What if the best buyer for your business is already working for you? In this episode of Beyond Succession, host Leah Tolton is joined by Bennett Jones partner Wes Novotny, one of the first lawyers in Canada to advise on the adoption of an employee ownership trust (EOT). Together, they unpack how EOTs are changing how Canadian business owners think about succession.
Leah and Wes discuss how EOTs allow owners to
- use business profits to fund the sale of the company
- access a C$10 million capital gains deduction
- preserve company culture by transitioning ownership to employees
All while creating long-term benefits for employees and the business itself.
If you’re advising a legacy-minded owner—or are one yourself—this episode offers practical insight into why EOTs are a compelling option for succession.
Transcript
Wesley Novotny: [00:00:00] Now for the vendors, if everything is structured properly, the vendor can get a couple good things coming out of this. The big tax incentive is, is if it's structured properly to get the $10 million capital gains deduction on the sale, which is, is quite an incentive. The typical lifetime capital gains exemption is also still available and can be stacked with it.
But that's usually more in the realm of about $1.25 million currently for each individual, whereas the $10 million for a sale to the employee ownership trust is a considerably bigger number.
Leah Tolton: [00:00:37] Welcome to Beyond Succession, a podcast series within the Bennett Jones Business Law Talks podcast that discusses topics around navigating the complexities of the family enterprise. I'm Leah Tolton, partner at Bennett Jones, LLP, and I'm a family enterprise and corporate lawyer. Passionate about helping family enterprise businesses navigate the complexities of governance, succession and growth.
Before we begin this podcast, please note that anything said or discussed on this podcast does not constitute legal advice. Always seek proper advice from your legal advisor as every situation is different and outcomes can vary. In this episode, we're exploring a new succession strategy that is reshaping the future of Canadian private business ownership, employee ownership trusts or EOTs as they're called.
Introduced into Canadian tax law in 2024, EOTs are a unique mechanism for business owners seeking a legacy driven exit that rewards their employees and preserves their company culture. This structure allows for a business to be sold to a trust that benefits all employees, such as enabling ownership without direct capital investment, while offering significant tax incentives to vendors, including a potential $10 million capital gains deduction To discuss this innovative model, I'm joined by my colleague, Wes Novotny, a partner at Bennett Jones, and a key legal architect in Canada's EOT movement.
Wes advised on Canada's first domestic EOT transaction, led advocacy efforts alongside the Canadian Employee Ownership Coalition, and in my opinion, is now one of the country's go-to advisors for business owners considering this route. Wes, welcome to the podcast.
Wesley Novotny: [00:02:34] Well, thanks and nice to be here, Leah.
Always, always fun to talk about EOTs as something new in the Canadian commercial and tax landscape and a real positive development.
Leah Tolton: [00:02:44] Great. Well, let's get started then. Let's start with the basics. Can you share with our listeners what exactly is an employee ownership trust and why is it so significant that Canada now has this structure available?
Wesley RNovotny: [00:02:57] Yep. What an EOT is, is it is just a regular Canadian trust. But it has some unique characteristics to it that lead it to have certain tax outcomes, which are very positive, both for potentially for the vendors and also for employees. It's a new succession vehicle is really what it is.
So, if you have a current business and taking, you know, very, very simple model and a kind of simple example, you got a vendor, let's say they're an individual, they own an operating company that has a business. Who do you sell this thing to? Traditionally, it might be your competitors. It might be private equity. It might be somebody doing similar things to you who wants to grow their business. It could potentially even be family if they want to take it over. Well, the EOT offers kind of a new option to do that. You settle a trust. The trust has some unique characteristics. The beneficiaries of the trust are the employees of the business.
And so they are effectively indirectly becoming owners of the business to benefit from whether it's the profits of the business, ultimately in terms of effectively profit sharing, or ultimately if the company is sold, they can participate in the growth and value of the company. So that's the unique piece for the employees.
They are the beneficiaries of this trust and indirectly the beneficiaries of the business.
Leah Tolton: [00:04:09] Mm-hmm.
Wesley Novotny: [00:04:10] And, in addition for the employees, if this is all structured right, the EOT allows the purchase of the business from the vendor to occur with the profits of the business, which is quite a unique structure.
But effectively, for this trust, the beneficiaries of the employees. Trustees will be a mix of people, but it has to have some employee representation. Cannot have too much representation from the vendor who's selling. The trust purchases, the company generally purchases the shares of the company that's being sold and becomes the shareholder.
And so again, indirectly they become the owner of the business. Now, for the vendors, if everything is structured properly, the vendor can get a couple good things coming out of this. The big tax incentive is if it's structured properly, get the $10 million capital gains deduction on the sale, which is, is quite an incentive.
You know, the typical lifetime capital gains exemption is also still available and can be stacked with it. But that's usually more in the realm of about I think it's $1.25 million currently for each individual. Whereas the $10 million for a sale to the employee ownership trust is a considerably bigger number.
Leah Tolton: [00:05:12] Mm-hmm.
Wesley Novotny: [00:05:13] So real incentive there for the vendors and I'll be honest with you, in our experience in discussing these EOTs with a lot of people, what's also really nice for the vendors is they are allowing their employees to take control of this company. That's a peak key piece of this. But they're passing the business along to those employees who have helped them be successful. Usually if you have, you know, business owners who are invested in their employees, this is a nice vehicle for them to. To get the employees involved and watch that business continue, hopefully, to flourish in their communities.
Often if you sell it to a competitor or private equity, they may come in and right, scoop up what they want and, and leave. But if you sell it to an EOT, while it's owned indirectly by the employees, they're very invested in staying in their community and watching the business succeed. And so, for vendors who are of that mindset, that's a very nice, nice vehicle for them.
Leah Tolton: [00:06:01] So, it sounds like there are potential advantages for both employees and employers.
Wesley Novotny: [00:06:05] That is correct.
Leah Tolton: [00:06:07] So, you've been involved in EOTs from the ground up. Can you walk us through how these EOTs came to be legislated in Canada and your role in that process?
Wesley Novotny: [00:06:16] Yeah it was an interesting process just through various connections in the legal tax community. Got to know an individual who was working at a private equity firm. They were in Toronto. Although, there actually, there's a number of them spread out across the country who are I will say more socially minded, more interested in, you know, employee ownership. Uh, more interested in doing transactions and supporting businesses that have good social purposes. Whether it can be people who are, you know, have disabilities or disadvantaged or groups like that.
Wesley Novotny: [00:06:44] So, these people try to facilitate these transactions. And, and of course everybody is, is intending to make money on these, maybe not as much money as a pure private deal but intending to make money on these things.
And so, you know, coming up with the right structures to allow these groups to succeed. And some of the people out of Toronto in particular, there are these, uh, these, these do exist in the US and more recently in the UK. And so, some of these business advisors and socially minded private equity firms were involved in these transactions.
One of the key ones was in the US and they saw how employees took over a successful private US business. The benefits that was flowing to the employees, whether it's effectively taking more middle class people, but allowing them to participate in the growth and value of the of these companies, which really helps them in their retirement when they, you know, you've worked for 20 or 30 years at a business and you're as part of that business, getting a piece of the growth of that.
And suddenly when you turn to retire, you have some value there that you can cash in. Or also just the ability to participate in the profits of the business. And when the profits, uh, company does well, these, these employees are doing well, which again, are mostly middle-class people, you know?
And allowing them to get access to that in a way that they otherwise could not, is a, you know, a very positive social. Good things for our society, good things for our communities. And they saw that in the us and then they started studying it more, more closely. And then in the UK there's been something similar launched maybe 15 years ago, but as it evolved.
In the last, let's say 10 years it's taken off in the UK and there's been a lot of businesses in the UK that have gone to this structure. So, they looked at this and said, well, you know, these are kind of our two major markets where we certainly look at as our peers. And we say, well, why don't we have something like that in Canada?
And they started looking at this and talking to, you know, and kind of developing a group internally in Canada, people who might be interested in advocating for this. And they started putting this forward. And then of course, you know tax is so implicated in this. At least in the way we've structured our economy in Canada Tax is so key to this that they needed some tax help and so they reached out and said, well, would you be interested in, you know, just helping us with some concepts here, like what, you know, what is a trust? How does that work for tax purposes, and what would we need to, how do we need to modify the trust to make something like this work?
In Canada we kind of were, were, we became involved in the background just commenting on things and chatting with them. And ultimately there were, they did make pitches to broadly based groups. So, they were certainly talking to finance, which is the federal finance department, which is the kind of the bureaucracy that advises the Minister of Finance on various matters and they are a very well thought out group who brings forward fiscal policy in Canada.
And so, they were interested. And then of course there were also, this group was also talking to political parties. We were not talking to the politicians. And actually we didn't talk directly with finance either, although we were looking at some of the proposals they were coming up with, but talk to the political parties and there was, you know, broad based support against all the major parties, whether it was conservative, liberal, NDP, because you know, you're taking smaller, medium sized businesses, potentially family businesses and allowing employees to benefit from this.
So, it's a very easy story to say, wow, this, if this works, this is a really positive thing. Yeah. And so, we were advising on the background and eventually so because of all this interest, you know, and it was outlined in a budget a few years back saying, we're looking at this.
And then in a subsequent budget they said, well, here's some proposed legislation. And we were commenting on the legislation. This is all coming through the Income Tax Act. So we were looking at the Income Tax Act provisions they were saying and say, well, here are some issues. Can you fix this? To which finance was actually quite receptive, and they did change some things to make the rules more beneficial.
And then ultimately, so they had these proposals and the structure was kind of outlined, which is good. But then ultimately they did follow up with a bit of an incentive, the kind of income tax kicker, which is the $10 million capital gains deduction for the vendors. Which I think brought a lot of interest to these EOTs and made it really something that vendors would look closely at.
So, we were certainly involved right from the get-go, and I don't think we're done. I think as these EOT structures get put into place or as roadblocks are, are come across, I think they'll be modified a little bit though we do have the bones of it here and there are overall, there's some issues to work through, but there are overall quite a positive set of rules.
Leah Tolton: [00:10:43] You know that's an interesting story. I often say that the business lawyers are not necessarily the ones who get to create law. Often, it's our friends who go down to the courthouse who get to create law. So, it's interesting to me that someone like you has had the benefit of the business background and the business experience, and you were able to have input into a structure that really is novel and innovative here in Canada, has the potential to create some real impact.
Wesley Novotny: [00:11:08] Yeah, I agree Leah, and certainly we've had a team of people here working at Bennett Jones with me. There's three or four of us, and I mean, that's certainly the comment we've had internally and certainly from some of our junior members is to say, well, geez, we always thought sending, you know, submissions to finance was like a mission impossible. But we, you know, we actually, you know, when we made thoughtful comments, they did react. So it was, it was actually quite, from our perspective, quite gratifying to see that.
Leah Tolton: [00:11:31] Great. Well, as you know on this podcast, you know, entitled Beyond Succession, we focus on topics as they apply to family enterprises. So perhaps you could comment on what types of businesses are best suited to consider an EOT structure, and you'll perhaps you could comment on whether family owned businesses are a fit for this.
Wesley Novotny: [00:11:52] Yeah, I think the market's still evolving. It's so new that we have to see what businesses this will work for. I think in theory it could work for almost any businesses. We certainly, in the services area, we've seen a lot of, whether it's, we've talked to mining services groups, we've talked to people who are supporting theater groups involved in the arts where you have like employees are very invested in the company and you have an owner, right, saying, I don't know who to sell this to my employee group, or maybe the only person I can sell this to. So the market is still evolving.
Probably a couple of key pieces that we've noticed in terms of people who are interested and I think the people that you need to succeed, you do need to have enough cash flow for, for two purposes, 'cause you got to buy the vendor out. Right? So, you need enough money to fund that purchase over a timeline that the vendor can accept. There are rules that allow the vendor in income tax rules here to allow the vendor to take that money over 10 years.
But that's a long time. And would a vendor be interested in taking it over 10 years? More common is generally five or less. So, you need enough cash flow to make sure the vendor's getting paid, but also that there are still enough profits to go out to those employees who are now the beneficiaries, you know, the indirect owners of this, that they can see the incentive that they can, you know, they're okay.
We're participating in the profits in this and we're benefiting from this. With the carrot being that once the vendor's paid out, well then all the profits are coming up. But you kind need enough to make it go both ways. And then the other key piece that we've seen is generally the vendors have to.
They have to be interested in this. It's a friendly deal, right? Like the vendor is effectively setting up the EOT trust and putting this structure into place. The employees, you know, the only way this works is if the employees understand the business and are senior enough, and know enough, to take over the business.
Sometimes in family businesses, the family runs the business so closely that it's hard to transition that to employees. Doesn't mean an EOT can't work, but you have to be thoughtful about it and say, okay, well if we're going to do this EOT, we're going to it in, let's say five years we want to retire.
We have got to start involving these people in the decisions and thinking about, you know, putting them in the position to have the information and to know what's going on here to, and then the right training to be able to take it over, you know, this bit of expense. You know, for the vendor to set it all up.
But it's a friendly deal, so it makes it a little bit easier to happen. But you do have to probably have a vendor who's interested in their employees in that and interested in having those discussions and to make it work.
Leah Tolton: [00:14:11] Right. So, you know, you've touched on a couple of things there about, you know, the vendor giving up control.
You've talked about the employees being in the know and being able to take over and operate the business going forward. You know, from a succession perspective. How do EOTs compare to other exit options, like third party sales or management buyouts? It seems to me that some of this would have to happen regardless of what succession vehicle you chose.
Are you able to comment on the similarities or the differences?
Wesley Novotny: [00:14:40] Yeah, it is effectively a sale of the business. So the vendor has to be ready for that. And you, you pointed out something a key point there that I should, I should highlight and that we've certainly had these discussions with the vendors is you got to give up control on the sale, the EOT, you can't say, well, I'm going sell you 40%. Now you can't do an EOT that way. You do have to give up the 50% plus one. You can still stick around. You can still be a minority shareholder. And you can still be involved with the trust. You can be a trustee of the trust.
You can't be more than 40%. You can still be on the direct board of directors of the company, but you can't be more than 40%. So you got to be comfortable with giving up control. That's a big hurdle. And then you got to get your employees trained and, and they got to understand what, what they're getting into.
Leah Tolton: [00:15:21] Right. So, I think you'd need to be in that mindset or have given thought to those concepts if you were going to sell outright to a third party.
Wesley Novotny: [00:15:29] Right, absolutely.
Leah Tolton: [00:15:30] You'd be given up control and you'd need to have people who are able to, you know, take the business forward. Presumably some of those people are important enough that you would want them to stick around after a third-party sale.
Wesley Novotny: [00:15:39] Yeah, that's right. So that's, you're right, it's very similar in that sense.
Leah Tolton: [00:15:43] Yeah.
Wesley Novotny: [00:15:43] And you can stay involved maybe more so even than a, a pure third party sale. Because if you sell it to a third party, maybe they want you to be involved in the business for two years, but they don't want you to be a shareholder.
So you, in some ways there's more flexibility.
Leah Tolton: [00:15:54] Yeah.
Wesley Novotny: [00:15:55] If it's a vendor and they're quite invested in their employees, the concern with a third-party sale is. I mean, maybe you know the third party quite well and sometimes, you know, they're competitors and you've been competing with them for years and you kind of understand how they're, they operate.
But the concern always for a lot of this is, is the, the vendor, and we've seen this many times where the third-party purchaser comes in, buys it, gets the IP, or gets the piece of it that they want, or just the few key employees, puts it together with their existing business and kind of shuts down.
And so, you know, if you're let's say a small manufacturer in a small town somewhere, and you're very successful at what you do, you're very good at it. But these competitors, they, you know, there's something there's some special sauce you have and that's what they really want.
Well, they'll get that special sauce, and they'll leave. Whereas with the EOT and you sell it to the employees, they're, they're going to stick around.
Leah Tolton: [00:16:39] Right.
Wesley Novotny: [00:16:40] The research that's been done on this is that these, you know, employee owned businesses are generally very successful and they're obviously owned by the employees, so the employee's interests are kind of at the forefront. So, when you have a tough time, when you have a recession, they don't go and lay everyone off. They kind of say, well we have got to spread the pain around here. We're not going to make as much money for a few years, but, but you know, we got, let's stick together and we'll get through this.
And then they're very well positioned when things turn around to jump on those opportunities because they haven't left and they haven't closed down everything or they haven't sold everything.
Leah Tolton: [00:17:10] And haven't lost all their valuable mind and management. The people who've got the knowhow who can keep the place running and exploit opportunities in the future.
Wesley Novotny: [00:17:18] Exactly. Exactly. Yeah. And then if you compare it with an employee buyout. What's difficult for employee buyouts is they have got to come up with the money, you know, the management, right. Usually a debt, right? So, if you're, even if you're the senior management, you want to take over the company, well you, you have got to go take a loan, right?
Leah Tolton: [00:17:34] Probably.
Wesley Novotny: [00:17:35] And that's a bit scary. Whereas with the EOT, there might be a loan, it would be to the business effectively, to you know, maybe pay the vendor a bit of an upfront amount. But this is all funded with the, as long as you're comfortable the company's profitable and you can mark, you know, model out that, okay, we're going to be making money over the next few years.
It's those profits that fund the purchase price, which makes it heck of a lot easier for the senior management to participate, but also the other employees.
Leah Tolton: [00:17:58] Mm-hmm.
Wesley Novotny: [00:17:59] So they get to come in as beneficiaries without having to take the risk. Well, I mean, in a sense, they are the indirect owners, but they don't have to go out and take a loan and buy shares.
And how do I fund that? And do I, you know, my kids are going.
Leah Tolton: [00:18:10] And what security do I have to give for that? And, you know, what risk am I doing with my own assets and what happens to my house?
Wesley Novotny: [00:18:16] Precisely. So that's a, that's which is a big, big benefit for, for employees.
Leah Tolton: [00:18:21] Okay. So, let's talk about the deal that you worked on, which was the first Canadian EOT transaction.
So, you assisted with the EOT for Grantbook. What made that transaction successful and what learnings can we take from that, that our listeners might benefit from?
Wesley Novotny: [00:18:43] Yeah, so this is an interesting one. So at a toss it had the hallmarks of an of an EOT, like they had some actual employee ownership of the corp, of the entity of Grantbook before the ownership, and was deeply invested in the employees, very interested in the employees doing well, and ultimately were actually kind of operating in the background when all these EOTs were rolling out saying, yeah, we're very supportive of this. This is a great idea. So they were, they were invested in their employees, invested in the business, thought they wanted the employees to take over. So that was a key piece to this.
Leah Tolton: [00:19:11] Mm-hmm.
Wesley Novotny: [00:19:11] And so, you know, management was fully involved in the business, fully understood what was going on, so very well placed to take it over.
Leah Tolton: [00:19:18] Mm-hmm.
Wesley Novotny: [00:19:19] So, I think with those two things in mind, we, we didn't really know. I mean, I know when we started out with the transaction, some of the discussions we had with Grantbook is to say like, look, the owner here does want to exit. Everybody's invested in this EOT, we know this is the first one, but if this doesn't work, is there another exit we can go to?
And we said, well, yes, at Bennett Jones, we have the expertise, we'll get you there. That's what you got to do. But to be honest with you, once we got into the, this discussion of the EOT, it just went very smoothly because everybody's interests were fairly aligned.
Leah Tolton: [00:20:06] Mm-hmm.
Wesley Novotny: [00:20:06] And management and the employees are going to be effectively taking over this company were very comfortable with the business and what they were getting themselves into. You know, there's always interesting stuff. You have to, in the, it is just a regular trust, but there has to be certain requirements in that trust.
Leah Tolton: [00:20:06] Right?
Wesley Novotny: [00:20:06] And so there's a bunch of discussions that need to happen there, you know, with both the vendor but also the management team and, and kind of, you know, the employees have to have some knowledge of this. So, you've got to have those discussions and there's some complexity in that and how do you implement that?
And having a little bit of flexibility there to make it work. But at the same time, the employee's understanding what the benefit that they're going to get into. But again, because everybody's interest in Grantbook were very aligned, it went very well. But you have got to develop also some governance. I mean, the employees, if they're indirect owners via the trust.
They need to have some information as to what's going on with the business and how the financials are working. And so, building the governance structure to do that, it just took some discussions, but to be honest with you, the transaction went, went quite smoothly because of the aligned interests.
Leah Tolton: [00:20:49] So, it sounds like this trust agreement that creates the EOT itself. You know, given that you're talking about governance and you're talking about employees having direct interest in that and distribution of profits out, it sounds like some of those components are similar to a unanimous shareholder agreement that you'd need to put into place if you had a different kind of employee share ownership structure.
Wesley Novotny: [00:21:10] Yeah, it's certainly, and you know, and there again, given the flexibility here, you can have a, because you, the EOT has to control, but it doesn't have to have all the shares. So, there is probably a USA there and, and then there is, you know, often a USA below the EOT. Mm-hmm. But yeah, there's an interplay there between certainly the unanimous shareholders agreement, whether the terms of that, but also that has to coordinate and work with the trust deed provisions.
Leah Tolton: [00:21:33] Mm-hmm.
Wesley Novotny: [00:21:33] And that's where you can see where there could be some, you know, some negotiation as to how that plays out.
Leah Tolton: [00:21:38] Right.
Wesley Novotny: [00:21:38] But if the values are aligned, you know, you just got to find the words and find the concepts and then get them down onto paper, which is what we do as lawyers in a way that works out for everybody.
Leah Tolton: [00:21:48] Right. So, it sounds like that particular transaction went fairly smoothly because everyone was aligned, you know, where are areas of complexity? You know, we've touched on governance, we've touched on the, the terms of the, the trust deed. Are there other complexities that people need to keep in mind when they're considering implementing an EOT?
And what kind of inputs do they need to manage those complexities? What advisors do they need for that?
Wesley Novotny: [00:22:11] So, there are a couple pieces there. The complexity and the advisors. So, depending on the size of these, I mean. Again, we're still figuring out how this works. I mean, you do certainly need lawyers because you need to settle a trust deed. You need to, you know, you need to do a purchase and sale agreement. If there's a loan, you need to have security.
Leah Tolton: [00:22:27] Mm-hmm.
Wesley Novotny: [00:22:28] You need to figure out how the money is going to flow legally. Like, you know, are they dividends? Are they loans? Or all this structuring? And certain people, you know, the EOT has trustees in those, so those trustees will have fiduciary duties to the beneficiaries.
So, they have to make sure they understand what they're getting themselves into by entering into the purchase and sale agreement. So, you certainly need, obviously need lawyers. The other pieces that we've seen though, are somebody who handles the softer side, like the governance at the EOT. And how do you involve the employees in the governance? And how do you structure? And it doesn't have to, that doesn't necessarily have to be legal, but how there's a sharing of information so the employees
Leah Tolton: [00:23:09] Yeah.
Wesley Novotny: [00:23:09] Know what's going on in the business and what's going on with the EOT.
Now certainly you have an employee who is the trustee of the EOT and likely, some of those people will know who are on the board of directors of the company. So, there should be a natural flow of information, but you got to have some thought about that. So, we've seen lawyers, kind of with the softer skills in terms of the governance, and then we've also seen some of these socially minded private equity firms.
This is what they do. You know, they're quite on top of the tax rules as well. I mean, they're not lawyers, but they're very on top of the tax rules. But they can help them if the business is big enough, model out how this works. How does the money flow? What is the timeframe that the vendor's going to be paid out on, given the nature of your business and your employee group, how do you split up the profits?
Is it some sort of based on salaries? Is it based on years of service? Like, you know, there's certain permitted grounds that you're allowed to divide up the profits under the, under the tax legislation. But within that, there's a lot of flexibility. And so how do you structure that? So, we have seen these private equity firms and they're very helpful.
Again, they're socially minded, so they're generally, if there's an alignment of values, this all kind of works out. But we've certainly seen them as well involved in the transaction and that can make things go quite smoothly. And they can have those preliminary discussions. That's can be, but they can also have those preliminary discussions with the businesses.
Say maybe the cash flows here don't work, or maybe the family involvement you want to continue to have.
Leah Tolton: [00:24:21] Mm-hmm.
Wesley Novotny: [00:24:22] Maybe that won't work for an EOT, but if you can see the, you know, but then they can also, if you can see this over five years or 10 years, you know, maybe the EOT structure for you down the road. That's the three buckets we've seen.
Leah Tolton: [00:24:34] Right. Got it. So, let's pick up on that governance piece and the soft skills you talked about. You know you've mentioned here in your remarks that one of the things that can be attractive in an EOT is that it can allow for really broad participation of employees who may not all be executive employees.
And in fact, probably a lot of them might not be executive employees.
Wesley Novotny: [00:24:54] Correct.
Leah Tolton: [00:24:55] So they're not necessarily folks who would be privy to, or who would have all of the information shared with them that they now will be, you know, managing and interpreting and trying to figure out how to make decisions about.
So, I would think based on, you know, those facts, that governance is pretty critical in these trust-based models. And so, what should family enterprise owners know about the ongoing oversight in management, and what do the employees need to know about that? What kind of special things would need to be factored in?
Wesley Novotny: [00:25:26] So ultimately it is the trust that's the shareholder of the business. And so, the trustees are the, well, they're making decisions on behalf of the trust and so they are voting those shares. And so, you can, you know, if you control, you can remove the directors and, you know, you can take all these kinds of steps.
And so, one of the things we've advised on, on this is you have got to have the right people as the trustees. And so, you can train the employees to be just, they can be the sole trustees if, if that's the direction you go. But if the group is not maybe sophisticated enough to handle that, because you do have to have governance and you do have to have, you know, trustee meetings and you got to follow a bit of a form to this, you can't be too, too loosey goosey in this.
And so, one of the things we've certainly talked about is you're allowed to have certain, effectively professional trustees, bank trustee, be a trustee of this — that's permitted. And so, if you're not super, if you're not comfortable with your employees, and maybe they're not sophisticated enough to run these types of things.
The employees certainly have to have a representative, but it probably makes sense to have someone like that, like a professional trustee that can bring the rigor and the discipline, take the minutes, you know, do those kinds of things when you have these meetings so that everything is properly documented, decisions are properly made, information is properly translated.
I think that's a key, is kind of that governance. Because that's, that's really ultimately the shareholders and they need to, you know, operate a certain way and at a certain level to make it successful. And then the second part is, is really, you know, your board of directors and your USA and those types of documents.
You have got to have the right people on the board of directors who can effectively run the business.
Leah Tolton: [00:26:58] Right.
Wesley Novotny: [00:26:58] And again, that coming back to some of the points we talked about earlier. You hope there are employees who are senior enough and who are on that board of directors and know what's going on.
But if there aren't, if it's families, and this takes, I think, a few years to do, quite frankly, you got to get those employees involved so that they are, they can become directors and they can take on those responsibilities and understand, um, the, the technicalities of what they have to do, but also, you know, the, the softer pieces as to what that means, and, and then having information.
Leah Tolton: [00:27:24] You know, this sounds a lot like, you know, the transition that takes place when a family business transitions between generations. Right. You know, as soon as you have more people and you have people who may not all have the same level of information or the same understanding or the same role, then you really have to give some careful thought to what information gets shared with people who may have an ownership interest, what kind of decisions they get to make when that information is shared with them, so that they have enough time to consider it or to ask questions, you know, structure your, your meeting processes so that there are opportunities for questions before people have to make the decision, et cetera.
You know, it sounds like there are a lot of commonalities. Here, if you put an EOT in place, that there would be, if you transition from one group of owners to another.
Wesley Novotny: [00:28:10] Yeah, I can't put it any better than what you just said. Yeah, absolutely. All that stuff applies here.
Leah Tolton: [00:28:13] So, you made a comment earlier about how these EOTs or companies that have these EOTs as owners have historically been quite successful.
So, I want to ask a question that I think is related to that. You know, how, how does employee ownership through an EOT change the culture or engagement in a business?
Wesley Novotny: [00:28:34] Yeah. I mean, it's, I guess it's all fact specific to your business, but what the studies have said and the reviews of this have said, I mean, it's just a fundamentally different mindset if you're an employee somewhere.
You're an employee. Mm-hmm. But if you're an employee and an indirect owner, well it's a heck of a lot different. You know, if you see that something's not working as well as it could, right? If you're a part owner, you might say, well, geez, if we could fix this machine, if we had this better process for how we're approaching things, if we maybe there's an untapped market that I think we should, you know, go after that.
Maybe as an employee, you're not as incentivized to care about. Well, if you're an indirect owner, you are right directly interested in that, which can lead to a lot of, you know, just naturally leads to a lot of good things.
I mean, one of the things, even in our law firm, we try to incentivize is people to recognize as, certainly as partners, but also our hopeful future partners as associates that, hey, you could be a part owner of this business, which changes your mentality. Right. And you think longer term.
So, I think, I'm a lawyer, not a social scientist or something, but from what I've read in the area and been told by others who are much smarter than I, that there's a lot of positive things from changing that mindset. And, so these businesses are generally quite successful and quite sticky in their communities, and I think that's important.
Leah Tolton: [00:29:46] Yeah.
Wesley Novotny: [00:29:47] For the family businesses and for some of our smaller communities and certainly while all across the country. We have a real successful little business, but then you can't figure out who can take that business over, maybe the family's disinterested or there's no one in the family who is, you know, qualified to take it over.
What do you do with these things? And the EOT is a very alluring structure to do that. Not to say you can't have a huge EOT, like, it will be interesting to see how big a company can be taken over by an EOT. I don't think there's really a limit on the size, and I think if you have the right kind of company and, you know, if you could get some private equity money to take a piece of the company with you, but the EOT has to control obviously, that, you know, this kind of, the sky's the limit as to how big it can get.
Leah Tolton: [00:30:25] Right. So, I take it from your comments that you think the model's here to stay.
Wesley Novotny: [00:30:30] I do. Yeah. I do think we need some tweaks in some of the areas because, and this gets into very tax stuff, and this is, you know, one of the questions you asked earlier, which maybe I didn't answer, where's the complexity in this one.
Part of the complexity is, is making sure the business and the EOT qualifies under the EOT requirements. And some of that is, what's the existing structure and how do we get to an EOT? And so, the existing structure, how people hold these things, whether it's through family trusts, which are generally fine, but a lot of people use holding companies and holding companies.
Can bring some complexity, you know, there are ways to work around it, but we would like, like to see some tweaks to the legislation for that. And then, so that's where a fair bit of complexity is saying, okay, here's your structure. Now we can get you to an EOT, but we have got to take some steps to get there.
And then the other piece that, you know, I probably should have mentioned earlier off the top is that currently the $10 million capital gains deduction is set to expire in 2027.
Leah Tolton: [00:31:21] Oh, that's soon.
Wesley Novotny: [00:31:22] Yeah, exactly. Uh, 22. So, we're already almost halfway through 2025 here, 2026. So, it does technically expire in 2027. So, we do need that incentive to be pushed out forever. And I think there certainly is a big push amongst the community who is advocating for these things to get that done. And I think there's probably an appetite if we can get to see some successes. For example, as you know, Grantbook is.
If we can get some successes in this area, then maybe we would see that pushed out. But that is a key piece that needs to change because, as we've been talking about, and as you as said very eloquently just moments ago, succession is not something you do tomorrow. Succession is something you've got to be thinking about, two, three, ideally five or 10 years out.
Leah Tolton: [00:32:04] Mm-hmm.
Wesley Novotny: [00:32:04] And I think there are a lot of businesses that can qualify for an EOT, and you can qualify for an EOT without claiming the capital gains deduction, but obviously.
Leah Tolton: [00:32:12] That's a big incentive. You would, why would you give it up if you didn't have to?
Wesley Novotny: [00:32:15] Exactly. So, you know, we have got to have these rules set and that 10 million capital gain should be available so that people can have these discussions.
And you know, and I think there'd be a big market for these in, you know, five, 10 years. And I do think the model will stick around. I think once a bunch of these transactions occur and there's some comfort with them.
I mean, if you're interested in your employees and you want to pass the business along, there's a lot of positives here.
Leah Tolton: [00:32:39] Right. What would you say to a family enterprise considering whether an EOT is the right succession strategy?
Wesley Novotny: [00:32:46] I think it's another arrow in the quiver, is what I would say. So, there are, we've talked about a bunch of them here. You know, does the business stay in the family? Do you sell it to a competitor? Do you sell it to private equity?
Sometimes you might be in a position where you don't know who the heck to sell it to at all. But the EOT is in that mix, and I think it is absolutely something you should consider. And there are incentives, certainly the $10 million capital gains deduction is a big one.
But also, if you're invested in your employees and you have a group that you quite like, I think you have got to look at this option. For sure.
Leah Tolton: [00:33:14] Great. Well, Wes, this has been a great discussion. Thank you so much for sharing your experience and your insights with us. I think it will be very valuable to our listeners. Thanks so much for appearing on the podcast.
Wesley Novotny: [00:33:25] Thank you for having me, Leah. It's always, as I said, a pleasure to talk about EOTs and always a pleasure to talk with you.
Leah Tolton: [00:33:29] Well, thank you. Thanks for joining me on this episode of Beyond Succession, a series within the Bennett Jones Business Law Talks podcast. Make sure to hit the follow button on whatever platform you are listening from. So you get notified whenever we release new episodes. Also, don't hesitate to reach out if you have any questions about challenges or issues that you are facing in your family enterprise. Take care. I'll catch you in our next episode.
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