Employee Ownership Trust (EOT) is in Canada

Most recent info on Canada’s Employee Ownership Trust (EOT)

Canadian business owners thinking about succession plans may be curious about a new option when considering an employee ownership transition; the EOT. 
Employee Share Ownership Plans (ESOPs) 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 has created an Employee Ownership Trust (EOT) which comes with tax incentives for business owners who decide the EOT is a fit for their goals.
As of January 1, 2024, an EOT can be used. Here is a breakdown of the Pros and Cons as we know it today (updated Jan 19, 2024).

Pros:

• transition ownership to employees 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
• there can be a time worked requirement before employees become eligible (up to 12 months)
• employees benefit through the trust and receive profit distributions and/or equity payouts for their proportional account in the trust when they leave the company (which may have tax advantages subject to certain criteria being met)
• offer a form of compensation on top of more traditional compensation and bonus plans
• governance continues in a fairly typical fashion just with the addition of a ‘Board of Trustees’ where the employees must represent at least 33% of the votes
• extend the timeframe of the capital gains reserve for the business owner

Cons:

• owner must immediately sell a controlling stake in the company to the trust and cannot make up more than 40% of the votes on the ‘Board of Trustees’ or the Board of Directors (each representative on the ‘Board of Trustees’ has 1 vote)
• delayed financial return for the owner as the proceeds come from company profits over the years (some deals may be able to finance all or a portion of the sale through a financial institution)
• employees don’t actually own shares, they are beneficiaries and receive benefits, but it is the trust that is the shareholder
• 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
• 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

Comparatively, other employee share ownership models that have been used by many private Canadian companies offer their own share of pros and cons. As a business owner, it is important to carefully consider your goals before choosing which model to use.

ESOP Builders Inc. is the leading provider of design and implementation of employee share ownership plans in Canada and has been working with companies across the country and across industries for more than 26 years. Client we work with range in sizes from as little as 10 employees to more than 1000 employees as there is likely a form of employee share ownership for almost any company. Learn more at our website or complete the free Feasibility Survey to get your ESOP Feasibility Review.

Equity Plan	Stock Option Plan	EVOP™️ (Phantom)
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”

1. Equity Plan

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.

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.

Pros

• Creates the maximum ownership mentality when employees purchase shares. This doesn’t have to be a high financial commitment. Most clients have a minimum purchase requirement of $1,000 to $2,000 per year if the employee chooses to participate (this could be as low as $20 per pay cheque).
• Employees understand how the company’s value increases and have more visibility on the relationship between their individual day-to-day responsibilities and the bottom line.
• It is fairly straightforward administratively
• Can be broad-based for all employees and new ones or key-person
• Provides cash liquidity to founders/owners or keeps cash in the company for operational use
• Employees may be able to use the lifetime capital gains exemption (LCGE) which is about $1.2 million in 2024 and is an excellent long-term wealth creator

Cons

• Need for annual valuation (a formula can be used for up to 3 years, then the valuator should review and complete a new valuation)
• Continuing communication and disclosure is needed to support the ownership culture created
• In a purchase plan, perhaps not all employees are financially able to participate to the same extent as other.
• A certain level of financial disclosure is needed and not every owner is comfortable with that. The level of disclosure can be minimized in certain circumstances.
• Unmanaged expectations from employees can impact the success of the plan

2. Stock Option Plan

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. It can also be used in conjunction with an equity plan as an additional motivator, as a bonus for example.

Pros

• No risk to the employees, they don’t own the shares until the future. If the value has increased, they would buy the shares at the pre-set lower price, and if the value hasn’t increased, they don’t have to purchase the shares.
• Focuses employees’ motivation on the growth of company value
• Is fairly straightforward administratively
• Can be used to attract and retain employees
• No financial disclosure is required to option holders
• No loss of control until the shares are purchased which might not be for up to 10 years
• Under certain conditions, an excellent way to incentivise when offering shares as a bonus as the tax may be deferred to the sale of shares by the employee and access to LCGE

Cons

• Need annual valuation of options as Generally Accepted Accounting principles (GAAP) require annual expensing of share options
• Less able to achieve an ownership mentality because employees have not made a financial investment, no skin in the game.
• Employees cannot access the LCGE until they trigger their options and have owned shares for 2 years
• Provides no cash to the Owners

3. Phantom Plan

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).

Pros 

• No financial disclosure
• No loss of control of the company
• Can be broad based to all employees
• Can be converted to actual share equity in the future
• Can be used to repay owner’s shareholder loan to the company, potential tax-free

Cons

• When units are “redeemed”, employee must take value as income and pay the appropriate taxes
• Employee cannot access the capital gains exemption, nor any capital gains treatment
• Need for annual valuation (a formula can be used for up to 3 years, then the valuator should review and complete a new valuation)
• An owner cannot use proceeds as a capital gain 
• Doesn’t actively create an ownership mentality

*Any information relating to tax or legal matters is not tax or legal advice and is not to be relied on. ESOP Builders is the leading provider of ESOP design and implementation in Canada. Complete a Feasibility Survey through our website to see what kind of employee share ownership plan can work for you and your company.