It’s the stuff of feel-good movies: The owners of a beloved family business fail to identify a successor, and a feisty band of employees saves the day by buying the company.
In real life, it’s not very common. But the federal government has introduced a way to make it easier by supporting employee ownership.
In fact, one of Canada’s largest family-owned construction firms moved to employee ownership in recent years. In 2020, EllisDon Corp. announced that the founding Smith family, who previously held 50-per-cent ownership in the Mississauga, Ont.-based company, would gradually transfer all of their shares to employees.
To enable this to happen more often, the federal budget introduced provisions for new tax rules to facilitate the creation of Employee Ownership Trusts in 2023. And the 2023 Fall Economic Statement proposed to exempt $10 million in capital gains from taxation when a business is sold to an Employee Ownership Trust. These rules passed into law in 2024.
An Employee Ownership Trust (EOT) differs from worker co-operatives or direct-share ownership in that the employees normally don’t buy shares directly; the trust holds shares on their behalf. The new EOT rules are in effect for the 2024 tax year and will continue indefinitely; the $10-million capital gains exemption, however, extends only until Dec. 31, 2026.
A Department of Finance official said that employee ownership can make a business more productive and resilient. With more than 75 per cent of small business owners planning an exit in the next decade, they added, “the changes also provided a new business succession option to business owners in cases where they want to preserve the legacy of their business or do not have family members interested in taking over the business.”
One of the arguments in favour of this was social benefit, “so that some of the poorest employees making minimum wage would be able to benefit by ownership of a business,” says Pamela Cross, partner and national business leader, tax, with Borden Ladner Gervais in Ottawa. The initiative also aimed to help keep businesses operating and in the hands of Canadians, she says.
Jennifer Williams is the founder of Ottawa-based Firefly Insights, which provides advice and tailors business plans for owners who are considering the transfer to employees. She’s also a supporter of the EOT model.
“We have more business owners in Canada than we have people ready to buy those businesses,” Williams says. “We have a risk that if those businesses don’t get transitioned in some creative form, they will be acquired either by private equity or by foreign businesses.”
EOTs offer a tax-effective way for business owners to sell at least 51 per cent of their business to their employees. “It’s not for all businesses, but it provides an alternative to allow their business to be owned and controlled by the employees who currently work there,” she says.
Williams notes that the U.S. and UK both incentivize employee ownership, and that the Canadian model is somewhat based on the UK example. “I think as a result the legislation in Canada is quite strong,” she says.
Not everyone is so optimistic, however.
“One of the first things I always ask a business owner is whether there’s somebody in their company who could run the business, and the answer’s always no,” says Eric Gilboord, CEO of WarrenBDC Inc. Based in the Greater Toronto Area, his company helps owners sell their businesses.
If you’re selling a business worth over $100 million, the $10-million capital gains exemption is not that significant, but in Canada we have a lot of businesses worth $5 million to $40 million.
Jennifer Williams, Firefly Insights
“In theory it’s a good idea,” Gilboord says. But he sees a corollary between looking to a family member and looking to employees to take over the running of the company. “The family members in many cases are not qualified. So you run into the same situation: Are the employees qualified?”
Ultimately, though, he sees money as the greatest obstacle. “Can I afford to have my employees take over my $5-million widget-making business and pay me out over 20 years? No.”
Pamela Cross expresses similar reservations.
“Why would a business owner consider it?” she asks. “When the government first announced it, there was very little interest in the business community. The government then announced that it would introduce a $10-million capital gains exemption—and it’s temporary. That is something that makes this more attractive from an outgoing business owner’s perspective.”
The real challenge, however, is meeting all the technical requirements and monitoring them afterward, Cross adds. The concern is that, should the trust be disqualified within 24 months because it does not meet the required conditions, the selling company would be liable for repayment of the exempted capital gains. (After that period, the trust would be responsible.)
“It is not clear if these incentives will be sufficient to counter the fact, unless third-party financing is available, that the selling business owners will likely receive the proceeds over a period of many years,” she says.
But Williams notes that other types of purchases can also take a long time. And, she says, there’s also “a level of ease”—selling to employees tends to be more comfortable than handing the business to strangers.
In order for an EOT to function well, she adds, “the business needs to have sufficient consistent cash flow to be able to pay out the loan and the owners over time. Of course, if you’re selling a business worth over $100 million, the $10-million capital gains exemption is not that significant, but in Canada we have a lot of businesses worth $5 million to $40 million.”
Since the legislation came into effect only in mid-2024, it remains to be seen how many companies may take advantage of it, but Williams thinks it may catch on.
“Regardless of who the next government is, the expectation is that employee ownership will stay,” she says. “I think in the first year in the UK there were eight or nine cases, and then there was huge growth. Canada will probably be similar.”
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