Offering Share Ownership or Stock Options to Employees: Legal Issues

Employees can be important in the growth and success of a business. For key employees who may be critical to the long term success of a company, some business owners may contemplate offering those employees share ownership in the company or perhaps establishing an employee stock option plan. There may be good business reasons for doing this including to encourage key employees to stay with the company, as another way to compensate employees, as an incentive to help grow the business and as a way to try and align the interests of key employees with the long term interests of the business and its owners. However, any decision to establish a stock option plan or to offer share ownership to employees should only be made after careful thought of all relevant legal, tax and other considerations.

When offering share ownership or stock options to employees, business owners should be aware that shareholders in private corporations, even employees who may own just a small percentage of a company, and whether they own voting or non-voting shares, have certain rights at law. For private companies incorporated under the laws of Ontario or Canada, the Ontario and Canada Business Corporations Act, respectively, include certain restrictions on how those companies can be operated which are intended to protect shareholders. Some of the rights of minority shareholders include, without limitation:

• The right to require that a company have audited financial statements unless all of the shareholders consent, which can be a significant expense to the company.
• The right to attend the corporation 's annual shareholders meeting, the right to requisition a shareholders meeting and the right to receive the company 's financial statements and auditor 's report at the annual shareholders meeting.
• The right to review the shareholder records of the company and the minute book for the company.
• A shareholder who opposes a proposed amalgamation of the corporation, an amendment to its Articles, sale of its assets, etc., may be entitled to require that his/her shares be purchased by the corporation for fair value.
• A shareholder can seek court intervention where the majority shareholders or the board of directors of a company have done, or threatened to do, something that is oppressive, unfairly prejudicial to or unfairly disregards the interest of a shareholder. A court has very broad powers to make orders to remedy situations where it determines there has been oppressive conduct.

For small and medium-sized private companies, with either one shareholder or shareholders who are all family members, they may have a significant amount of independence to operate the business as they see fit. Introducing key employees as shareholders can mean loss of independence in decision-making and additional reporting requirements. This is because directors of companies have legal obligations to act honestly, in good faith and to act in the best interests of the corporation, rather than their own personal interest. Failure to do so can expose directors and majority shareholders to claims by minority shareholders.

Also, when thinking of having employees as shareholders, some consideration should be given as to whether there are future plans to sell the company and whether such minority shareholders could interfere with, or be an obstacle to, a sale of the company.

For these reasons, if a decision is made to offer share ownership or stock options to employees then it is the best interests of the company to ensure that there is some mechanism in place to buy the employee’s shares in the future, if necessary, including if the relationship with the employee does not work out as expected or if the employee’s employment with the company is terminated for any reason. Some of these issues may be addressed through a Shareholders Agreement or, where a stock option plan is created, the terms of the Stock Option Plan Agreement that may be established by a company.

Given all of these concerns, a decision whether to offer shares or stock options to an employee should be made carefully after considering all business, legal, tax and other considerations. A business owner should also consider other alternatives to offering employees share ownership or stock option plans - for example, establishing a profit- sharing plan or a phantom stock option plan for employees.

This is just a short summary of some of the legal issues to consider if you have a private company in Ontario and are considering offering shares to your employees or considering establishing a stock option plan. It is recommended that you consult with a lawyer and tax adviser to advise you as to the many legal and tax issues to consider in these circumstances.

The foregoing should not be considered to be legal advice and should not be relied upon as such. Please consult a lawyer to get advice and an opinion on your unique circumstances.