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