Employee Ownership Trusts: A New Era for Canadian Business Succession Planning

Imagine transforming your loyal employees from spectators into co-owners, empowering them to steer the very business they’ve helped build—without requiring them to buy shares. Employee Ownership Trusts (EOTs) are revolutionizing the way Canadian business owners approach succession planning. Introduced in 2023, EOTs offer a seamless and tax-efficient solution for transferring business ownership to employees, ensuring continuity and fostering a profound sense of shared responsibility and commitment within the workforce.

EOTs are not just a succession strategy—they are a game-changer for Canadian businesses, positioning employees as stakeholders in the future success of the company. This innovative approach bridges the gap between ownership and operational expertise, cultivating a thriving environment where everyone benefits. Business owners across Canada now have the unique opportunity to secure their legacy while empowering their employees to take the reins.

What is an Employee Ownership Trust?

An employee ownership trust provides an alternative for business owners to transfer their business to their employees in a tax-efficient manner.

A portion (or all) of the corporation is sold at fair market value to the Employee owned trust. The corporation takes on debt to buy out the owner’s shares. The trust will then hold the shares and become the owner on behalf of the employees. The EOT must be made available to all employees.

Unlike traditional ownership models, employees do not directly own shares; instead, they become beneficiaries of an irrevocable trust that holds the shares on their behalf.

While the EOT owns the shares of the company, it doesn’t operate the company day-to-day – that falls to the business leaders and management team, who will report to a board of directors.

This structure means that employees do not need to provide any capital to facilitate the ownership transition, allowing them to share in the profits of the company without a financial burden of buying the shares.

Benefits for Business Owners

For business owners considering succession planning, EOTs present several advantages:

Tax Incentives

One of the most significant benefits is that the first $10 million of a seller’s capital gain is exempt from tax (applicable to transactions between 2024 and 2026) and allow the remaining capital gain over and above this amount to be spread over 10 years. By reporting only a portion of the gain annually, it eases the tax liabilities on the seller when sale proceeds are received over several years.

Importantly, the EOT tax incentive does not affect the ability to use the Lifetime Capital Gains Exemption (LCGE) – the EOT incentive can be used in addition to the LCGE.

$10 million of a seller’s capital gain is tax exempt

Business Continuity & Privacy

By transferring ownership to employees, business owners can ensure the continuity of their business operations. Employees in EOT-owned companies often experience a stronger sense of job security, knowing that the company’s success is directly tied to their efforts. This sense of security can lead to higher job satisfaction, reduced turnover, and a more committed and engaged workforce.

EOTs can help maintain the privacy of business affairs, as the ownership transfer process does not require public disclosure. This ensures that sensitive business information remains confidential, protecting the interests of both the business owner and the employees.

Benefits to the Employees

Employee Ownership Trusts (EOTs) offer numerous non-financial and financial advantages to employees, particularly in the areas of profit sharing and retirement benefits.

One of the key benefits of an EOT is the opportunity for employees to participate in profit sharing. As ‘co-owners’ of the business, employees are entitled to a portion of the company’s profits, which can be distributed as bonuses or other forms of compensation. This profit-sharing arrangement fosters a sense of ownership and alignment between employees and the company’s goals, leading to increased job satisfaction.

Requirements and Considerations

To qualify as an EOT, several conditions must be met, such as:

• The trust must be an irrevocable trust resident in Canada.
• 50% of the fair market value of the shares was derived from assets which were used principally in an active business

• Throughout any 24-month period ending before the disposition of the shares, the seller was actively engaged on a regular and continuous basis in the business.

• The trust must hold a controlling interest in the shares of one or more qualifying businesses, with these shares accounting for at least 90% of the fair market value of the trust’s property.
• At least 75% of the employees who are beneficiaries of the EOT are resident in Canada. 

Additionally, the qualifying business must be a Canadian-controlled private corporation (CCPC) that meets specific criteria regarding ownership and control.

Is an EOT right for your exit strategy?

While this structure will not work for management buy-outs or a buy-out by only a few key employees, it can be a viable option for business owners who wish to reward their employees by giving them a tangible stake in the business. 

Business owners who sell to EOTs are generally passionate about their companies, communities, and employees’ development. They are often against selling to the most common buyers, like competitors in their industry or private equity companies. They want to preserve the company culture they’ve worked years to build and the jobs in their local communities. 

The best candidates for EOTs are companies with strong and consistent cash flows in mature industries with a thoughtful management transition either in place or in progress. This lowers the risk of the transaction and helps ensure that there’s sufficient cash to pay the purchase price of the company, leaving a lot of the future benefits left over for a company’s employees.

EOTs could be an appealing option for sellers who want to leave a legacy and do not need an immediate payout.

Talk to an advisor – There are several intricate details not covered here, and a well-executed transition will necessitate meticulous planning.

Additional Resources: Check out the Government of Canada’s website for more details.