Substantive Legal Content

How Not to Screw Up Offering Shares to Employees

Here is a warning for Canadian business owners and their lawyers. Your plan to motivate and reward your employees may backfire if the messaging is not correct from the outset. There is no better way for an owner to screw up the morale of its most valued employees than to start talking about offering them shares in the company before figuring out exactly how to structure the arrangements.

It is not a good day when the senior executives walk into their lawyer’s office and proudly announce that they are becoming ‘partners’ in the firm, only to have their lawyer pronounce, ‘Maybe technically you are going to be partners, but these documents really just make you glorified employees.’ 

Overselling what you are offering can only lead to misery.  With that in mind, here are some things to think about:

  1. Are the employees going to receive voting or non-voting shares?
  2. What are the employees going to pay?  Net book value? Fair market value? Fair market value less a discount? Something else? Nothing?
  3. Do you intend to help the employees obtain financing to purchase the shares?
  4. Will the employees have to give up their bonuses to pay for their shares?
  5. Will the fair market value of the shares be determined by a reputable and independent professional business valuator?
  6. Will the employees have any elements of control?  Representation on the Board? Veto over non-arm’s length transactions? Veto over changes in corporate structure?
  7. Are employment arrangements going to change? Add a non-competition or non-solicitation provision? Limit severance on termination?
  8. Will the employees be required to guarantee the bank loan? If so, will the guarantee be joint and several (responsible for the whole debt, perhaps with a pro-rata indemnity from the other shareholders) or several (responsible for their pro-rata share)?
  9. Will the employees be required to contribute their pro-rata share of shareholders loans?
  10. On termination, will the employee’s shares be purchased by the corporation (dividend tax treatment and the corporation’s right to pay the price may be limited by statutory solvency tests) or by another shareholder (capital gains treatment, possibly subject to the capital gains exemption, and no statutory prohibitions on paying the purchase price)?
  11. When the employee’s shares are being repurchased, how is the price going to be calculated? Net book value? Fair Market Value? With or without a minority discount?
  12. When will the employee’s shares be paid for if repurchased on termination?  In cash on closing? Over time? Will it vary depending upon why they were terminated? For example, cash on closing if employment is terminated without cause and over time if the employee was terminated for cause or resigned. With or without interest? With security or guarantees (bloody unlikely!)
  13. Can the shareholder expect to receive dividends?
  14. Will the majority shareholders accept limits on their compensation to protect the value of the employee’s shares?
  15. Will there be a drag-along to force the employees to sell their shares if the majority wants to sell the company?
  16. Will there be a piggy-back to allow the employees to insist that their shares be included in any sale if the majority shareholders want to sell their shares?
  17. Will the agreement protect the employees if the majority shareholders buy back the employee’s shares and then flip them to a third party for a higher price?
  18. Will the employees agree to waive an audit?

This may seem overwhelming. If so, you haven’t thought it all through. You need to be able to answer all of these questions (and many more) and understand how your employees might reasonably react to the answers.

You should probably get some professional help. Not from me. I am retired.

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