With employee trusts, Canada opens a pathway to worker ownership

ImpactAlpha Editor

Roodgally Senatus

ImpactAlpha, December 14 — Expect to see a surge in Canadian companies converting to employee ownership in 2024.

Legislation set to go into effect in the new year creates a framework for “employee ownership trusts” and provides incentives for Canadian companies to transfer ownership to workers, rather than, say, selling out to private equity firms. A capital-gains tax break on the first $10 million of a sale could save departing business owners more than $2 million in taxes.

“We’ve finally got all of the pieces in place that we need for there to be a burgeoning employee-ownership sector here in Canada,” says Jon Shell of Social Capital Partners, a Toronto-based nonprofit that has championed worker ownership strategies. Shell and his colleague Bill Young, with their own money, launched The Ownership Fund to build a demonstration portfolio of worker and homeownership funds and businesses.

Canada is joining the ranks of countries using worker ownership as a strategy to foster economic growth, preserve jobs and mitigate rising income inequality. The UK has seen a surge in employee-ownership conversions since the government introduced employee ownership trusts in 2014. 

In the US, employee stock ownership plans, or ESOPs, provide significant tax advantages to companies in which employees hold a stake as small as 30%. The Employee Equity Investment Act, introduced by Democratic Sen. Chris Van Hollen and Republican Sen. Marco Rubio, would enable the creation of Employee Equity Investment Companies to finance ESOP conversions.

The EEICs would have access to low-interest debt capital from the Small Business Administration, much like Small Business Investment Companies, or SBICs, have today. 

Silver tsunami

Worker-ownership transitions have had little policy support in Canada. The country has a few dozen “worker-owned companies” via stock options and shared-purchase plans that offer employees an opportunity to buy shares in a company.

Three out of every four small and mid-sized businesses will see a change in ownership over the next decade in Canada. Like the US, the country is facing a “silver tsunami” of retiring business owners without a succession plan. That represents an opportunity to transfer trillions of dollars in wealth to workers via employee-ownership transitions. 

“Right now, If you’re a business owner looking to sell your business, you’re gonna sell it to a private equity investor or competitor, which will exacerbate all of the problems we already have in Canada around too much wealth concentration,” Shell told ImpactAlpha.

In the absence of such policy support, Social Capital Partners has focused its efforts on encouraging Canadian pension companies to invest in ESOP conversions in the US in order to take advantage of the tax benefits.

Shell is a member of the Canadian Employee Ownership Coalition, made up of a few dozens of business, nonprofit and academic leaders committed to driving employee ownership in Canada. The new employee-ownership trust structure draws elements from both the US and UK models. 

The Canadian legislation extends to employees the benefits of business ownership, including governance rights. Employees will hold their stakes in individual accounts, much like ESOPs in the US. In the UK, the employee ownership trusts hold workers’ stakes collectively, and oversee company operations to benefit employees.

“This is another big experiment and we’ll have the benefit of seeing how it goes in Canada,” said Mark Clayton Hand, an employee-ownership and public policy researcher and assistant professor at the University of Texas at Arlington. “If it’s at all like what’s going on in the UK, then we should see thousands of these companies established in the next few years.”

Asset-building strategies

Equity ownership in businesses, along with homeownership, is considered a key strategy for bridging racial wealth gaps. Employee-owners have 92% more wealth than non-owners, with greater financial flexibility to buy homes, send their children to good schools and save for retirement.

Canada, one of the most ethnically- and racially-diverse countries in the world, is home to a large population of immigrants mainly from Asia, Latin America and the Caribbean. Such minority groups are less likely to own financial assets and businesses and homes compared to white Canadians, says the Royal Bank of Canada. 

Employee ownership “really is the solution,” says Tiara Letourneau of Rewrite Capital Advisors, a Canadian women-owned advisory firm and a member of the Canadian Employee Ownership Coalition. 

Canada’s employee trust legislation is expected to go into effect on January 1, 2024. The capital gains tax exemption rule would go into effect later in the year and run as a pilot for the years 2024, 2025 and 2026. 

“Now every time you tell your accountant or the professionals that serve you, ‘I’m thinking about selling my business,’ they’re gonna say, ‘Have you heard of an employee ownership trusts?’” Letourneau says.

Nine out of 10 UK companies that have transitioned ownership to employees via an employee ownership trust say they would recommend them to others, says UK think tank Ownership at Work. 

“The EOT is quite a good structure that suits companies of all sizes, even very small companies with under 10 employees, so it’s very malleable to the type of companies that you’re working with” Christian Wilson, an employee-trust lawyer and advisor in the UK, told ImpactAlpha

“With Canada, I think they’ll look to the UK and that may well give the advisors in Canada a sense that this is not a crazy idea and that it’s working well in the UK.”