Is your Private Company Ready for an Employee Share Ownership Plan?

In MNP’s Consulting Services, we are often presented with a client who is faced with issues related to employee recruitment, retention and motivation. For private companies, an employee share ownership plan (or ESOP) provides an avenue that allows employees the opportunity to participate in the successes of the company and can be a great motivational tool. Ill-conceived or poorly executed plans, however, can have the opposite effect as poor communication, a lack of understanding of the arrangement and ambiguously written agreements can all result in disputes and bitter feelings.

In the right circumstances, a company can enjoy a highly-motivated workforce and perhaps even a succession plan for the current owners under an ESOP. For high-growth companies, share-based compensation can also help preserve critical cash by converting a portion of employee compensation to shares.

What is an Employee Share Ownership Plan?

In Canada ESOP can be used to describe any plan that gives some type of participation in the equity interest of the company. This is different than in the U.S. where the ESOP can refer to specifically qualified plans under the U.S. Internal Revenue Code.

Participation can take several forms, including:

• Direct share ownership
• Stock option plan
• Phantom share plan

While any of these options may meet your needs, each plan has its own advantages and disadvantages that should be discussed with a trusted advisor. There are a number of considerations business owners will want to factor into their decision on whether to proceed.

What are the potential benefits

Companies with an ESOP had the following characteristics, according to a study performed by the Toronto Stock Exchange of Canadian companies comparing public companies with an ESOP to companies without an ESOP:

• Five-year profit growth was 123 per cent higher
• Net profit margin was 95 per cent higher
• Productivity measured by revenue per employee was 24 per cent higher
• Return on average total equity was 92.3 per cent higher
• Return on capital was 65.5 per cent higher

Is it right for your business?

While there are observable benefits, prior to embarking on a plan, the company will need to assess whether an ESOP makes sense in their situation. Some of the significant considerations include:

1. Are current owners willing to share information? Minority shareholders have specific statutory rights available to them including limited access to financial information
2. Is the business financially strong? Companies that are in a precarious financial situation or that have minimal prospects for growth may find that may not realize the potential benefits of an ESOP
3. How are current relations between shareholders and employees? The relationship between the current shareholders and the employees should be honestly assessed before setting up the plan. An atmosphere of animosity and mistrust could be compounded by further intertwining the relationship
4. What is the willingness of employees and owners to work together? As business partners, the relationship with employees will change significantly. This can be a great opportunity but both parties should go in with eyes wide open.

Additional Considerations

With the lack of an active market for the shares or options, the company will need to have a mechanism in place to value the shares for incoming and departing shareholders. A shareholders’ agreement is required to define the shareholders' rights, privileges, protections and obligations. With respect to valuing the shares of the company, the shareholders’ agreement would need to address certain items, such as hhow often will the shares be valued - on an annual basis, upon a triggering event?, and will considerations be given for minority discounts?

So, while there are some clear, observable benefits to setting up an ESOP, each situation is unique. Having your experienced, MNP advisor working with you from the assessment phase through to implementation and with on-going maintenance will help you deal with the complexities and risks, and position you to meet your goals.

For more information on how MNP can help, contact Trevor Kawka, CPA, CA, CBV, CFA, at 403.537.7678 or [email protected].