Estate Freeze in Plain English

An estate freeze is one of the most used tools in Canadian private-company succession. It is also one of the most poorly explained. In plain language, you lock in the value you have already created and arrange for value created from today forward to accrue to children, a spouse, or a family trust.

The basic mechanics

Suppose the company is worth a certain amount today and you own the common shares. In a typical freeze, those common shares are exchanged for preferred shares with a redemption value equal to today’s fair market value. New common shares are then issued for a nominal amount to the people or the trust who should own the growth.

If the company later becomes worth more, that extra value attaches to the new common shares. Your preferred shares still represent the frozen amount, plus any special rights designed into them, such as votes or dividends.

Why families use it

• To limit the tax that will arise on the founder’s death to the value frozen today, rather than today’s value plus twenty years of growth

• To give the next generation a way to participate in growth without transferring today’s company out of the founder’s economic security

• To create a cleaner story for a later sale, including possible use of more than one person’s capital gains exemption if the shares qualify

• To support estate equalization: one child may receive growth shares in the company while another receives different assets or insurance proceeds

What has to be true for the freeze to be honest

The valuation has to be defensible. The share attributes have to work under corporate law. The tax elections, if any, have to be filed. The company’s minute book has to match what everyone thinks happened. And the shares that are expected to qualify for the lifetime capital gains exemption later must be capable of qualifying.

A freeze completed on a company that is not “clean” can still cap the founder’s value. It cannot manufacture qualification that does not exist.

Control does not have to leave the room

Many freezes are designed so the founder keeps votes. Growth can move without the operating steering wheel moving. That design should be explicit. If it is only assumed, it is not designed.

After the freeze

Preferred shares need a plan: will they be redeemed over time, left until death, or used in a later reorganization? The common shareholders or the trust need a plan for year 21 if a trust is used. The will must not casually give away a different story than the share register. Insurance may be needed if the frozen value itself will create a tax bill.

A freeze is a powerful first move. It is not the whole game.

Key takeaways

• A freeze exchanges current common-share value for preferred shares, and issues new common shares that will carry future growth.

• The founder can often keep voting control and a claim on today’s value.

• A freeze is only as good as the valuation, the corporate records, and the eligibility of the shares for later tax planning.

• It is a beginning structure. Wills, insurance, and family conversations still have to match it.

A next step, if this sounds familiar

If the value of your company is rising and most of that future increase would otherwise land on your estate, a freeze conversation is worth having — after the foundations, including any exemption eligibility, have been checked.

The first conversation is a discovery meeting, not a product pitch. You should leave with a clearer picture of your current path and whether more coordinated planning would be useful.

This article is general information for educational purposes. It is not legal, tax, accounting, or insurance advice and should not be relied on as a recommendation for any particular structure, product, or transaction. Rules affecting trusts, corporations, the lifetime capital gains exemption, probate, and insurance change and depend on individual facts. Speak with qualified advisors about your own situation before making decisions.

Related services

If this article is relevant to your situation, these Financial Planning Simplified services go into more detail:

• Estate Freeze

• Corporate Restructuring