An estate freeze is a share reorganisation that locks a founder’s shares at today’s value in fixed-value preferred shares, so any future growth in the business accrues instead to new common shares issued to a family trust or the next generation.
The mechanism is section 86 of the Income Tax Act — “in the course of a reorganization of the capital of a corporation”. In a typical freeze, the founder exchanges all the shares of a class (usually the common shares) for new preferred shares fixed at the exchanged shares’ then-current fair market value, and new common shares carrying the future growth are subscribed for, often by a family trust, at nominal cost. Because it is a reorganisation of capital rather than a sale to a third party, the taxpayer is generally not taxed on the exchange itself — the tax cost simply carries forward into the new shares.
For a fund evaluating a family-owned target, a freeze that was executed years before the deal surfaces is a diligence item, not a footnote: the freeze preferred shares are a fixed, senior claim on the company (a redemption amount, usually with a modest dividend) that sits ahead of the common equity the fund is actually buying, and it is very often controlled through a unanimous shareholder agreement that decides who the fund actually needs signatures from. Skip past it and the purchase price bridge is wrong before the SPA is even drafted.
A founder’s common shares, worth $6,000,000, are exchanged under section 86 for freeze preferred shares with a $6,000,000 redemption amount and a fixed non-cumulative dividend; new voting common shares are subscribed for $100 by a family trust for the founder’s children. Three years later, a fund agrees to buy the operating company for $9,000,000 of enterprise value. Before that price reaches the common shareholders, the $6,000,000 of freeze preferred has to be redeemed or specifically assumed — leaving only $3,000,000 for the common the fund is actually acquiring, plus whatever the trust and any co-investing children hold.
See also: Intergenerational transfer rules · Crystallisation · Paid-up capital.
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