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Brett House: Canada's greying economy needs more employee ownership

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bay-street-vw0111

It’s time to add retiring entrepreneurs to the list of economic existential threats posed by Canada’s aging population.

A new report from the Canadian Federation of Independent Business (CFIB) found that 76 per cent of Canadian owners of small- and medium-sized enterprises (SMES) — companies with between one and 499 employees — plan to exit their businesses during the next decade. Some 56 per cent of SME owners aimed to get out within the next five years. About three-quarters of these soon-to-be former business people are looking to retire completely.

The CFIB white paper confirms similar findings in a 2017 study by the Business Development Bank of Canada (BDC) and in Statistic Canada’s annual surveys of SMEs: the ranks of Canada’s seasoned business owners are about to be substantially thinned.

The implications for the Canadian economy are massive. SMEs accounted for 98.1 per cent of all Canadian businesses with employees in 2021. They employed about 10.3 million people, equivalent to 63.8 per cent of Canada’s total labour force.

SMEs are critically concentrated in the sectors we need to call on to build our way out of our housing supply deficits, to boost Canada’s anaemic productivity, and to support our balance of payments with the rest of the world. Construction accounted for the largest share (16.3 per cent) of SMEs in a single industry, followed by professional, scientific, and technical services (14.6 per cent). SMEs have also been leading our international trade recovery since 2020’s shutdowns.

Based on Statistics Canada data, CFIB estimates that baby boomer retirements will trigger transfers of over $2 trillion in SME assets to younger generations of business owners. That’s  equivalent to 75 per cent of Canada’s annual economic output.

This wave of change adds risks to Canada’s already wobbly long-term outlook. The OECD expects Canada to notch up the worst growth and productivity performance amongst its 38 industrialized-country members over the next few decades.

Retiring business owners are set to follow the lead of retiring workers. While the pandemic induced the Great Resignation in the United States, Canada has seen the Great Retirement: in addition to folks over the age of 65 calling it a day, a record number of Canadians aged 55 to 64 have retired. Widespread labour shortages that weren’t expected to bite for five to 10 years are putting a damper on economic growth. Rising immigration numbers can compensate only partially for these deficits.

We need to encourage older Canadians to stay in the labour force. One key move would see the federal government follow through on earlier attempts to raise the bar for Old Age Security eligibility to age 67. But the politics around this are challenging to say the least.

We also have to ensure that the SMEs that employ so many Canadians transition smoothly through their owners’ retirements. Yet, the CFIB found that only one in 10 of these business owners have formal succession plans. About half of SME owners surveyed said that finding a suitable buyer was their biggest barrier to a steady hand-off of their businesses.

Many other countries face the same SME succession challenge and they offer lessons on how Canada could address it.

The U.S. and U.K. now have years of experience with the use of employee ownership trusts (EOTs) to help exiting SME owners realize the full value of their companies while handing the reins to trusted employee stewards. Typically, these trusts secure a loan to buy the company on behalf of employees; this debt is then serviced out of the enterprise’s annual profits.

Over 45 years, U.S. trusts have allowed 14 million American workers to amass US$1.6 trillion in business assets. Similarly, since the 2014 introduction of U.K. EOTs, over 700 British businesses have been sold into these structures.

Compared with other enterprises, British and American employee-owned firms tend to be more resilient to shocks, more durable instruments of regional development, better sources of pay and more effective generators of employee wealth. This success is widely recognized. Even Pope John Paul II endorsed employee ownership back in 1981.

Employee ownership puts capital and labour on a more equal footing by transforming stakeholders into shareholders. The CFIB noted that just over half of Canadian SME owners would be more likely to sell their businesses to their employees if EOTs were available here.

In research with Toronto’s Social Capital Partners, I projected along with Jon Shell that between 500 and 750 SMEs could be sold to their employees in the eight years following the creation of a Canadian EOT structure with accompanying incentives similar to those in other countries. That could create somewhere between $4 billion and $9 billion in wealth for about 50,000 to 114,000 Canadian workers — with further gains in later years.

The federal government expressed an interest in EOTs in its April 2021 budget. Ottawa then committed in its April 2022 budget to create a Canadian EOT structure under the Income Tax Act, but the fall economic statement in November 2022 was silent on the matter.

In the coming months, we need the federal government to bring forward legislation to allow for Canadian EOTs. The scale of our approaching tide of SME successions and our enduring growth challenges augur for urgent action.

Brett House is professor of professional practice in economics at Columbia Business School and a fellow with the Public Policy Forum, the Munk School, and Massey College. He tweets at @BrettEHouse.