What is a stock option plan?

15 August 2025

Employee stock option plans (a “stock option plan”) are one of the most commonly used types of incentive plans.

In an era where labor shortages and fierce competition require the development of an effective recruitment strategy, this employee compensation and retention mechanism is highly relevant. It is often used as a tool to attract qualified and motivated talent.

By offering certain employees the option to purchase company shares and participate in its growth, they are encouraged to become more committed to the company. This approach can improve the company’s overall performance.

How do stock option plans work in Quebec?

A stock option plan allows certain employees to purchase company shares at a predetermined price at a later date. This means that the employee does not immediately become a shareholder when the option is granted. After a vesting period, the employee can exercise their option and purchase a stake in the company.

Such a plan also allows the company to offer a form of deferred compensation while positively impacting its cash flow, although it does entail potential dilution of capital. This makes it a particularly attractive strategy for growing companies with limited financial resources, such as start-ups.

What types of stock option plans can companies offer?

There are several types of option plans, each with distinct objectives and tax implications.

Traditional stock option plans

Traditional plans usually allow employees to purchase shares at a predetermined price, often at fair market value on the date the option to subscribe for shares is issued, or at a price below fair market value, set when the options are granted, in order to allow employees to benefit from equity participation at a reduced cost.

Phantom stock option plans

Phantom stock option plans are an alternative to traditional stock option plans. Rather than granting an actual right to acquire shares, the employer agrees to pay the employee an amount equivalent to the capital gain that the employee would have realized if they had exercised options entitling them to acquire actual shares.

These plans are particularly useful for companies that want to offer a performance-based incentive without changing their capital structure. Since no securities are actually issued, there is no dilution of existing shares. However, the tax treatment of these amounts, which are considered taxable employment income at the time of payment (subject to certain conditions) and may be less advantageous than that applicable to certain real option plans. Phantom stock option plans require careful drafting, particularly with regard to triggering events, the method of calculating value, and payment terms.

Are their other forms of stock-based compensation besides option plans?

Yes, in addition to stock options, some companies consider other forms of compensation based on stock value, such as:

Restricted share units (RSUs)
Performance share units (PSUs)
Warrants

RSUs are generally granted at no initial cost to the employee, entitle the employee to receive shares at the end of a vesting period or a cash payment, subject to certain conditions, and are generally taxable on the vesting date, subject to certain conditions.

PSUs, on the other hand, are conditional on the achievement of performance targets.

Warrants are similar to stock options but can be offered to individuals other than employees.

Each mechanism has advantages and disadvantages depending on the tax context, governance structure, and objectives of the company.

Who are the intended beneficiaries of stock option plans?

As a general rule, the goal is to reserve approximately 10% of outstanding shares for a stock option plan, although a range of 5% to 15% may be reasonable depending on the context.

The target beneficiaries are usually long-term executives or key employees whose contribution can have a significant impact on the company’s growth.

In Canada, granting stock options to an external consultant or service provider may, in certain circumstances, compromise their status as an independent contractor in the eyes of the tax authorities. Tax authorities assess the working relationship based on several criteria, including effective subordination in the work, the economic criteria, the integration of the work performed by the worker into the company, the specific result, and the attitude of the parties toward their business relationship.

The granting of options, typically associated with employment, can be perceived as a factor of economic dependence, particularly if it is accompanied by conditions related to the term of office or performance. Such a situation may result in the beneficiary being reclassified as an employee, with significant tax consequences: mandatory withholding taxes, employment insurance contributions, CPP/QPP contributions, and potential penalties for the company.

It is therefore essential to structure these mechanisms properly and ensure that the independent nature of the contractual relationship remains clear and consistent in all respects (legal, tax, and operational).

What are the terms and conditions for exercising stock options?

The exercise price is generally set at fair market value at the time of grant, but it may be reduced in certain cases, particularly to reward an employee for their services.

The exercise of options is often conditional on the occurrence of an event: this may be a qualitative objective (an acquisition or change of control) or a quantitative objective (seniority).

It is common practice to stipulate that options not exercised within a given period—often between five (5) and ten (10) years—become void. Similarly, a clause may provide for the loss of options in the event of dismissal, particularly for serious reasons.

Finally, it should be noted that when an employee exercises their options and becomes a shareholder, it is strongly recommended that they automatically become subject to any applicable shareholder agreement.

Taxation of the Canadian stock option plan

Compensation in the form of options may offer certain tax advantages over traditional salary. When the option is exercised, the employee must include in their employment income a taxable benefit equal to the excess of (i) the fair market value of the shares at the time of exercise over (ii) the total amount paid or payable for the shares and the amount paid by the employee to acquire the right to subscribe for those shares, if applicable.

Under certain conditions and in the case of private companies, the inclusion of this benefit may be deferred until the shares are disposed of. In addition, subject to certain conditions, the employee may benefit, in calculating his or her taxable income, from a deduction equal to 50% for federal tax purposes and a deduction equal to 25% or 50% for Quebec tax purposes. Thus, this tax treatment is similar to that given to capital gains.

In these circumstances, the company is not entitled to any deductions, unlike the salary paid to an employee. The company is also responsible for withholding taxes at the time the options are exercised, subject to certain exceptions.

It is therefore essential to assess the tax implications of an option plan when planning the overall compensation of employees.

Stock option plans in Quebec: documentation must be provided in French

Since the 2022 amendments to the Charter of the French Language, all companies operating in Quebec must provide all documents relating to employment conditions in French, including stock option plans.

These requirements also apply retroactively, which means that plans adopted before the amendments came into effect must be updated and translated to comply with the new obligations. This requirement also extends to all ancillary documentation related to the plan, including grant notices, exercise notices (or option exercise notices), subscription forms, applicable shareholder agreements, and any official correspondence related to the implementation or management of the stock option plan.

Failure to comply with these French language requirements for Quebec companies can result in significant legal and administrative consequences. It is therefore recommended that a complete review of the relevant documents be conducted to ensure their linguistic compliance.

Stock option plans: a positive effect on company valuation

The implementation of an option plan can have an impact on the valuation of the company, particularly during financing rounds. Investors evaluate not only the dilution caused by the options, but also the quality of the incentive program. A well-structured and transparent plan is often viewed positively, as it demonstrates a talent retention strategy. Conversely, overuse or unclear terms and conditions can raise concerns among potential investors.

How should stock option plans be handled in the event of a sale or liquidity event?

It is important to include provisions in the stock option plan for the treatment of rights in the event of a change of control, sale of the company, or initial public offering. Often, these events trigger a clause accelerating vesting or exercise rights, allowing employees to convert their options more quickly. These clauses must be clearly worded to avoid any ambiguity at the time of the event and to facilitate the transaction.

Legal framework for stock option plans

Depending on whether the company is incorporated under provincial law, such as the Business Corporations Act (Quebec) or the Canada Business Corporations Act, certain rules may apply to the issuance of shares under a stock option plan. It is essential to ensure that the board of directors has the necessary powers to authorize the issuance of shares and that the company’s articles of incorporation allow it. Legal due diligence is therefore recommended before implementing the plan.