Employee Ownership Trust (EOT) is in Canada

Canadian business owners may be curious about a possible new option when considering an employee ownership transition; the EOT. 
Employee Share Ownership Plans in Canada have been used by business owners as they are shown to facilitate numerous benefits; increased retention, engagement, productivity, and profit. They can also improve the country’s economy by spreading the wealth more fairly, protecting small businesses and local work, and improving resiliency of these businesses. 
The government had previously announced the creation of an Employee Ownership Trust (EOT) in the 2023 budget and have now confirmed it’s creation in the Fall Economic Statement along with announcing tax incentives for business owners who decide the EOT is a fit for their goals. New EOT legislation can hopefully be a positive contribution to employee ownership in Canada.
While the legislation is still yet to be finalized, here is a breakdown of the Pros and Cons as we know it today.

Pros:

• transition ownership to employee via a trust
• until 2026 the first $10 million of capital gains realized on the sale are exempt from tax (subject to certain conditions)
• employees don’t have to invest any money, if they meet the eligibility criteria, they are beneficiaries of the trust which owns the shares
• employees benefit through the trust and receive profit distributions
• offer a form of compensation on top of more traditional compensation and bonus plans
• extend the timeframe of the capital gains reserve for the business owner

Cons:

• owner must sell a controlling stake in the company to the trust
• delayed financial return for the owner as the proceeds come from company profits over the years
• employees don’t actually own shares and therefore it will be more difficult to fully create an ownership culture 
• requires ongoing education and communication to employees
• must manage employee expectations as to what participating in the EOT means to them personally and in relation to their roles and responsibilities
• no tax incentives to the employees
• requires an employee group that has people in it that can take the reins of the business (or hiring someone), given the limited participation in the business allowed for the seller, post sale

Complete a Feasibility Survey through our website to see what kind of employee share ownership plan can work for you and your company. 

Whether it be for a down payment or university tuition of a dependant we all run into larger than life expenses from time to time. When it comes to an ESOP, a mini market can often help deal with these issues. In an established ESOP the Plan Administrator (typically the Board) has the discretion to create in the future an internal market for share trading where ESOP shares may be bought and sold. This is referred to as the Mini market.

If implemented, it would be open to employees who own ESOP shares. Trades would be administered by the Company in order to facilitate the buying and selling of shares. The share trading price will be the annual share value, the FMV as calculated by the most recent valuation. The details of the structure would be provided at the time of implementation.

In a survey EBI conducted, 80% of the respondents utilize mini markets in their ESOP.

Of those, 90% offer the mini market annually. Most found their mini markets to be moderately successful in terms of what their employees wanted. Many saw their employees wanting to buy and sell multiple times a year and others found there were too few shares to produce liquidity in the mini market. These responses were collected in 2018. Like many aspects of the ESOP the mini market requires participation to be successful. Utilizing the mini market allows employees to buy and sell as they need, within the specified timeframe of course. Mini markets don’t have to be an annual event either; it can be at the discretion of the board or the participatory engagement of the employees. Your mini market can be when you decide based on demand and your comfort level. The mini market is designed to allow some liquidity for employees as well as an opportunity to increase their investment in the Company (subject to any caps).

The mini market furthers a participative culture by involving the employees in the process of buying and selling and the excitement that creates. It also raises to employees the importance of investing in their futures, which is ultimately in line with the growth of the company (appreciation in share value). It creates an atmosphere of ownership that can only come from owning shares. Further the sale of the shares to other employees (not the company) by way of the mini market may make the shares eligible for the Long Term Capital Gains Exemption (LCGE) making the sale gains tax free to the employees.

By Colleen Johe, Employee Ownership Specialist & Perry Phillips, President 

Social psychologists say that the root of organizational trust is predictability. Surprise is the opposite of predictability, and although it is impossible to eliminate surprises, company leaders should make it their personal goal to never be the source of an unnecessary surprise. Companies can reduce surprises and be more predictable in a number of ways, all of which have the impact of increasing levels of trust.

Communication cycles: Many employee-owned companies communicate in a series of interlocking cycles. They send weekly (or daily) email updates about the state of the company. They have monthly department meetings, quarterly newsletters, and annual shareholder meetings. They have elections every July for their employee committee, a guess-the-stock-price contest every May, and a state of the company address from the CEO every February! The information itself is useful, but maybe even more important, these cycles become expected, and when people’s expectations are met, trust builds.

Open-book management: The better people understand the business, the less likely they are to be surprised. Teaching business literacy and sharing key financial information not only makes people feel like insiders and helps them manage their day-to-day decisions, it also lets them better see the road ahead.

Anticipate problems: What does a business downturn look like and what can we expect in response? Some ESOP companies have built themselves business contingency plans. Such a plan could describe, for example, a “stage 1” downturn in terms of a specific threshold of revenues, EBITDA, projects “in the pipeline,” or product development. The contingency plan, if business is soft, will let people know what needs to happen to the numbers to get out of stage 1, and the warning signs that the business may be approaching a “stage 2” downturn, or worse. One of our clients called their contingency plan “What happens if Ted gets hit by a bus?”, Ted being the founder and president and the main source of revenue. 

An ESOP alone creates conditions for success, however the routine communication practices are one of the important components of a successful plan because it builds trust.

By Joanna Phillips, CHRL, CVB, Vice President, and Perry Phillips CPA, CA, CBV, President

As ESOP Experts we write about participation a lot when it comes to ESOPs. Our whole design and implementation methodology is based around a participative approach, and that’s no coincidence. But what does participation look like? Does it always mean representation on the Board of Directors?

Where a goal of the ESOP is an overhaul or integration of the company’s corporate culture, a significant factor could be whether or not employee-owners should have a right to representation on the board of directors. In a unionized company the unions usually require that representation, if they are to look at an ESOP as a means of supplementing wage concessions. Because ESOPs are put into place as a means to allow employees to participate in the value growth of the company, there is a tendency to develop the right of the employee-owners to representation on the board of directors. This is generally done over time as the shares owned by employees becomes about 40% or greater. Studies in the United States have shown that a majority of companies, after five or six years of operating the ESOP, tend to appoint employees to the board, as all stakeholders begin to understand and respect the issues that are involved in running the corporation, and trust each other to do what is best for the growth of the company.

One of our clients decided that board representation was important to their company culture. They decided that one board member would come from among the employee-owners and would have a term of three years. To select this board member, the employee-owners voted for one of three candidates chosen by the founding owners. 

A successful ESOP is flexible and adapts with the changing needs of the growing company. In this way the level of participation can change as the plan grows and employee-owners show greater understanding of what is involved in running an organization.

By Joanna Phillips, CHRL, CVB, Vice President, and Perry Phillips CPA, CA, CBV, President

Employee Share Ownership Plans in Canada are often thought to work best in industries such as engineering, construction, high-tech, and famous little airline companies like the one based out of Calgary, AB.  Any guesses?

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