Shareholders agreements in the context of an estate plan - Hull on Estate and Succession Planning #149
Listen to Shareholders agreements in the context of an estate plan
This week on Hull on Estate and Succession Planning, Ian and Suzana discuss what a shareholders agreement is and how that can be an important tool in the context of an estate plan. They focus on the fact that the efforts to create a shareholders agreement forces the family to consider what they're going to do with the estate plan and where they're going to go forward.
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Shareholders agreements in the context of an estate plan - Hull on Estate and Succession Planning #149
Posted on January 28th, 2009 by Hull & Hull LLP
Welcome to Hull on Estate and Succession Planning, a series of podcasts hosted by Ian Hull and Suzana Popovic-Montag that will provide information and insights into estate planning in Canada. From the offices of Hull & Hull in Toronto, here are Ian and Suzana.
Suzana Popovic-Montag: Hi and welcome to Hull on Estate and Succession Planning. You’re listening to episode 149 of our podcast on Tuesday, January 27th, 2009.
Ian Hull: Hi Suzana.
Suzana Popovic-Montag: Hi there Ian. How are you today?
Ian Hull: Fantastic thank you.
Suzana Popovic-Montag: That’s good.
Ian Hull: So please come to our website, look at our information and browse around. Look for our daily blog at estatelaw.hullandhull.com.
Suzana Popovic-Montag: And if you have any comments or would like to pass on any thoughts to us, please feel free to contact us at hullandhull@gmail.com.
Ian Hull: Well Suzana, we’re working through the concept of what a shareholders agreement is and more importantly, how that can be an important tool in the context of an estate plan. And focusing on the fact that the efforts to create a shareholders agreement in and of itself forces the family to consider what they’re going to do with the estate plan and where they’re going to go forward and it creates its own agenda.
We finished off the last podcast talking about really was the starting point in the shareholders agreement. And what the first thing you’re going to look for and that is what is the nature of the business? So once we’ve established the nature of the business, whether it’s an investment holding company or it’s an active operating company. The next thing I think that is worth looking at is really the types of legal entities that are involved. And we can’t forget that there are really a variety of choices but there’s the classic corporation; then there’s the classic trust that are used in many of the estate planning scenarios; and then there’s the sole proprietorship or the unincorporated entity.
Suzana Popovic-Montag: Actually Ian just to add to that, I was thinking a little bit about the fact that, you know, we can use these kinds of processes and these kinds of discussions also when you’re dealing with partnerships. And I was just thinking from a legal perspective…
Ian Hull: That’s another idea, yeah.
Suzana Popovic-Montag: …you’ll see many times a father/son or a mother/daughter kind of family partnership that involves legal services or other services for that matter, too. And so a lot of the concepts that we’re talking about, I think, lend themselves into that kind of situation as well.
Ian Hull: No it’s a really good point because really we can talk about two entities, two tools: one is a shareholders agreement; another is a partnership agreement.
Suzana Popovic-Montag: Right.
Ian Hull: And the partnership agreement would be set up in a classic scenario, say a father and son were working in the business. The son had come into the business and the business was a book-selling company. A retail business. So they had a bunch of different stores and so on. The father had started with one and grown it. The son gets into it. Just one son gets into it. They both…what they’ll do is they might create two separate holding companies for their specific shareholding interest.
Suzana Popovic-Montag: That’s right.
Ian Hull: But they’re operating one business. So a partnership agreement there as between the two business entities would be a really good tool. So that’s a great point and one that we shouldn’t forget in that really we’re talking about…and we may want to talk separately about partnership agreements…but the general concept of a contract governing the behaviour of the parties, beyond a Will.
Suzana Popovic-Montag: That’s right.
Ian Hull: Okay. So that’s a great point. So we’ve got to look for the entities itself. And the sole proprietorship is not an impossible scenario either, when you’ve got a situation where you start small. And we stay with the book company and it was just, at one point, a small book company in a mall and grew. And the entity itself started off as just an entity and it wasn’t incorporated. So really what I think is important is (a) looking very hard and looking at what the corporate structure is and what exactly the entities are; and (b) reconsidering whether or not at this point in time maybe we have to upgrade the entity or change the entity. The other aspect of it, of course, is that in a classic estate freeze, a trust is used to hold the shares or the common shares. And we can talk through an estate freeze at more detail. But the point is, is that that entity is there.
So it gives us an opportunity (a) to consider the entities and (b) to consider what those entities mean with your family. So that the kids understand why there’s a trust.
Suzana Popovic-Montag: That’s right.
Ian Hull: Or they understand why there’s a partnership agreement and so on. So it’s a learning tool as well.
Suzana Popovic-Montag: And the communication that surrounds all that planning I think is key because then you can put collectively your minds to the different scenarios, the different possibilities, and as a family unit you can make those plans going forward.
Ian Hull: Alright. That’s terrific. So a subset of what are the entities if, of course, who are the shareholders? And let’s spend some time thinking that through and why that, again, allows for communication, allows for all of the things we want to encourage but why its important legally.
Suzana Popovic-Montag: Right. And from a legal perspective and the reason that it matters who the shareholders are is because we need to identify who the owners, in effect, are because shareholders are the owners of a corporation just like partners are the owners of a partnership. And so being able to identify who they are, what percentage of an interest they have which will normally bring with it some level of control or direction of the company that’s involved, helps to identify those kinds of issues and a plan.
Ian Hull: Alright, and let’s just talk about…we don’t want to get overly corporate, we don’t pretend to be corporate lawyers or tax lawyers but…with the context of the shareholder, there are different variations on the theme. But there really are the two central thinking and that is that there are common shareholders and there are pref shareholders.
Suzana Popovic-Montag: And when you say that, Ian, what’s the difference between that, just from you know a view above ground, not too complicated?
Ian Hull: Well that’s right, and I was going to ask you that question.
Suzana Popovic-Montag: I beat you to the punch.
Ian Hull: That’s right. And where its best illustrated is when you get in a situation where you want to pass on the growth of the company to the next generation. So the husband or the mother sets up the book company and she has run this book company for many years, she’s the sole shareholder. She has two kids. One of the kids wants to come in; other kid doesn’t want to come in. She wants to stay in control because she knows how to run the business. So what she will do is, she will essentially freeze her value in the estate freeze context and pass on the growth to the children. And the way she passes on the growth to the children is, is that she passes the common shares to the children and she leaves the pref shares in her hands, which allows no growth, you fix the price so say the company is worth $100,000 at that point, you say the fixed price on the pref shares is $100,000 but the growth is all to the common shares. And so you’ve allowed control at the level where it needs to be because the pref shares will hold not just the fixed value but they will typically hold the control votes. And then the growth shares will be enjoyed by the kids at a very tax efficient way.
Suzana Popovic-Montag: Now Ian, even though those are sort of the normal attributes attributed to the respective shares, the common shares and the pref shares, is it possible within a planning context, to change any of those attributes?
Ian Hull: I don’t know exactly what you’re getting at in the sense of we can vary it for sure, but what do you mean?
Suzana Popovic-Montag: Can you draft so that you can add maybe more power? Can you give common shareholders power, for instance, to make decisions? Or is it really just key with the pref shares?
Ian Hull: Well I have no idea because that…no I’m just joking…and from a corporate standpoint, we just don’t have the expertise to…I don’t have the expertise to address how we’re going to reflect the common shares and the pref shares. But what you can do is, of course, create different layers. So you might create X class shares or Y class shares. And in that, you may give special powers or special voting rights or even special growth.
Suzana Popovic-Montag: Right.
Ian Hull: There is tax deferral that you can put into them and so forth. So yes, I mean the truth is, I know that there are various options available. You have lots of flexibility…
Suzana Popovic-Montag: Right.
Ian Hull: …if you set up the core pref share and corporate share structure, but where you take it with is case by case.
Suzana Popovic-Montag: Okay, that’s fine.
Ian Hull: But the important thing is I think that if we just stay at the basic level is that we understand that we’ve got common shares and pref shares, and that that brings with it the sort of core elements of control and growth. And then what we need to do is talk about corporate governance because once we understand the entity, once we understand the core structure of it - growth and ownership - then the next step is what do we do with day-to-day control?
Suzana Popovic-Montag: And I guess you’re alluding there Ian to the concept of both directors and then officers of a corporation.
Ian Hull: Exactly and the rules that come with that. So I think that’s an important step and we want to talk through that on our next podcast because it’s the governance now that…of the day-to-day operations…needs to be talked through, needs to be communicated and understood in the context of the family arrangements and especially in closely-held families. So let’s deal with that in our next podcast.
And remember please to go to our blog at estatelaw.hullandhull.com.
Suzana Popovic-Montag: Or provide us with any feedback or comments you might have at hullandhull@gmail.com.
Thanks very much Ian.
Ian Hull: Thanks a lot.
