April 2, 2018
Equity compensation plans are a valuable and versatile tool for many corporations, from early-stage startups to established blue-chips. Corporations can use them to attract new talent, to motivate employees to achieve performance milestones or reward them for long service, and to retain employees for the long haul. An equity compensation plan is a way for a corporation to make payment to another – usually an employee – with an ownership stake (or a valuable asset that mimics an ownership stake), instead of with cash. These plans come in several forms; the one that’s the best fit for a particular corporation will depend on its unique circumstances and on what it hopes to achieve.
Here’s a quick look at the five most common types of equity compensation plans.
1. Stock Option Plans
A stock option plan offers the promise of equity at a set price at a future date, typically on meeting certain conditions. An option gives the holder, often an employee, a right to purchase a certain number of shares at a point in the future at a pre-determined price (the “exercise price”). This right is often tied to the option-holder’s commitment to remain with the corporation for a certain period of time.
Stock option plans are particularly attractive to startups that often lack the cash to entice and keep top talent (like employees, directors, consultants and advisors) to help the corporation grow, and is one of the considerations founders should think about when incorporating their startup. There are some disadvantages of stock option plans. The main one for the corporation is the possible dilution of other shareholders’ equity when option-holders exercise their options. The main one for the option-holder in a private corporation is the lack of liquidity compared to cash bonuses or greater cash compensation. Until a corporation creates a public market for its shares or is acquired, the options won’t be the equivalent of cash benefits; and if the corporation – and its stock value – doesn’t grow, the options and underlying shares could ultimately prove worthless. The option-holder’s motivation is, generally, that the exercise price will be lower than the potential fair market value of the shares at a particular time in the future such that the option-holder both has a stake in the corporation’s future and can acquire that stake at a discounted price.
Stock option plans typically contain some or all of the following terms (among other standard terms):
Option Pool. The Board of Directors determines the size of the “stock option pool”: the number of options reserved for award. The stock option pool diminishes every time the corporation awards options; if the plan isn’t well organized, the options can run out. Plans typically give the corporation discretion to ensure it can retain its outstanding shares in the event of employee departures by giving it rights to cancel options in exchange for a specified financial value.
Stock option agreement. Plans typically require the corporation and the person to whom it will grant the options to sign a written option agreement specifying the date the options are granted, the total number of shares subject to the option, the exercise price, the vesting commencement date and schedule, the expiry date, and any unique terms.
Shareholders’ Agreement. Once the option-holder exercises their option and purchases the shares, they typically enter into a shareholders’ agreement with the corporation and the other shareholders that governs the ownership of shares and management of the corporation.
2. Restricted Share Unit Plans (RSU Plans)
In an RSU Plan, participants are granted notional units called “restricted share units” rather than actual shares. The RSU value mirrors the market value of the granting corporation’s common shares and fluctuates with their rise and fall. The plan participant then receives the shares underlying the RSUs according to a vesting schedule after achieving required milestones, such as remaining with the corporation for a specified length of time. RSU Plans typically contain these terms (among other standard terms):
Administration. Normally, the corporation’s Board of Directors will administer the RSU Plan, including granting of RSUs, determining the terms of the grant, interpreting any matters arising from the RSU Plan and making any other determinations necessary for the plan’s administration.
Shares Reserved for Issuance. The plan sets out the maximum number of shares the corporation can issue upon the vesting of any RSUs granted under the plan. This can be an absolute number or a rolling number based on a percentage of the total outstanding shares.
RSU Grant Agreement. Upon the grant of the RSUs to the plan participant, the corporation and the participant enter into a grant agreement containing the terms and conditions the plan requires and any other terms and conditions the corporation’s Board of Directors determines in respect of the plan participant at the time of the grant.
Vesting. Vesting of the RSUs can be based on time, performance, or both. RSUs that vest based on performance are sometimes called “performance share units” or “PSUs”. Once the plan participant meets the vesting conditions, they can settle their RSUs in shares of the corporation, cash, or both. Assuming the RSU Plan is structured properly and the Income Tax Act’s salary deferral arrangement rules don’t apply, the value of the shares received on settlement of the RSUs is added to the participant’s income and taxed as such in the year of settlement (as opposed to the year of grant). Typically, the corporation withholds a portion of the shares to pay income taxes and the participant receives the remaining shares. RSUs settled in cash must vest no later than three years after the grant to avoid the salary deferral arrangement rules; if caught by those rules, the plan participant will be taxed in the year of grant.
Employment. Typically, the plan requires that the participants’ entitlement to the RSUs depends on their continued employment with the corporation. Upon the participant’s employment termination, retirement or death, their RSUs are typically forfeited or a portion immediately vests.
Share Capital Adjustments. RSU Plans usually include standard provisions about the adjustments to the outstanding RSUs on the occurrence of certain events, such as any change in or reorganization of the granting corporation’s capital structure.
Change of Control. An RSU Plan customarily also deals with participants’ rights if there’s a “change of control” of the granting corporation.
3. Share Appreciation Right Plans (SAR Plans)
Under SAR Plans, the corporation grants plan participants share appreciation rights. Each SAR entitles participants to receive, on vesting, the net value of the increase in the market value of the corporation’s share between the grant date and the vesting date. Share Appreciation Right Plans are similar to stock option plans in some ways, and to RSU Plans in others:
Value. Share Appreciation Rights function much like stock options in many ways – but unlike stock options, participants aren’t required to pay the exercise price when they exercise the SAR. Share Appreciation Rights start with a nil value at the time of grant, so will have no value at vesting if the market value of the shares has decreased between the dates of grant and of vesting.
Plan Terms. Share Appreciation Right Plans typically contain provisions similar to those of RSU Plans in respect to plan administration, maximum shares reserved for issuance, grant agreement, market value, employment, share capital adjustments, change of control and shareholder agreements.
Vesting. Like RSU Plans, vesting provisions in SAR Plans can also be based on time, performance or both. Performance-based SARs are sometimes called “performance appreciation rights” or “PARs”. Once vested, the plan participant can settle the SARs in cash or in an amount of shares that equals the amount payable to the participant divided by the per share market value.
4. Deferred Share Unit Plans (DSU Plans)
Deferred Share Unit Plans are used as a way to defer compensation to the granting corporation’s directors since they will be taxed on the DSUs only in the year in which they are settled rather than the year of grant – assuming the plan is properly structured so that the Income Tax Act’s salary deferral arrangement rules don’t apply. Deferred Share Unit Plans function very similarly to RSU Plans:
Grant. The corporation grants plan participants notional units, in this case called “deferred share units”.
Value. The value of DSUs mirrors the market value of a class of the corporation’s shares.
Plan Terms. In other respects, DSU Plans are also similar to RSU Plans with a key exception: DSUs typically vest only upon employment termination, retirement or death. They are therefore designed to be longer term in nature and vesting isn’t linked to performance criteria.
5. Restricted Share Plans & Deferred Share Plans
Under Restricted Share Plans and Deferred Share Plans, the corporation issues shares to plan participants at no cost. But there’s a catch: the shares are awarded conditionally, and are only released to the participant upon satisfaction of the condition(s). The conditions might be time-based, performance-based, or both. These types of plans aren’t typically used in Canada primarily due to the adverse tax consequences to participants: they are normally taxed on the award at the date of issuance.
Please contact your McInnes Cooper lawyer or any member of the Corporate Finance & Securities Team @ McInnes Cooper to discuss how your company can use equity compenstion plans and which is the right one for you.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
© McInnes Cooper, 2018. All rights reserved. McInnes Cooper owns the copyright in this document. You may reproduce and distribute this document in its entirety as long as you do not alter the form or the content and you give McInnes Cooper credit for it. You must obtain McInnes Cooper’s consent for any other form of reproduction or distribution. Email us at [email protected] to request our consent.
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On July 14, 2016, the Supreme Court of Canada decided that the “Unjust Dismissal” sections of the Canada Labour Code ensure that…
Jun 29, 2016
Employers are entitled to mandate dress codes in the workplace, and even to discipline employees who refuse to comply. But a workplace dress…
May 31, 2016
You’re on a tight timeline to issue a press release. You finish your draft and ‘cut & paste’ your standard “forward-looking…
May 10, 2016
This publication has been updated as at April 18, 2022. Access to sufficient capital is always a business issue, from the startup stage right…
May 2, 2016
Updated October 4, 2023. Workplace accidents regularly lead to charges under occupational health and safety (OHS) law. These charges can be…
Apr 15, 2016
On April 14, 2016, Canada’s federal Justice Minister proposed legislation setting out the conditions that a person wishing to undergo…
Mar 9, 2016
On January 11, 2016, the Ontario Superior Court of Justice sentenced a front-line supervisor to imprisonment for 3½ years for four counts of…
Feb 23, 2016
Employee tardiness is a significant problem for employers - and bad weather is one of the top three reasons that employees give for it according…
Feb 1, 2016
Updated April 13, 2023. A well drafted and properly implemented written employment contract can be instrumental to both avoiding or resolving…
Jan 27, 2016
On January 21, 2016, the Ontario Superior Court of Justice dramatically expanded the scope of legal privacy protection – and the liability…
Dec 7, 2015
Updated July 19, 2024. Violence has become an unfortunate reality in current society, and the workplace is not immune. With more people…
Oct 23, 2015
Incorporation offers legal advantages to sole proprietors of small businesses, including certain tax advantages. However, when a corporation…
Aug 13, 2015
The employment contract, at its core, is an exchange of work for compensation. So at a very basic level, employers are entitled to expect…
Jun 25, 2015
Updated October 4, 2023. Most people know a company itself has occupational health and safety (OHS) obligations and risks corporate liability…
Apr 2, 2015
The market for the sale and the supply of goods is a global one for many businesses in today’s economy. Both exporting goods from Canada and…
Mar 31, 2015
Updated June 24, 2021. Women make up close to half of the employed workforce: in 2019, Canadian women 15 years and older represented 47.4% of…
Mar 25, 2015
On March 3, 2015 Canada’s Privacy Commissioner determined that Health Canada breached privacy laws by mailing letters to over 40,000 Marihuana…
Mar 6, 2015
On March 5, 2015, the Canadian Radio and Television Commission (the CRTC, the main agency charged with administering and enforcing most of CASL)…
Feb 13, 2015
Updated January 26, 2022. With people spending so many of their waking hours at or connected to work these days, romantic relationships…
Feb 9, 2015
NOTE: On April 14, 2016, the federal government proposed legislation setting out the conditions that a person wishing to undergo…
Feb 2, 2015
On January 30, 2015 the Supreme Court of Canada decided that the Canadian Charter of Rights and Freedom’s protection for freedom of…
Jan 30, 2015
In December 2014, the Newfoundland & Labrador Supreme Court ordered an employer to pay its former employee $30,000 in moral damages to…
Dec 11, 2014
On December 11, 2014 the Supreme Court of Canada continued its trend to recognize privacy rights – and develop the law to protect them –…
Dec 11, 2014
On January 15, 2015, the software provisions of Canada’s Anti-Spam Legislation (CASL) will take effect. CASL’s anti-spam sections, touted…
Dec 10, 2014
“Corporate Social Responsibility” (CSR) as a concept has been floating around in business-speak for years – but stakeholders in the mining…
Dec 5, 2014
Updated December 11, 2020. Employers host numerous events throughout the year – summer and holiday office parties, retreats, client and…
Dec 1, 2014
The construction industry - project owners, contractors, subcontractors and trades - might be relaxing, ignoring the hype around Canada’s…
Oct 14, 2014
CASL’s anti-spam sections came into force on July 1, 2014. Every organization that CASL affects should now be complying with it – and their…
Sep 16, 2014
Updated August 25, 2022. Many believe that only public companies or large, established companies with many shareholders need to be concerned…
Aug 1, 2014
Most Canadians have heard about Canada’s Anti-Spam Legislation (CASL): we’ve been bombarded with “CASL Compliant” emails asking us to…
Jun 16, 2014
On June 13, 2014 the Supreme Court of Canada decided that Canadians have a reasonable expectation of privacy in their online activities, and…
Jun 12, 2014
The countdown to CASL is almost over: there are only 13 business days until the anti-spam provisions of CASL – and most of the penalties for…
May 8, 2014
On July 1, 2014 – less than two months from now - the anti-spam sections of Canada’s Anti-Spam Legislation (CASL) take effect. Individuals…
Apr 15, 2014
The countdown to CASL is on: on July 1, 2014, the anti-spam sections of Canada’s Anti-Spam Legislation (“CASL”) take effect. Individuals…
Feb 28, 2014
On July 1, 2014, the anti-spam sections of Canada’s Anti-Spam Legislation (aka “CASL”) will take effect. CASL is: Broad. It applies…
Feb 28, 2014
On July 1, 2014, the anti-spam sections of Canada’s Anti-Spam Legislation (aka “CASL”) take effect. CASL will apply to just about every…
Nov 8, 2013
On November 7, 2013, the Supreme Court of Canda decided police require specific authorization in a search warrant to search the data in a…
Jul 2, 2013
On June 14, 2013, the Supreme Court of Canada’s decision in Communications, Energy and Paperworkers Union of Canada, Local 30 v. Irving Pulp…
Nov 28, 2012
On October 19, 2012 the Supreme Court of Canada (SCC) decided a teacher criminally charged with possession of child pornography and unauthorized…
Jun 14, 2012
As any Canadian knows, July 1st – Canada Day – is the first long weekend of the summer; or is it? What about when July 1 falls on a…
Mar 1, 2012
Social media blurs line between work time and “off duty” time. Employers can, however, discipline employees who go over the line. We have 10…
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