Employee Share Ownership Plan (ESOP) in Canada

An employee share ownership plan (ESOP) is a way through which companies can offer employees a stake in the business. ESOPs are commonly used across Canada in a wide variety of industries and ranging small and medium-sized privately owned businesses to large publicly traded firms.

Here, we’ll discuss:

• What is an ESOP?
• Types of ESOP vehicles available in Canada
• Benefits of an ESOP
• Tax treatments of ESOPs
• ESOP teams and the design phase
• Employee communication

What is an Employee Share Ownership Plan (ESOP)?

An ESOP is a type of company-run equity plan that can include stock, stock options, restricted stock, phantom stock, or any combination of these . The plan can be offered to either some or all employees, depending on your business needs, and can be done through purchasing with cash, fulfilling length of employment, etc.

ESOPs can often present a long-term win-win solution. For an employer, it’s any effective way to align the interests of employees with those of a business over time, while the employee is in a position to potentially receive additional financial rewards if the company continues to grow.

Types of ESOP vehicles

• Stock: Considered the most widely used ESOP type, employees purchase (or acquire) stock through the legal transfer of ownership of a share of stock issued by the company. These may or may not have voting rights.
• Stock Options: With stock options, employees have the right (but not obligation) to purchase the shares in the company at a pre-agreed price, at a future date. If the company increases in value at that future date, the employee will be able to exercise the option shares to purchase company stock at a discount.
• Restricted Stock Units (RSUs): RSUs are typically granted for free, meaning employees don’t have to purchase the award. They earn the full value of the shares after certain conditions such as length of employment are met.
• Phantom Stock or Share Appreciation Rights (SARs): They aren’t really stock but they do mirror real stock to reward employees with compensation that is tied to the company’s stock performance.

Benefits of an ESOP

• Improved recruitment and retention: Since the potential financial benefit of ESOP can be appealing, it’s commonly used to attract and retain talent. This is particularly useful for smaller businesses when looking for a unique edge when competing against large firms.
• Improved productivity and motivation: Employees are more likely to think and act like owners because they hold a stake in the company, and thus act more like a shareholder with both company and employee agendas aligned.
• Flexible plan design: Each plan can be designed and operated according to your company’s need. Your plan can comprise only one equity type or a combination of two or more. If the equity is subject to vesting, i.e. the process of gaining ownership of an equity award through meeting certain conditions, you can establish what the conditions are to custom-fit your needs.
• Favourable tax treatment: See the section below to learn more about the potential tax benefits.

Tax treatments of ESOPs

Different ESOP types have different tax implications. The ownership type of an individual’s company will also determines one’s tax events.

Looking at the most commonly used ESOP type – Stock Equity, an employee of a Canadian Controlled Private Corporation (CCPC) who is offered a stake in the company is likely to enjoy generous tax benefits. Upon receipt of the shares, they would not be subject to tax. When they sell their shares, they can also access capital gains tax treatment.

They would potentially also be able to access the Lifetime Capital Gains Exemption or LCGE, which is $1,016,836 in 2024, meaning there is the potential to reap major tax savings on gains, if qualifications are met.

ESOP Design

As discussed, one of the benefits of ESOPs is flexibility in design so you are allowed to personalise the plan based on your business’ goals, needs of employees, etc. In the design phase, the optimum is often to have a wide range of input from the various ownership groups (e.g. HR, comps & benefits team, etc), external advisers (e.g. a lawyer, accountant, tax professional, business valuator etc.) and the employees themselves. The greater the input at the beginning, the more relevant and robust the plan is likely to be and should therefore potentially yield better results.

Here are some plan design components you should consider:

• Source of equity: This may come from the company itself or an existing ownership group, depending on your plan purposes. For example, is liquidating owners’ equity something you want to achieve through an ESOP? If so, it would sound logical that the shares come from an owner. In this way, he or she would have liquidity when receiving cash from the purchasing employee.
• Types of ESOP vehicles: There are many different types of ESOP available ranging from a single type of participation through to a combination approach. For example, a combination of stock purchase and stock options is quite commonly used.
• Number of shares to be issued: Your allocation formula will usually be based on an employee’s base salary, seniority, or achievement of targets.
• Employee eligibility: Depending on your business goals ESOPs can be offered to certain employees only or to all employees. Generally, there’s a requirement for a continuous period of employment before an employee becomes eligible for ownership
• Vesting: Vesting is the process of gaining ownership of an equity award through meeting certain conditions, e.g. length of employment or specific milestones. So, you can customise your vesting based on your business goal – performance or retention or both.
• Buyout provisions: You’ll need to specify these terms in the agreement in the case of termination of employment, retirement or death, e.g. will you buy out their shares at a full FMV or at a discount?
• Share acquisition and Financing: Employee equity can be purchased at fair market value (FMV), at a discount, or offered free of charge. There are many possible ways to finance this, including purchasing the shares outright, through payroll deductions, or with the funds loaned by the company.

Employee Communication

A successful ESOP requires open, clear communication to help increase employee understanding, awareness and engagement. It should at the very least include the objectives of the plan, how the plan works, tax implications and the benefits they are likely to receive.

It could be difficult to develop an effective employee communication program if you don’t have resources and skills in-house. Why not outsource to an ESOP service provider with experience in developing bespoke employee communications programs? They can help you segment your employees, create a communications package, demystify the equity process and translate materials into multiple languages as required.

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J.P. Morgan Workplace Solutions has the experience and knowledge to be your ESOP service provider. We can offer you an automated equity management platform that gives complete administrative services from plan setup and launch to task tracking, reporting and employee communication. Along with a robust team of equity professionals, we manage the heavy lifting work for you so you can focus on your core business.

Contact us if you want to learn more about ESOP and how we could help you operate an effective employee ownership plan.

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