Can a recapitalization work as a partial exit for a business owner?

On this page a recapitalization means a deal that changes who holds a company’s shares and how its capital is arranged, so that an owner takes some money out while staying on as a shareholder. That makes it a partial exit rather than a sale of the business. The route matters: an investor can buy some of the owner’s shares, or the company can buy them back, and the legal and tax consequences differ.

Selling some shares to an investor

When an investor buys part of an owner’s shares, the owner disposes of those shares and keeps the rest. The CRA lists dispositions of qualified small business corporation shares among the gains that can qualify for the capital gains deduction, so whether the shares meet its tests is worth establishing early. Under the Ontario Business Corporations Act, a written agreement among all the shareholders may restrict the directors’ powers to manage the business, and a transferee of shares subject to such an agreement is deemed a party to it. How much say the owner keeps is therefore a matter for that agreement.

Having the company buy shares back

A corporation may buy its own shares, subject to its articles, but the Ontario and federal statutes both bar the payment if there are reasonable grounds to believe the corporation is, or would after the payment be, unable to pay its liabilities as they become due, or that the realizable value of its assets would fall below its liabilities and stated capital. Sections 31 and 32 of the Ontario Act and sections 35 and 36 of the federal one set exceptions that carry their own limits. On the tax side, subject to exceptions including those in subsections 84(2) and 84(6), subsection 84(3) of the Income Tax Act deems a dividend to be paid when a corporation resident in Canada redeems, acquires or cancels its shares, equal to the amount by which what it pays exceeds the paid-up capital of those shares. The tax result can therefore differ from a sale to an investor.

Questions to settle with advisers

• Who pays the owner: an outside investor, the company, or both?
• Do the shares being sold qualify for the capital gains deduction, and could part of the payment be a deemed dividend?
• Does the corporation meet the statutory tests for a buyback, and do its articles allow one?
• What does the shareholder agreement say about control, and about a later full exit? The comparison of full sale vs partial sale frames the trade-offs.