Employee stock options in Canada: how startup equity works for your team
Written by For Founders Law, a Toronto firm licensed by the Law Society of Ontario. About us
In short
Most Canadian startups give employees equity through stock options granted under a board-approved option plan, usually with vesting over several years. For employees of a Canadian-controlled private corporation, the taxable benefit is generally deferred until the shares are sold and may qualify for a deduction that taxes it at a rate similar to capital gains. Grants need a securities law exemption and proper corporate approvals, and a promise of a percentage in an offer letter isn't a grant.
Equity is how early-stage startups compete for people they can’t yet pay market salaries. In Canada, that almost always means stock options. Getting the structure right is mostly about doing a few things in the right order, and avoiding promises you can’t paper later.
This post is general information, not legal advice.
Options, not shares, for most employees
A stock option gives the holder the right to buy a set number of shares at a fixed exercise price for a period of time. Employees usually don’t pay anything to receive the option, and they only pay the exercise price if and when they choose to exercise. Startups use options because they’re simpler to grant at scale than issuing shares, and because of how Canadian tax treats them.
The option plan
Options are normally granted under a stock option plan approved by the board, and sometimes by shareholders, depending on your articles and any shareholder agreement. The plan sets the pool size, who can receive grants, vesting rules, what happens when someone leaves, and what happens on a sale of the company. Each grant is then approved by the board, usually by directors’ resolution, and documented in a grant agreement.
Most plans use a four-year vesting schedule with a one-year cliff, but nothing in Canadian law requires that pattern. Record every grant on your cap table.
Tax: why CCPC status matters
Under section 7 of the Income Tax Act, an employee is generally taxed on the difference between the value of the shares when they acquire them and the exercise price. The timing depends on the company.
- Canadian-controlled private corporations. If the company is a CCPC when the option is granted, the taxable benefit is generally deferred until the employee sells the shares, not when they exercise. That matters at a startup, where an employee could otherwise owe tax on shares they can’t sell.
- The stock option deduction. If conditions are met, the employee can claim a deduction of one half of the benefit, which brings the effective tax rate in line with capital gains. For CCPC shares, one route is holding the shares for at least two years. Another depends on the exercise price being at least the fair market value of the shares at the grant date. See stock option deduction.
- The $200,000 limit. For options granted after June 30, 2021 by employers that aren’t CCPCs, the deduction is limited to options on $200,000 of shares vesting in a calendar year, based on the value at grant. CCPCs aren’t subject to that limit, and neither are non-CCPC employers with annual gross revenue of $500 million or less, measured on a consolidated basis from the most recent financial statements (see the CRA’s guidance and subsection 110(1.31) of the Act).
The proposed increase to the capital gains inclusion rate, which would have reduced the deduction, was cancelled in 2025.
A Delaware flip or other change of control can end CCPC status, which affects options granted afterward. Plan grants with your accountant before a reorganization.
Securities law
Granting options is a distribution of securities. National Instrument 45-106 (section 2.24) includes a prospectus exemption for distributions to employees, executive officers, directors and consultants of the issuer, provided participation is voluntary, meaning the person isn’t induced to take part by an expectation of employment or continued employment. Check whether a filing is required where your option holders live.
Common mistakes
- Promising a percentage in an offer letter. “1% of the company” is ambiguous (of what share count, at what date?) and isn’t a grant. Promise a number of options, subject to board approval and the plan.
- Granting before the plan exists. Board approval and a plan come first.
- Setting the exercise price too low. If it’s below fair market value at grant, the tax results can be worse for the employee. Document how you set the price.
- Ignoring what happens on leaving. The plan should say how long a departing employee has to exercise vested options, and what happens to unvested ones.
- Treating contractors like employees. Consultants can receive options under many plans, but tax treatment differs from employees. See employee or contractor.
Before your first grant
- Adopt a plan and set the pool size with your investors in mind.
- Confirm the company’s CCPC status.
- Set and document the exercise price.
- Approve each grant by board resolution and sign a grant agreement.
- Update the cap table and minute book.
- Give employees a plain-language summary of what they’re receiving.
We set up stock option plans and prepare employment agreements at fixed fees, listed on our fees page. You can estimate a first-year legal budget with our legal budget tool. To plan your first grants, book a free 15-minute consult.