What Is an ESOP Plan? A Guide to Expanded Approaches to Employee Stock Ownership in Canada

From founders to employees — how ESOPs create stability, wealth, and business continuity

If you are a business owner looking to secure your company’s future and transition ownership in a way that benefits both you and your employees, Employee Stock Ownership Plans (ESOPs) might be the perfect solution.

Traditionally, stock options are an equity award used as incentives to attract and retain employees – a tool for rewarding loyalty and performance. But today, ESOPS in Canada are becoming a powerful mechanism for business succession, allowing founders to gradually transfer ownership while keeping leadership intact.

For many private companies, the idea of an IPO or external sale can feel overwhelming. It is a big leap, with no guarantees of success, and it often means having to relinquish a significant degree of control to outside investors. An ESOP offers an alternative – a structured way to gradually transition ownership to employees who have helped build the business, guaranteeing continuity, stability, and a long-term vision that aligns with your company’s values.

In this post, we break down what an ESOP plan is, how it works, and why more Canadian businesses see employee stock ownership as a strategic growth tool. Whether you are a founder considering exit strategies or an employee wondering about ESOPs, this commentary highlights practical next steps. Before taking those next steps, ESOP adopters and participants should seek input from qualified tax advisors, to address their unique tax situations at the outset.

Context and Market Dynamics

In recent years, ESOPs have evolved from simple employee incentive programs into a powerful tool for business succession and ownership transfer. As founders balance a desire to exit strategically with a desire for business continuity, ESOPs provide a structured yet flexible approach that can address both objectives.

The broader market is experiencing shifts that have been making ESOPs more attractive, and relevant. The Canadian IPO market has been highly unpredictable, with fluctuations that make it difficult for private companies to time their public offering effectively. An IPO can be expensive and uncertain – often requiring a high level of confidence that market conditions will be hospitable. For many founders, the risk and cost of going public usually outweigh the benefits.

This is where ESOPs can come into play. Rather than relying on external investors or private equity firms, ESOPs allow business owners to transition ownership to employees over time, building long-term stability and retaining the company’s culture and vision. As a result, more companies are choosing ESOPs over IPOs as a preferred method of succession planning.

Basic Features of ESOPs

For private companies looking to implement an Employee Stock Ownership Plan (ESOP), structuring the plan correctly is the most important step. Unlike public companies, which have predefined stock exchange rules, privately held businesses have greater flexibility in designing their ESOP structure – but with that flexibility comes the need to address certain considerations.

At its core, an ESOP allows employees to gradually acquire company shares, either by purchasing them outright or through stock options vesting over time. The win-win of this scenario is that employees get a stake in the company’s future success, while founders can transition ownership without suddenly losing control.

Here are the important elements of an ESOP to consider, in order to design an ESOP with a greater likelihood to be positively received:

Set Purchase Price – The ESOP should have a clear share price that is fair and reasonable, whether shares are purchased from the company out of treasury or directly from founders.
Defined Share Allocation – The plan should specify how many shares can be acquired, and who is eligible.
Vesting Periods – To encourage long-term commitment, ESOPs typically provide for the acquiring of shares over time, rather than receiving all shares immediately in a single transaction. That is accomplished by having options with vesting schedules, or purchase agreements that contemplate staggered purchases taking place at certain specified dates.
Trade Restrictions & Liquidity – Unlike public stocks, private company shares are not easily tradable. Employees should understand the illiquidity of their shares and the conditions for, and restrictions on, selling them in the future.
Exit & Termination Rules – ESOPs must outline what happens if an employee leaves the company – including if they must sell back their shares or retain ownership. These provisions are often detailed either in unanimous shareholder agreement, or the documents under which the shares were acquired.
Governance & Decision-Making – Employees participating in an ESOP should expect that the ESOP documentation will reflect that founders will retain majority control while employees gain financial benefits without influencing major strategic decisions.

Common Shareholder Agreement Considerations

So, what happens once an employee holds shares? What does that really mean for that employee’s relationship to the company? This is where a well-crafted shareholder agreement is particularly useful.

The shareholder agreement defines the rules of engagement – who gets a say in major decisions, how shares would be handled in various scenarios, and what protections exist for both majority and minority shareholders.

Here are what a strong shareholder agreement concept for an ESOP:

Voting Rights & Decision-Making – The agreement should specify which, if any, decisions require the approval of shareholders holding a small percentage of outstanding shares.
Buyback & Exit Clauses – Employees should know what happens to their shares if they leave the company – it is common that employees who leave the company would be required to sell them back to the company.
Fair Valuation Methods – A transparent valuation process provides comfort that employees would receive fair market value if they choose (or are required) to sell their shares. There are various approaches to valuation, some of which include the use of a third-party valuation.
Drag-Along & Tag-Along Rights – These clauses protect both majority and minority shareholders in the event of a sale:
Drag-Along Rights: If major shareholders (often a group of founders) decide to sell the company, employee shareholders may be required to sell their shares at the same terms, in order to ensure the larger transaction is not held up by those holding small percentages of shares.
Tag-Along Rights: Conversely, where the major shareholders wish to sell the company, the minority shareholders (employees) may have the option to sell their shares at the same price, in order to ensure that the holders of smaller percentages of shares are not left behind to be faced with a new controlling shareholder.
Conflict Resolution Mechanisms – A clear process for resolving disputes – whether between founders and employee shareholders, or among employees themselves – helps maintain a harmonious ownership structure.

A Novel Strategy – Purchasing Founders’ Shares

Those who are looking to gradually transition out of their business without the complexities of an IPO or external sale, selling shares directly to employees through an Employee Stock Ownership Plan (ESOP) offers a compelling alternative. Unlike traditional ESOPs that primarily focus on granting stock options or incentives, this approach enables true ownership transfer while maintaining operational continuity.

By selling shares in stages, founders can retain control during the transition while giving employees the opportunity to buy into the company over time. This method reinforces a stable leadership handoff, avoids the disruptions of a sudden sale, and aligns employee interests with the long-term success of the business.

This strategy is particularly relevant in today’s business climate, where wealth transfer between generations is becoming a growing concern. Many companies face succession challenges as founders near retirement and need an exit strategy that preserves the company’s culture and mission. Selling shares to employees, rather than to an external buyer, creates a sense of continuity and keeps ownership within the company.

Importantly, this does not mean that a founder’s influence disappears immediately. Many ESOP structures allow founders to retain decision-making power for a set period, which ensures the transition is orderly and that the company continues to operate smoothly. This setup provides a balanced approach, founders gain liquidity for their years of hard work while employees take on ownership in a structured, sustainable way.

Ultimately, this method benefits all parties: the company maintains steady leadership, the founder exits at a controlled pace, and employees gain ownership in a manner that creates long-term commitment. It’s a model that rewards loyalty and secures the future of the business in a way that traditional exit strategies often fail to do.

Proviso on Illiquid Securities

One important caveat when implementing an Employee Stock Ownership Plan (ESOP) in a private company is illiquidity. Unlike publicly traded stocks, shares in a privately held business cannot be easily bought or sold on the open market. Employees who acquire stock through an ESOP should understand that their investment is long-term and that selling shares may be subject to company restrictions or require a buyback agreement.

Before launching an ESOP, businesses should make sure that employees are fully aware of these limitations and that a clear exit strategy exists for those who may wish to sell their shares in the future. Consulting securities laws and structuring the ESOP with a well-defined liquidity framework will help avoid confusion and guarantee fairness to all participants.

We will happily share more details to help you determine what is needed and how to do this efficiently and economically. Often, businesses can handle most (if not all) of the necessary steps themselves with the right guidance, but we again highlight the need for input from qualified tax advisors at the outset. If you would like to explore if an ESOP is the right fit for your company, be in touch with Walter Wagnleithner at walter@kissacklaw.com or Joel Kissack at joel@kissacklaw.com. We’re here to help.