A lawyer and business founder break down the requirements for this innovative exit strategy
Grantbook, a consultancy serving the philanthropic sector, recently made history as the first Canadian company to be majority-owned by a domestic employee ownership trust (EOT).
The EOT ownership model, established in Canada in June as an alternative to traditional company sales and buyouts, means that employees share a majority stake in the business through the new trust.
Wesley Novotny, a partner at Bennett Jones who worked on the deal, and Peter Deitz, co-founder of Grantbook, spoke to Canadian Lawyer about the process and what may be in store for EOTs in Canada.
While EOTs offer an alternative exit strategy, not every business is a fit. Deitz and Novotny agree that sellers must consider key financial and structural factors before transitioning.
For the sale to an EOT to make sense, the company must be the right size and have solid cash flow and values aligned with this exit strategy, Novotny says.
Cash flow is essential because the company must make enough money to pay the vendor back and pay the employees' salaries. Once the seller is fully paid, employees stand to gain as they can then share in the company’s full profits.
“You must have an empowered management and an employee group that can take over” ownership of the business, he says.
On the technical side, the business owner who decides to exit by selling the firm to an EOT must hire various professionals to ensure a successful and smooth transition.
Novotny says that the group would usually involve lawyers specializing in tax and corporate law, a business consultant to help with governance and a banker, especially if the deal is bigger. A lawyer specializing in intellectual property law is also required in specific cases.
Deitz says Grantbook sought help with legal matters, governance, and accounting.
“It is a novel transaction format... You need someone to structure that transaction,” Deitz says.
Novotny says that the Grantbook deal didn’t bring any unexpected challenges for the legal team and attributes the smooth finalization to participation in the legislative process regarding EOTs.
He describes the main challenges in the transition as typical transactional hurdles rather than major roadblocks. While all stakeholders were aligned in their vision, he says the process required adjustments along the way.
“This is not unusual,” Novotny says, adding that modifications in this kind of deal often include minor tweaks of the company’s structure to match EOT legal and financial requirements. Sometimes, there can be personnel changes, such as the need to appoint a new trustee when the original choice moved on to another job opportunity, he says.
Despite these adjustments, the process went without significant setbacks. “All of it was typical deal stuff we could handle and get around. It went fairly smoothly,” Novotny says.
While Grantbook’s EOT is Canada’s first, Wesley says he expects more of these deals in the future. The main reason is the newly introduced capital gains tax incentive based on the UK model.
The practice was introduced in the UK in 2014, and while it started somewhat slowly, the pace picked up quickly once the incentive was introduced.
Given that Canadian regulators decided to offer a capital gains tax deduction worth $10 million to vendors who sell ownership to an EOT, Novotny expects the adoption in Canada to be quicker. However, he says that the deduction regulation only stands through 2026, and succession takes years to plan.
“There's a big momentum to get that incentive pushed out to be indefinite past 2027, and I think we need that to happen for this to become a snowball,” Novotny says.
He expects EOTs to prove to be a valuable option for small and medium-sized business owners. While Deitz agrees, he also stresses that potential vendors shouldn’t consider EOTs only to create a legacy or make a social impact.
“I see myself as a social entrepreneur first and an entrepreneur second. But I don't think this model is limited to … businesses that have a specific social impact, vision or purpose… It could just as well be a construction company, a manufacturer, or any kind of professional services provider,” Deitz says.
Novotny acknowledges that regulators must make minor changes but states that interest in this exit strategy exists within the business community.
“It will definitely multiply in popularity. It might take a couple of years, and we need the tax incentive to be made indefinite, but once that happens, in three to five years, you are going to see a lot of these,” Novotny says.
