Originally published Jan 2023. Updated March 31, 2023
Overall, there are a couple of ways to achieve “Employee Ownership” in Canada. EOTs could be an added design parameter to achieve Employee Ownership depending on the goals the owner would like the plan to achieve.
The main difference between these two is that votes are equal in a co-op whereas in an ESOP votes are dependent on the shareholders’ type of share (voting or non-voting) and how many shares they own.
In Canada, we consider an ESOP the umbrella term, but there are different types of plans under an ESOP that achieve slightly different goals.
Employees become shareholders through share purchase
An option is granted to employees to purchase shares in the future at a pre-set price
No ownership is transferred. Employees become unitholders. It’s like a “super bonus program”
The owner or company sells shares to employees. This could be set up as a purchase plan using cash, payroll deductions, bonuses, loans, dividend reinvestment to name a few. The Canadian federal government has announced an Employee Ownership Trust (EOT) coming to Canada (see our special bulletin). This could be another way business owners can design an employee share ownership plan to help facilitate succession and exit planning. The two most quoted models using EOTs are in the US and the UK, the US also has specific ESOP legislation. The recommendations for Canadian EOTs was to model components of structures in these two countries. A purchase plan is the most common plan design that our clients implement for the reasons below. If you are considering implementing some form of employee ownership, identifying your goals is the first step. All of the ESOPs we have helped design and implement have not been created with EOTs (since there is no legislation for it) and have had success especially for Small and Medium Sized Enterprises (SMEs), which are privately owned.
Employees receive options to purchase shares at some future date at a set price. This is typically used to incentivize and motivate senior management and executives to create greater company value or in a start-up to attract employees to work in a high growth company with the expectation that there will be a sale or IPO in the future.
We call these Equity Value Ownership Plans (EVOP™️) since trying to communicate a phantom is…tricky…These create more of a “super bonus plan” since employees don’t become shareholders, but unitholders. It is more than a bonus or profit-sharing program because the units can go up and down in value as the value of the company increases or decreases (like a share would).
It is important to understand how the EOTs are structured in the US and UK to help determine if it might be the right design for your company if implemented in Canada.
For example, in the UK, the owner must sell a controlling stake to the EOT. The trust then owes that owner the value of the shares and over time, profits pay down the debt and payouts to employees (new owners).
With ESOPs in the US, a trust is established to purchase the shares from a founder (see this NCEO article describing how ESOPs work in the US). The company contributes funds to the trust or a loan can be acquired from a financial institution to buy the equity. The trust owns the shares and over time profits pay the loan (principal and interest) and allocate equity to the employees via the trust.
In the US and UK, legislated structures provide substantial tax benefits to the exiting owner and can create great ownership mentality. They are quite complex and costly to set up, and can be restrictive. Because of this, many small to mid-sized companies find that other models align better with their goals.
We can see some useful data from the NCEO here.
Unfortunately, while this could provide an additional mechanism for how to structure a Plan in certain limited circumstances, the proposed EOT has really missed the mark and the government does not seem to have listened to the recommendations given to create more Employee Ownership. These limited circumstances for its use would be a business that is steady, has stable cash available, not growing much, and the owner has no other exit options. As it is described now, there doesn’t seem to be much incentive, tax or otherwise, to create the Plan through the EOT. In the end, the employees do not actually own the shares, employees become beneficiaries of the EOT which owns the shares. The employees are only entitled to dividends while they are employed. It is perhaps more like an employee benefit trust rather than an EOT.
Our advice to the government would be:
So, are EOTs right for Canada? In the right circumstances some owners could see a use for them. As we’ve said, the owner should first define the goals they want an ESOP to achieve and then strategically design the parameters using the options above based on those goals.
ESOP Association Canada
2023 Employee Ownership Conference – May 11-12 in Edmonton AB
Roundtable Session (for members only) – meet and openly discuss with reps from ESOP
companies, ESOP experts, lawyers, business valuators, ESOP tax experts, etc.
ESOP Design, Communication, Education and Implementation
Complete the Feasibility Study to see if an ESOP can be right for your company now
NCEO – US ESOP Info and cultural testimonials
By Joanna Phillips, CHRL, CVB, Vice President, ESOP Builders
July 18, 2022: FriesenPress announces ESOPs in Canada now a bestseller as many search for employee ownership information in Canada.
More and more business owners are reading about Employee Share Ownership Plans or ESOPs. ESOPs can be a smart way to sell your company and a great way to attract the best employees. Owners and professional advisers are turning to the practical guide, ESOPs in Canada, to learn more about how to sell to employees successfully and employee ownership in general.
Interest in employee ownership got a boost in February when Budget 2022 stated that the federal government plans, “to create the Employee Ownership Trust—a new, dedicated type of trust under the Income Tax Act to support employee ownership.” Back in 2021, the federal government began engaging stakeholders about barriers to creating these trusts. The government now needs to finalize the new tax rules.
Perry Phillips, co-author of ESOPs in Canada: How to Implement an Employee Share Ownership Plan to Grow and Exit Your Business with Your Legacy Intact, says,
“Employee ownership is a solution to some of the biggest challenges facing the Canadian economy. Baby boomers are exiting their businesses. Companies need to attract talented people who can help them become innovative and productive. ESOPs make that possible.”
Learn more about ESOPs in Canada or Buy Now
CONTACT Joanna Phillips, Vice President, ESOP Builders Inc.
What an interesting spring it has been, we’ve seen Employee Ownership Trusts (EOTs) development proposals in the budget, in the news, and have been very busy in our offices. In June’s newsletter, we thought we’d share with you a current clients’ Canadian ESOP design and implementation.
Engage employees across the organization to be more consciously aware of the “Big Picture” at the Company.
Enhance the commitment and motivation of the team.
Create a long-term, flexible exit and succession plan for the current Owners.
Retain the people who drive the success of the company.
Attract qualified and entrepreneurial talent.
During stage one, we performed a total of 10 owner/employee interviews and 51 employee questionnaires. These interviews and questionnaires allowed us to gain insight into both the employees’ and owners’ understanding of ESOPs and what participation would look like for this potential ESOP. Our client provided us with all requested documentation regarding the company’s structure and current financial situation and our analysis began. Utilizing the information, we then prepared a Feasibility and Recommendations Report that outlined the unique plan design for this company. We met with the client to review any questions they had regarding the report and our general conclusion. Finding that an ESOP was feasible and after reviewing the recommendations with the client, we were then headed into Stage two of our design and implementation model based on our recommendations – a broad-based equity plan.
Stage two began with an owner survey to gather data on how the owner was leaning on certain decisions such as launch date, financial disclosure, eligibility, purchase methods, etc. These responses were used to prepare the preliminary ESOP design documents, the ESOP Blueprint. Next was the formation of the client’s ESOP team. We like to start these team sessions with an Ownership Thinking exercise to get everyone in the mentality of what it means to be an owner within the ESOP. The purpose of the ESOP Team is to create the conditions for a participatory design approach. Our meeting progressed with a full review of the ESOP Blueprint which is the document from which the Employee Shareholder Agreement will be based on.
Some of the design elements in the ESOP Blueprint that the ESOP Team provides input on before it is finalized are:
Eligibility (broad-based or key-person plan, what is the waiting period)
Allocation (how shares are allocated to eligible employees)
Purchase methods (payroll deduction, shares as part of a bonus, loans, etc.)
Minimarket (participants can sell or buy during a brief internal market)
Buy-out (what happens to shares when someone leaves)
Tax implications (using a trust to buy shares of departing employees so that employees of a CCPC can access the capital gains exemption)
Risks (liquidity, market, tax, etc.)
Currently, there is a general ESOP info session being scheduled, a valuation is being conducted, tax reviews are underway, legal documents are being drafted, and communicated materials are being created. The final launch is scheduled for October 2022 where employees will receive an information package containing an intro letter from the President, the ESOP Blueprint, all legal documents, tax summary, share allocation letter, and FAQs. They will then have about a month to review the information and make their decision to participate. Finally, we would run the CORE4ESOP survey, which is a performance analysis tool to help support the success of the ESOP.
In 2023, we will provide a client update to hear how their ESOP launch went.
Learn more about Canadian ESOP design by completing the feasibility survey, joining our newsletter, attending one of our events, and following us on social media (ESOP Builders on LinkedIn, Twitter, Facebook, and YouTube).
By Joanna Phillips, CHRL, CVB, Vice President & Colleen Johe, Employee Ownership Specialist