An Employee Ownership Trust (EOT) transaction is a succession planning process that allows owners to sell their company to their employees collectively, without the employees needing to put up cash for the purchase. 

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There are five parties involved in an EOT transaction:

1. The Seller is the current owner of the business. They have sole authority to choose who will buy the company.
2. The Buyer/ The Trust allows employees to own the shares as a group in a tax-effective way, without requiring individual employees to purchase and manage them. 
3. The Corporation is the business being sold, and also where the money comes from for the sale. Future revenues of the company will be used to pay for the purchase price.
4. The Employees continue to work in the business and are the beneficiaries of the corporation's profit and value.
5. The Financier is most often a bank, and is an important partner. Any money that the seller will receive on the day of transaction will be from bank financing.

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On day one of the transaction, the majority of company stock is sold to the EOT on behalf of all employees. The entire value of the company becomes a debt owed to the seller. This debt is paid over time in a couple of ways. One option is 100% seller finance, where the seller is paid out over a period of time no longer than 15 years. Each year, profit is distributed to the seller until the debt is paid off. 

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In the second option, a bank is involved. Much like a home purchase, the bank finances a portion upfront, with the cash going to the seller immediately. The company repays the bank first. Once the bank debt is settled, the seller gets paid for any remaining outstanding amount.

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Not all EOT transactions are for 100% of the shares. Existing shareholders can choose to retain a minority equity position at the time of sale. This allows sellers to participate in the growth of the value of the company while they wait to be fully paid out in the future.

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Not all EOT transactions are for 100% of the shares.

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Though EOT legislation is new in Canada, the structure is tried, tested, and true in the US and UK. In the UK, EOT legislation has been in place for 10 years. In 2023, one out of every 20 private companies sold to their employees via an EOT. That's an exponential growth rate, and we expect the same results in Canada.

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What’s more, there are tax benefits for owners who sell their shares to an EOT. If you sell to an EOT in Canada, you can benefit from a capital gains tax exemption on the first $10 million of the sale value. How much this is worth depends on what the inclusion rate ends up being for capital gains taxes. At a 50% inclusion rate it’s about $2.5M, and at a 2/3 rate, like the new rate recently proposed by the Federal government, it’s about $3.6M. In both cases it will vary a bit depending on what Province you’re in.

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If you sell to an EOT in Canda, you can benefit from a capital gains tax exemption on the first $10 million of the sale value.

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Navigating an EOT requires careful consideration of the structure to be compliant with EOT tax law. These transactions need to be thoughtfully designed with a focus on how employees can benefit. It's essential to work with partners experienced in this space, who can guide you through the entire process. Expert advice is encouraged, from the start of the transaction, through to post-transaction, and into the transition phase.