Bringing on a business partner in Canada: shares, price, and the agreement you sign first

Summary

If you own a corporation and you’re thinking about taking on a business partner, in law that usually means somebody becomes a shareholder of the company you already have. Shares are the units a company’s ownership is divided into, and a shareholder is a part-owner of it. There are only two ways to get shares into a new partner’s hands, and they send the money to different places.

1. You sell shares you already own, personally. The price goes to you, and you report a capital gain, which is the sale price minus what those shares originally cost you. Most owners paid a token amount for their first shares, so that cost is often a few dollars and nearly the whole price is gain.
2. The corporation creates brand new shares and issues them to your partner, which is called issuing from treasury. The money lands in the company’s bank account, you get nothing personally, and your percentage falls.

Which route you pick is a business question before it’s a tax one. In our view, sell somewhere between 10% and 40% out of your own holdings, so that you keep control of the company. Above 50% the company’s own taxes change too, a bigger subject than this page. The price has to be fair market value, meaning what an informed buyer would pay an informed seller when neither is under pressure, with a file showing how you got there. Selling cheap to somebody who works for you is the costliest mistake here, since the shortfall becomes their employment income. Put your partner’s shares in a second class, a class being a labelled group of shares (e.g. Class A, Class B) with its own rights, so that the company can later pay a dividend (i.e. a share of profit) to one of you and not the other. Don’t hand anything over until a shareholders’ agreement has been signed the same day. We’d switch to a treasury issue where the business needs the money more than you do.

Where the money goes

Selling shares you already own is the simpler transaction. Half of your capital gain is added to your personal income in the year of sale, so at top personal rates the tax comes to roughly 25% of the whole gain.¹

If your company earns its money from operating a business rather than from holding investments, and isn’t sitting on cash, rental property or a share portfolio beyond what the business needs, your shares may be qualified small business corporation shares. A lifetime allowance called the lifetime capital gains exemption then covers up to $1,275,000 of gain on 2026 sales, tax free.² The figure is an amount of gain rather than of tax saved, and each individual gets one, covering every sale they ever make added together. Qualifying turns on the 24 months before a sale: more than half of what the company owned has to have been used in the business throughout, and nobody outside your family may have held those shares. Those past months need checking before you agree a sale, alongside the stricter asset test at closing.³

Two costs sit underneath selling your own shares: no money reaches the business, and your partner funds the purchase out of personal after-tax cash. A claim near the full exemption can also pull in alternative minimum tax, a second calculation that can cost you cash even where the exemption covered the gain.⁴

Having the corporation issue new shares from treasury does close to the opposite. Nothing is disposed of, so you have no tax to report and no exemption to claim, and the money funds the business rather than your bank account. On the flip side you’re diluted: your percentage falls while your bank balance stays where it was. A federally incorporated company, which yours is if its certificate names the Canada Business Corporations Act rather than a provincial statute, must also receive the money, property or past services before a share is validly issued. A written promise to pay won’t do.⁵

Setting the price

Three separate rules punish a price below fair market value, and they land on different people.

First, if you and the person buying in aren’t dealing at arm’s length, the tax rules treat you as having sold at full value whatever you actually charged. Family always fails that test, and two people with a long working relationship sometimes fail it on the facts. So if the shares were worth $500,000 and you charged $100,000, you’re taxed as though $500,000 had reached you. An outright gift works the same way, whoever gets it.⁶

Second, if the corporation issues shares worth far more than the price paid for them, the difference is a shareholder benefit, added to the recipient’s income for the year even though no cash reached them.⁷

Third, where that recipient is an employee, the shortfall between what they paid and what the shares were worth is employment income instead. For a Canadian-controlled private corporation, meaning a private company controlled by Canadian residents, the timing is kinder than owners expect: nothing is withheld off a paycheque at the time, and the amount isn’t taxed until the year the employee sells or exchanges the shares, with half of it deductible if they held on two years. What’s unkind is that the figure is fixed at the value on the day they got the shares, so a bill sized on today’s value falls due whenever those shares next move. The deferral also needs the employee to be at arm’s length from the company, so an employee who is family is taxed in the year they receive the shares.⁸

Giving somebody shares as a reward for work rather than for money, usually called sweat equity, is in our view where owners get hurt worst. Take a company worth $2 million, and say 30% goes to a long-serving manager for a token $100. Under corporate law that issue can be valid, since past services worth the fair equivalent are proper payment for a share. Under tax law the manager has picked up about $600,000 of employment income, payable whenever those shares next move, or a little less, because a minority stake nobody can sell on its own is normally valued at a discount.

When the partner can’t fund a real price, the answer isn’t to discount the shares. Either freeze today’s value onto a new class of shares issued to you, called preferred shares, so that the ordinary shares your partner buys start out worth almost nothing and nobody receives a taxable gift, or pay them a written profit share until they can afford to buy in. A freeze fixes the value of your preferred shares, while future growth belongs to whoever holds the new ordinary shares.⁹ You can keep some of those too, whereas a profit share gives the partner no ownership.

Insist on a price adjustment clause in the purchase agreement either way. It says that if the Canada Revenue Agency (the CRA, Canada’s federal tax authority) later decides the shares were worth something different, the price resets to the CRA’s number and whichever of you underpaid writes a cheque to the other. The CRA recognises one only where four conditions are all met: a genuine intention to transfer at fair market value, a value reached by a fair and reasonable method properly applied, an agreement in writing to accept the CRA’s or a court’s figure, and the difference actually paid over. It answers the shareholder benefit and deemed-value rules above, and on the CRA’s own published list it does nothing about the employment income problem.¹⁰

The shareholders’ agreement

Corporate law supplies almost none of what two owners need from each other. Company decisions get made by counting votes, and shares carry the votes. Without a written agreement, a holder of exactly half the votes can block nearly everything, a holder of just over half can appoint the board of directors (i.e. whoever has legal authority to run the company) and set salaries, and neither of you has a way out.

Four things belong in it, and a template pulled off the internet tends to cover the mechanics of transferring shares and leave the rest to you:

• A buy-sell clause naming who buys whose shares on a death, a disability, a departure or a default, and at what price. Default here means breaking the agreement itself (e.g. competing with the company).
• A written method for setting that price, either a formula or an independent valuation.
• Funding standing behind that price, because an obligation to buy out a deceased partner’s 45% stake with no life insurance behind it means selling the business at the worst moment.
• A list of decisions needing both signatures whatever the percentages say (e.g. new debt, or changing what either of you gets paid).

Paperwork

Signing and paying doesn’t by itself move any shares. Both routes also need a directors’ resolution, which is a written decision of the board kept in the company’s records (i.e. the minute book), a share certificate, and an entry in your securities register, the list of who holds which shares and since when.¹¹ Gaps there surface years later, during a buyer’s or a lender’s due diligence.

How often this changes

The law here moves slowly, and what goes stale silently is your own paperwork. Reaffirm two things every year at your year-end: the valuation basis written into the shareholders’ agreement, because a formula agreed when the business earned $300,000 of profit is wrong once it earns $900,000, and the insurance standing behind the buy-sell, because coverage drifts below the obligation without anybody noticing. Re-open the whole arrangement early if a third owner joins.

Closing thoughts

In our view the part of a buy-in that attracts most argument is the price, and the part that attracts least is the clause deciding who keeps the business. The gap between $2 million and $2.4 million is a few hundred thousand dollars, once. A missing departure clause can cost one of you the company. The day you sign is the only day you both have aligned incentives about an exit, because neither of you knows which side of that clause you’ll be on.

How we handle it

We run the corporate side of a buy-in: the financial information the price gets built from, the file recording it, the directors’ resolution, the certificate and the securities register, and the reporting that follows on both the company’s return and your personal one. Valuing the business is a valuator’s work and the agreement is a lawyer’s, and we’ll tell you which of the three (accountant, valuator or lawyer) you need first.