Types of Freezes
Freezes are generally done by way of internal freeze or holding company freeze.
An internal freeze initially consists of the business owner exchanging existing common shares for new preference shares with a fair market value (FMV) equal to the common shares immediately before the freeze ( these new preferred shares known as the “freeze shares”). This transfer can be accomplished in a variety of ways on a rollover (non-taxable) basis.
The next step involves the corporation issuing a different class of common shares to new shareholders or an inter vivos trust for the benefit of those shareholders. The preference shares typically contain certain rights:
- Redemption/retraction rights: The freeze shares will have redemption/retraction rights equal to the FMV of the old common shares. This means that the holder can demand the corporation to redeem the new shares at any time. Additionally, there are often dividend restrictions in place on all other classes of shares, including the newly issued common shares, so as not to impair the redemption value of the freeze shares.
- Voting vs. non-voting: the preference shares may have special super-voting privileges and/or the common shares may have restrictive voting capabilities. This will leave the person who has undertaken the estate freeze (the “freezor”) with control of the company.
Holding Company Freeze
Under a Holding Company Freeze, the business owner transfers his or her common shares in the company to a newly established holding company, receiving in exchange new fixed value (“frozen”)preference shares in this holding company. The preference shares will have a fair market value equal to the exchanged common shares. Common shares of the new holding company will then be issued to the new shareholders (typically family members or a trust). The new common shares will initially have nominal value, and the freeze shares will have all the attributes discussed above.
A holding company freeze is typically used when there are multiple shareholders of the Operating Company (“Opco”). This structure allows each shareholder in the Operating Company to put into place their personal estate plan independent of the other co-owners. The same issues relating to dividends and control as discussed above need to be considered with this type of freeze.