What do you want to offer investors? A long term piece of your business or something closer resembling a loan?
Also known as common equity, this is where investors get an ongoing piece of your business. Effectively they become your partner. Investors holding common shares aren’t entitled to regular dividends or to receive their money back within a specific timeline, but they do get to share in the growth of your business. When a dividend is declared on the common shares, both you and your common share investors will be entitled to receive them. It is often difficult to determine what is a fair price to offer common shares at, particularly if it is in an existing business. In addition, common shareholders can participate in the election of directors, which are responsible for overseeing the management of the company. If you ever decide to wind-up your business common shareholders are also entitled to receive their share of the cash realized from the sale of the company’s assets after all of the company’s debts and any amounts owed to preferred shareholders have been paid. Entrepreneurs with an existing company may be hesitant to offer common shares if they’re just in what they see as a temporary lull due to something like the COVID-19 Pandemic.
Common shares are typically held by the founder(s) of the company – you. Many business owners are hesitant to issue additional common shares and dilute their ownership. For those companies not wanting to issue common equity, they’re usually left with debt. Unfortunately, debt can be a killer for a small business, especially one that is just getting started or being rebuilt. Aside from that, the debt of private companies isn’t typically RSP eligible.
Thankfully there is another way for a business to access money from registered plans; by issuing preferred shares. Preferred shares typically require the payment of regular dividends to the investor and are required to be bought back by the company, either at the request of the company (called a redemption) or at the request of the investor (called a retraction) for the original amount paid for preferred shares.
Unlike common shares, a preferred share investor does not share in the growth of the company and is only entitled to receive the required dividends and the return of the principal amount he or she invested. Usually, preferred shares are not entitled to participate in the election of directors. It’s important for the business to consider if they can meet the obligations of the preferred shares as they’re effectively taking on another payment obligation.
When dealing with outside investors, there are three important things you must establish: (1)How do investors enter with their money? (2)How are investors treated while their money is in the business? (3)How do investors exit with their money and a fair return? Preferred shares can address these issues while allowing you, the entrepreneur, to get on with building your business. A good securities lawyer can help you create a structure that works for both you and your investors.