Venture
Philanthropy
Guide.org

Natasha van Bentum, CFRE

Gift of Stock Options by Corporations

In September, Toronto's Hospital for Sick Children Foundation gained approval from the Toronto Stock Exchange for the creation of a new class of options, which will enable companies to donate to charity at the time of their initial public offering (IPO). This class of options, known as "charitable options," is an inexpensive method for companies with future potential but restricted cash flow to make a potentially large contribution to charity.

An option is a right to purchase a certain number of shares in a company for a pre-established price. Options have no book value at the time of issue, but they become valuable when the stock market price of the share rises above the exercise price of the option. The owner can exercise the option and sell the shares, pocketing the difference between the exercise price and the market price. Typically, options are issued to the employees of a company as part of a compensation package.

With the arrival of the dot-com age, options have become a valuable commodity which have captured the popular imagination. Although there are precedents, it is extremely rare for companies to issue options to charity. Due to regulatory restrictions in the United States, gifts of options are even rarer. The creation of charitable options should change this reality, at least in Canada.

Most young, growth-phase companies cannot afford to donate cash to charity. Their greatest asset is their potential for future growth and increase in shareholder value. Since options cost nothing to issue, and in small numbers represent a minor dilution of equity in the company, they are an inexpensive donation method.

The Hospital for Sick Children Foundation created the charitable option as part of a six-month campaign to solicit donations from companies at the time of their IPOs. Andrew Sheiner, a vice president at Onex Corporation and chair of the Campaign, deserves much of the credit for making the campaign and charitable options a reality. Mr. Sheiner also recruited volunteers at 17 brokerage houses in Toronto to solicit clients on behalf of the Foundation.

The structure of the charitable option was developed on a volunteer basis by William Ainley, a senior securities lawyer with Toronto firm Davies Ward & Beck. Ainley drafted the characteristics of the charitable option and worked with the Toronto Stock Exchange to gain approval.

Charitable options are a separate class of options that will not affect the limits on options available as employee incentives under corporate stock option plans as long as they remain within the approved guidelines. At this time, charitable options can only be issued in the prospectuses of companies conducting an IPO, not existing public companies. For companies to be listed on the Toronto Stock Exchange, charitable options must have the following characteristics:

1. may only be issued to charitable organizations and public foundations, not private foundations;
2. 10-year term exercisable at any time during their term;
3. exercise price equal to the public offering price and payable only in cash;
4. vest 100% on issue;
5. total limit on charitable options for a single TSE listed issue is 2% of outstanding stock;
6. charitable options may not be transferable, and except for minimum anti-dilution protection, may not be amended during their term.

These characteristics clearly define charitable options as non-employee options with a limited scope and purpose. Furthermore, the issue of charitable options to a charity would only occur when and if the company successfully completes its public offering. At the direction of the Exchange, special care was taken to ensure that all gifts of options constitute arm's-length transactions, hence companies are prohibited from issuing charitable options to private charitable foundations or personal trusts.

The issue of charitable options is qualified by the prospectus once the offering has cleared the standard regulatory process with the relevant securities commissions and exchanges. A donation of options under these circumstances does not constitute a taxable event, nor is it a trade, due to the absence of consideration. The Ontario Securities Commission has been informed of the proposal.

As mentioned, there are no tax benefits for a gift of charitable options. A donation of options is incurred at no cost to the company, and hence no tax receipt is issued for the gift. The benefit to the charity will only occur if the company's stock goes beyond the exercise price of the option. Depending on the company, the upside could be significant. Conversely, there is no downside for the charity.

Moreover, a gift of charitable options has no effect on a charity's disbursement quota, and consequently is outside the purview of Canada Customs and Revenue Agency. Any revenue derived from charitable options would be technically classified as investment revenue for the charity, not fundraising revenue.

The greatest challenge for any charity receiving charitable options is choosing when to exercise the options. The Hospital for Sick Children Foundation has developed guidelines and will be managing its portfolio of options in a manner similar to the management of its existing equity portfolio.

Questions have been raised in the media about whether corporations to will choose to donate charitable options rather than cash. These concerns are unsubstantiated because charitable options may not be issued by public companies, only private companies at the time of their IPO. Furthermore, no responsible charity will provide recognition for gifts of charitable options on par with cash donations because charitable options are not receipted.

Interest in charitable options from charities, pre-IPO companies, the media, and the planning and legal communities has been considerable since they became public with a front-page story in The National Post on October 10, 2000. It will be interesting to see if this new giving technique becomes a widely adopted donation method or merely an innovative idea with marquee appeal.