So that does many things. It talks about how the company will be run during its life. I sort of sometimes describe it as a prenuptial agreement for business owners. And so it talks, it's-
Jason Pereira: And there's no romance in business so it's okay to [inaudible 00:10:29].
Ted Maduri: [crosstalk 00:10:30].
Jason Pereira: There's less resistance to these than prenups.
Ted Maduri: Yeah. But it's a document that I think you worry about and then put away for a rainy day, and it talks about what happens upon certain things happening in the future like death, disability, marital breakdown, what happens if there's a sale of the company. I think those are some of the key issues that you want to tackle in a shareholder agreement. Especially what's called a drag along. Right?
Ted Maduri: So if you have other shareholders, minority shareholders, and you as the majority shareholder want to sell the company, having a shareholder agreement that talks about what happens in that scenario is very important so that if there's a buyer who wants to buy your company, you can tender 100% of the shares of the company. So those are the sorts of things that are discussed in a shareholder agreement that you can put in place right at the outset.
Jason Pereira: Okay. So again, at a later date we're going to touch upon that in greater detail, but Ted was brought in specifically to talk about structuring. So let's talk about considerations for how you basically own the shares of the corporation. What are the key things people should be considering? What are the different methodologies for how they would do that, and what are the factors at play?
Ted Maduri: Yeah, and I think it's some of the same things we talked about in the kind of business form that you set up at the beginning. Those considerations are relevant here because what you set up originally isn't necessarily how you need to keep it forever. So you can set up your company with you as the sole shareholder, and then once you see that the company's going to be successful you can add some complexity.
Ted Maduri: So you can add some complexity by introducing a holding company. You can introduce some complexity by introducing a family trust or some combination of those things, and the idea behind adding that complexity is that there's some tax benefits. There's some creditor proofing advantages to setting up those kind of complex structures. So I think that's something that you should consider at the appropriate time when you see that the business that you've set up is doing well.
Jason Pereira: So what are the key things that indicate it's the appropriate time?
Ted Maduri: Mostly that you can afford it.
Jason Pereira: Fair enough.
Ted Maduri: For each company, for each family trust, you're adding costs up front as well as annual costs, both for accountants and lawyers. And so you want to make sure that you can pay for that. And so coming out of the gate with a fancy corporate structure isn't always advisable. Because maybe the business isn't going to work, and maybe you're just spending money needlessly. So I do think that's something at the appropriate time when you see that this thing has legs where you can consult an investment advisor like yourself who knows these issues, or an accountant, or a lawyer, and you can talk about if it's the appropriate time.
Jason Pereira: Yep now, I mean that being said the one thing about doing it early is that it's clean. However, like you said, the problem is you have to weigh that out with the fact that the cost is there, and then frankly by the time the business is successful, maybe your life has changed, and what you would have set up initially if you had your wish wouldn't be what you want down the road.
Ted Maduri: Correct. And sometimes if you set it up originally with a fancy structure, it'll cost you x. If you set it up down the road and you want to make some tweaks, it might cost you 2x, but at least you know then that you can afford the 2x, there's going to be a business that can pay for it, but to do it later it does cost you more than doing it a certain way up front.
Jason Pereira: Yeah, and frankly the reality is is that if you're doing ... it's going to cost you 2x, it's going to be warranted that there's a benefit to do that. So let's talk about dos and don'ts. So what are the kind of mistakes you see people do when they're setting up these corporations or fancy structures? What are the things you would advise people starting out not to do, and then after that what would you advise people who have gotten to that stage where what are the other indications beyond they're successful? Like, what are the underlying needs for restructuring?
Ted Maduri: Yeah. Maybe if I could just talk about the shareholder agreement dos and don'ts for a second.
Jason Pereira: Yeah, we should [inaudible 00:14:09] those. Let's do that first. Yeah.
Ted Maduri: Because I do think some people, when they realize through their other lives or through investments that they've made, when they realize how lengthy a document it is, the shareholder agreement, they just decide that because it's expensive and lengthy to negotiate and put into place, they'd rather have nothing and not pay for that. It's always better to have something than nothing, and some folks have put together abridged versions of a shareholder agreement to get something in place. You know, you're talking sort of like a term sheet where five, six pages you talk about the key issues between your partners and yourself. I think that's better than-
Jason Pereira: Than nothing at all.
Ted Maduri: ... waiting until the perfect time when you can absolutely afford a 40 page document. So I do think having something's better than nothing when it comes to the shareholder agreement.
Jason Pereira: I'll tell you, I've seen it go sideways so many times, I'm sure you have, that my preference is to have it done right. Because again, we're talking about a couple things. This agreement, like death, disability, and disagreement, right? Like, those are the three big Ds. You're dead, you want to make sure that your family gets what's rightfully theirs, right? You're disabled, you're in a position of vulnerability. Maybe you can't even negotiate on your own behalf, right? And then disagreement. I mean, the number of times I've seen people ... [inaudible 00:15:14] a partnership agreement, and then they're in massive conflict already. That's not the time to negotiate when it's not going to go so well.
Ted Maduri: Correct. Correct.
Jason Pereira: Yep.
Ted Maduri: And that's why I do think something is better than nothing. You're right as between your various legal items that you want to eventually tackle, I do think the shareholder agreements should be at the top of your list.
Jason Pereira: Going back to the original question, so let's talk about specifically first the mistakes people make when setting up their corporate structure. What are the most common ones or the things that you see done?
Ted Maduri: Well, I think there's a few that come to mind. I think like you said, there's the opportunity to put a structure in place that they think is going to be the be all and end all, and then they just outgrow it. And so it doesn't fit their scenario anymore. So to think that you've done it right and it doesn't need to be adjusted in the future I think is not right. I think combining assets in one corp is a thing we see all the time. For example, combining your real estate investments with your operating company. That's a big no-no.
Jason Pereira: So let's talk about why that is. Why is that a big no-no?
Ted Maduri: Yeah, it's a big no-no in the event that you want to sell the business. You want to make sure your business is set up for future sale. That's what this is all about. So if you're combining your real estate with your business and you want to keep your real estate when you sell your business, then that's a problem. You'll have to separate them down the road.
Ted Maduri: Sometimes when you have an investment property with your business, it disqualifies your business from-
Jason Pereira: From the small business rate?
Ted Maduri: Correct. So I think it's always better when you have different asset classes to put little boxes around them to have separate legal entities around those things. And obviously consult your accountant or lawyer because I do think combining or co-mingling assets is potentially problematic.
Jason Pereira: Yeah, and I did talk about there the small business tax rate, but the other rate we were getting at was disqualifying is that there is an exemption for a lifetime capital gains exemption where anyone selling shares of a Canadian controlled private corporation qualifies for the first 860-ish thousand.
Ted Maduri: Next year it's almost 900,000.
Jason Pereira: Almost 900,000. Yeah, so the number changes every year with inflation. That's why I'm iffy on it. I look it up every time just to be safe. It's going up to a million before it gets capped, in theory. We'll see what happens. The government's, you know. But bottom line is that in order to do that you have to be selling an operating company that's not loaded up with investment assets, and real estate's an investment asset. So that can put you offside and rob you of the ability to save the tax on that much money of a sale.
Jason Pereira: So yeah, we want to make sure that if you're going to have ... You want to make sure that if you have a corporate structure that when you sell those shares that you qualify for that very lucrative exemption.
Ted Maduri: Yeah. The other mistake I think we see a lot is a Canadian company running a US business under the same umbrella as the Canadian company. Again, for the same reason. If you commingle your real estate with your business, if you co-mingle your Canadian business with your US business, you could also disqualify your company from being able to take advantage of the lifetime capital gains exemption. So making sure that you consider whether it's appropriate to have an entire US based structure separate from your Canadian, and that's not that complicated. You just have a sister, a mirror image, where you have a US corp owned by the same shareholders. Just, it's not a subsidiary of your Canadian business. It's a separate mirror image. And so setting that up properly, once you see that there's some real potential for your US business to be successful, keeping that separate is an important consideration as well.
Jason Pereira: At the same time, I mean you're separating your liabilities, right? You're dealing with two very different legal codes. I mean, still based in common law. And nevertheless, you get sued in the US there's, for operations down there whatever it might be ... Funny side note, it was a funny story Bernie Ecclestone, the guy who runs F1, was once asked about what it's like to do business in the states when he first started doing business in the states.
Jason Pereira: He said, "Well, imagine you're walking along and someone asks you what time it is, and you say noon, and it's 12:01, they turn around and sue you." So it may not be that bad, but it's a litigious society. So the point is that if you can separate out your liabilities from country to country, that's also not a bad thing.
Ted Maduri: Yeah, I think the other thing that leads into another thing I've seen a lot which is having various divisions of a business all operating under the same umbrella or all under the same legal entity, and sometimes it's more appropriate to have separate legal entities for each of those divisions.
Jason Pereira: Liability based as well. Yeah.
Ted Maduri: 100% liability.
Jason Pereira: Yeah.
Ted Maduri: Yeah, so even if, think about a restaurant or some other business where you have multiple locations. You should think about having separate legal entities for each of those locations, or if you have multiple divisions of the same kind of business it might be appropriate to set each of those divisions up as a separate legal entity mostly for putting all of that liability related to that business under sort of one umbrella.
Jason Pereira: You typically see that a lot, too, with property development.
Ted Maduri: Correct.
Jason Pereira: You know, every separate development will be a separate corporation all together, and the company will come in and do all the work on it, but that way god forbid something goes terribly wrong on one job site, it doesn't jeopardize every other job site that we have.
Ted Maduri: Correct.
Jason Pereira: Yeah, okay. So that's the complications or the mistakes made when they're getting overly stretched out. Down the road they basically have gotten bigger, they've expanded out. What are the common mistakes you see later on when they basically ... they no longer outgrow, they've taken the time, but in terms of setup what are the factors you need to consider and the things you've seen them not consider properly when setting up a proper kind of second generation structure?
Ted Maduri: Yeah, I think when people have turned their minds to setting up a structure that doesn't just see them hold the shares personally and individually, they maybe set up a holdco or they set up multiple classes of shares for their different family members. I think what sometimes they forget about is once you put shares into someone's hands, they own those shares.
Jason Pereira: Yes, it's a common issue.
Ted Maduri: And so that's why I think having something as powerful as a family trust is useful because the business operator can be the sole trustee, and they can put the family members that they want to distribute shares to or dividends to or property to, they could become beneficiaries of that trust, but they retain sole discretion over those decisions.
Jason Pereira: As for clarification, a family trust is a trust. So another legal entity that can own things on behalf of other people run by a trustee who has control over that and acts on their behalf. So, as you said, they can put in the family trust, and they can be the trustee. Then they could have family members or beneficiaries. Those beneficiaries get whatever they get, but they don't get to dictate terms, right?
Ted Maduri: Correct, correct, and they don't have to get anything. It's the trustee's decision whether to distribute anything to them.
Jason Pereira: Assuming it's drafted properly.
Ted Maduri: Assuming it's drafted properly, and you don't name names, and you describe categories. We see it all the time with sort of individuals naming their spouse. Instead, we've taken the stance that perhaps you should describe the category [crosstalk 00:21:40]-
Jason Pereira: The current spouse as opposed to Janie.
Ted Maduri: Yeah, exactly.
Jason Pereira: [inaudible 00:21:44] no knock on Janie, and it's not my wife. Nevertheless, don't name them by name. Name them as current spouse.
Ted Maduri: Yeah. We just also see a lot of trust agreements have multiple trustees, both the spouse and the business operator, maybe a third. I think that's gone the way of the dodo bird. I think mostly we see trusts now drafted with a sole trustee, just in case there's a breakdown in the marriage.
Jason Pereira: Or I do see them still with, yeah usually not with spouses, but I do see three trustee structures, but typically the business operator's vote must be included in whatever decisions made so no one can team up against them.
Ted Maduri: Yeah.
Jason Pereira: Yeah. So yeah, that's useful. I mean, one of the common mistakes I see all the time, I typically see a corporation will get to a size where they're starting to pile up cash in the corporation, right? They either [inaudible 00:22:27] ... The entrepreneur's taking out enough to sustain their lifestyle. They don't want to pay 53% on the tax that they're taking out, 53% being Ontario's rate, so they leave money behind the corp for a rainy day or to start investing and growing it.
Jason Pereira: And the accountant turns around and says, "Hey, we should protect that money. Let's put a holding company in place." So they create another company and move the operations of that company and the assets stay behind the holding company, and every year they take the cash and move it down. What's the problem with that structure?
Ted Maduri: Yeah, and you're sort of highlighting ... You're just moving up the problem. So you can't have a situation where the operating company, for all sorts of reasons, collects investments or assets that would put it offside for sort of qualification reasons but also for credit proofing reasons. Right? You don't want to make it accessible to creditors to attack.
Ted Maduri: So what you sometimes see is the money moved up to a holdco and then investments made, real estate purchased. That's just moved up the problem. It doesn't solve the problem. In the future, if you were to want to sell the operating company, you would want to sell the shares of the holding company. But now you have all sorts of assets in that company, so you have to purify it or cleanse it.
Jason Pereira: Yeah, so you don't have, again, you don't qualify for the exemption because-
Ted Maduri: You don't qualify [crosstalk 00:23:36].
Jason Pereira: ... there's too much money in there.
Ted Maduri: Right.
Jason Pereira: And all too often, I see this is the accounts think first about the credit protection but don't think about the long-term setting up the sale of the business.
Ted Maduri: Correct.
Jason Pereira: So yeah, so that's my little setup for the most common mistake I see. So keep that in mind. So basically in terms of optimal structure, this is something that's kind of unique to everybody, right?
Ted Maduri: It is, yeah.
Jason Pereira: I don't really see one solution work for everyone.
Ted Maduri: Yeah, I think it is unique, and everyone has his or her own situation, but I think the most typical structure you would see is to have an operating company with a family trust as the shareholder, and then as one of the beneficiaries of the family trust, you would have a holding company.
Jason Pereira: So that allows me to push money from the operating company, through the trust, to the holding company?
Ted Maduri: Correct.
Jason Pereira: And then eventually sell the shares because they're held by a trust.
Ted Maduri: The trust, yeah. So that gets around the need to sort of keep that holding company pure. There's reasons that maybe ... Depending on the number of shareholders and the percentage owned, maybe you need to do some sort of hybrid structure where you have a clean holding company with a family trust, and then a beneficiary of the family trust. But as a base case, I think the most typical scenario that we advise people on is having the operating company with a family trust and a corporate beneficiary.
Jason Pereira: Excellent.
Ted Maduri: Or a personal wealth company, as some people call it.
Jason Pereira: Excellent. So what other advantages do you think there are to proper corporate structure planning? I mean, we've talked about a credit protection. There's also the tax planning opportunities with access to the small business tax rate and of course the lifetime capital gains exemption. Anything we're not covering?
Ted Maduri: No, I think that pretty much does it. You sort of mentioned to tax deferral.
Jason Pereira: Yeah.
Ted Maduri: And so if you can move money up from the operating company to the trust, and then on the way to your corporate beneficiary holding company, and then you don't need to spend it and it stays in your personal wealth company, that defers taxes. Eventually if you take it out, you'll have to pay the additional personal tax, but that defers tax, and if you don't need it then you've deferred it for a period of time, and you can use that money to invest, to buy real estate, or to make investments with someone like yourself. So I think tax-
Jason Pereira: [crosstalk 00:25:37].
Ted Maduri: Tax deferral, I think, is an important point.
Jason Pereira: Yeah, so and there is going to be another episode where we're going to talk about the passive income rules because that's something we have to be aware of it. It's not as "lucrative" as it used to be to leave money in the corporation beyond a certain threshold, but we'll talk about that at a later date.
Jason Pereira: What are the kind of words of advice you have for people when it comes time to look at their corporate structure or the business structure? Let's talk about, start off with someone starting out. What are the words of advice you would give them?
Ted Maduri: I think it's to make sure you have a good team. And so I think we've tried to introduce people to good investment advisors, good accountants, people who have had these issues and dealt with them before. I think you want to make sure you have this corporate structure in place, you have a shareholder agreement in place, you are keeping proper corporate records.
Ted Maduri: I think the way we approach the setup of a company is that we're getting ready for the ultimate sale. And so we want to make sure we've put all our ducks in a row to ultimately sell the business and not at the end of the day sort of panicking to get everything done at the end of the piece.
Jason Pereira: Well, the other thing too we got to remember is that people need to understand that you have to have a structure in place for 24 months.
Ted Maduri: Correct.
Jason Pereira: Before you qualify for that exemption. So we've seen it time and time again where people like, "Oh yeah, I have an offer on my business. Can we sell this?"
Jason Pereira: I'm like, "Well, you can sell it, but you need to do all this purification of your organization. So you guys are offside for the exemption," and when you tell them what the tax bill's going to be, and they're like, "Well, can we fix it now?"
Jason Pereira: It's like, "No, if you want to sell it in two months you can't fix it now. It's too late for that."
Ted Maduri: Yeah. That's why I think keeping your eyes on the prize right from the outset is important and knowing what your ultimate exit strategy is is important. Same too with your corporate records. You want to make sure you're keeping good corporate records because trying to reinvent the wheel at the end of the piece is very difficult. So having proper corporate hygiene from the outside is important.
Ted Maduri: Another piece of advice that we haven't touched on is just making sure that, maybe related to your corporate records, that you have proper agreements with your customers, long-term agreements with your customers, that you are trying to capture the value whether through your customer contracts or with your intellectual property. So I think this is all about sort of-
Jason Pereira: Getting the right advice, and ...
Ted Maduri: Correct.
Jason Pereira: We're worked on a couple of these cases together. The number of times we've had clients who talked about wanting to do this, put it off, and then a buyer popped up out of nowhere. Or one of the more amusing ones we had which was two people looking at a reorganization saying, "Look no one ever buys companies in our business. It just doesn't happen. It doesn't happen," and sure enough.
Ted Maduri: Lo and behold.
Jason Pereira: Six months later, they get a life altering offer and were just like, "Wow, I wish I had something as unsellable as the two of you." Right?
Ted Maduri: Yeah.
Jason Pereira: So you know I think, and also having spoken to deal brokers who do this sort of thing at any point, the reality is any business that has money coming in that's reasonable or sizable, someone's going to be interested in buying it somewhere. It may not be easy to find them, but someone's going to be interested.
Ted Maduri: Yeah, I use that example all the time when someone tells me, "There's no one to buy our business," I use that example. There's probably a buyer out there.
Jason Pereira: Yeah. Well, there's one case we're working on together right now where a personal friend of mine and the exact same thing. He was like, "Look, in our industry no one buys shares. Everybody buys assets," and just be clear when you sell your business, you can sell the assets of the business. In which case they don't buy the corporation, you retain the corporation and the liability, and they buy the assets. The advantage to them is that they get no liability that comes with the corp, however the disadvantage is the tax situation. You're paying capital gains, you're not getting the exemption. We'll go into that deeper in a future episode.
Jason Pereira: But this is what he was telling me. He's like, "No one ever buys that. They buy the assets. End of story." Lo and behold, they get a phone call last month. "Oh, so a family member's thinking of buying the business." I started laughing. Because it's like, "Oh great, so ..." He's like, "Yeah I want to sell the shares."
Jason Pereira: I'm like, "Great, so are you going to pay taxes?"
Jason Pereira: "But you said I wouldn't."
Jason Pereira: I said, "No, I said you wouldn't if you re-organized yourself properly to make sure you didn't, and it's too late now."
Jason Pereira: He's like, "Okay, so what if we put this off for 24 months?"
Jason Pereira: It's like, "So you want to enter into a deal now for two years down the road? No, you can't do that." Right? So it's, you know, this is just a message out there: never, ever, ever [inaudible 00:29:37]. It's like insurance, right? When the house is on fire, that's when you need the insurance, but no one's going to give you the insurance when the house is on fire, and CRA's not going to give you the tax break after the fact.
Ted Maduri: Yeah, correct.
Jason Pereira: Yep. So any parting thoughts or words of advice that you would give beyond what we've talked about thus far?
Ted Maduri: I think the only other thing we've talked about setting it up properly and getting it ready for sale. I think the one thing we haven't touched on is often times, especially in this day and age with the startup scene and the tech scene in Canada, which isn't like it used to be, where we haven't touched on sort of the possibility of getting funding as you grow your business.
Jason Pereira: Yes, okay. So let's talk about that [inaudible 00:30:12].
Ted Maduri: And so a lot of times what we've talked about, keeping good corporate records, protecting your IP, getting in agreements in place with your customers, getting your employees and contractors to sign agreements, those are all helpful to ultimately sell. But they're also helpful to raise capital as your grow your business.
Ted Maduri: In Canada now, there are ways to raise capital in a way that there wasn't 10 years ago. And so whether it's-
Jason Pereira: You were telling me the venture capital scene's exploded in Canada.
Ted Maduri: Seed investors, angel funds, venture capital. A big chunk of my practice is representing venture capital firms from the US investing in Canadian companies. And so I do think a lot of these things would lend itself to raising capital as you run and operate your business. So it has a couple of purposes. It's not just for ultimately to sell the business.
Jason Pereira: Yeah, and I mean you touched upon several times about keeping clean books and keeping everything up to date. All too often we basically find these issues where something gets presented. It's like, "Oh, this person wants to buy my business," and it's like okay well your financials are a mess. You haven't updated your minute book in five years or longer. Nevermind the corporate structure stuff. You can't even find the documents. All you're doing is someone comes and knocks at the door and says, "I'm willing to cut you a check for your business." You're not exactly showing them that you have the most sellable business when you're scrambling to find and catch up on stuff that you haven't done for years.
Ted Maduri: Yeah, and I think in today's day and age you find firms, law firms, accounting firms, who if you have a good idea and you have a good track record, you don't have to be scared of the price tag attached with the professional services that are being offered.
Jason Pereira: No.
Ted Maduri: Because if you do have something that is ultimately going to grow, there are firms out there that will take a chance on you, defer fees, discount fees, become a partner of yours in the sense that they're not going to hit you over the head with a huge bill right out of the gate.
Ted Maduri: So I think if you try to find a firm that can assist you and grow with you and not just settle for the friend down the street, making sure that you're getting the right advice up front whether it's from a legal professional or accounting professional. You don't have to be scared of the price tag necessarily.
Jason Pereira: Yeah. And I'll tell you, I sleep much better knowing that I have the proper legal and accounting advice because I've seen it all too often where someone has outgrown the corner shop guy that took care of this one thing, or the guy, you know we give him the business because he's affordable. It's like well yeah, but you got to realize that the right team is also an insurance policy.
Ted Maduri: Correct.
Jason Pereira: And I'm not telling you to go break and bank and hire KPMG to do your books when you're a one man operation, but I am saying you got to find someone that has internal resources so that as your business goes from point A to point B, you're able to do that. The number of times I have clients who basically, I tell them, "Okay, I need to talk to your accountant."
Jason Pereira: The first thing they look at me and say, "Okay, you let me know if they're the right accountant," anymore. It's like, "Okay, so they've been with me for a long time. They do this. I pay them a fair amount." I just had this conversation today. They pay them good money, but I don't feel like they get that much out of them. They've literally been outgrown, but very few people ever say, "You've outgrown me. Move onto someone else." So yeah, find the right people to start.
Ted Maduri: Yeah, finding the right people, the right team, and putting that team in place from the outset. And the adjusting if it's not the right team I think is important.
Jason Pereira: Yeah, yeah. And making sure you get value. I mean, I'm putting him in contact with someone who's actually been on my other podcast, [inaudible 00:33:25], where they, for a similar price point this guy was doing the books and filing the taxes. For a similar price point, these people do the books, file the taxes, have in house legal counsel, do payroll, do accounts payable, all this other stuff. So far more value, far more touch points, and far more professionalism.
Jason Pereira: So sometimes it's not about the cost. The cost can actually be pretty similar between the good and average. You just got to find where to find good.
Ted Maduri: Yeah. The firms that you're talking about have had experience dealing with small, medium sized businesses, startups, and they're able to provide that expertise over and over again.
Jason Pereira: Yeah, that's really the important thing is making sure you find people who in a lot of ways have had experience dealing with specifically your type of business, and often times when I've made referrals to you in the past, sometimes it'll be in industries that you've had a lot of exposure to. And the level of comfort that that brings to the people who are basically getting that referral, they feel a lot better. Because like, you've seen this. You know what goes wrong, you know what goes right, you know how I should be doing this. It's a lot of value to be added there.
Ted Maduri: Yeah. You can talk the talk. You can understand the jargon just like I'm sure there's been a lot of jargon on this podcast, but I think knowing the industry and being able to have the communication in the language they understand is helpful.
Jason Pereira: Yeah. I mean, you know me. The number of business clients where the key value proposition for me is translating what the accountant and lawyer says into plain English, it's hilarious. But it is valuable to them, and it makes a lot of sense. It's just part of the overall offering.
Jason Pereira: Yeah, so this has been great, Ted. Thank you very much for taking the time to come in.
Ted Maduri: Well thanks, Jason. This has been fun. Thanks for having me.
Jason Pereira: No, so where can people find you?
Ted Maduri: DLA Piper. We're here in Toronto. We have offices across the country, all across the world.
Jason Pereira: I was going to say, across the world. Don't sell yourself short.
Ted Maduri: Yeah.
Jason Pereira: Yeah, so perfect. Thank you very much. Take care.
Ted Maduri: Thanks, Jason.
Jason Pereira: So I hope you enjoyed that interview, and I hope you found it informative and came to understand why strong corporate structure that services your long-term goals is very important and from an asset protection standpoint. So I hope you continue to join me on this podcast as I speak to different people who will help you in your entrepreneurial journey. And with that, I'm Jason Pereira.
Jason Pereira: If you enjoy this podcast, please leave a review on Apple Podcasts, Stitcher, Google Play, or wherever it is you get your podcasts. Doing so helps people discover us. Until next time, take care.
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