Employee ownership; a strategy that fits
A leading expert explains the advantages of employee ownership and the growing interest in the subject
I visited Scotland recently to speak to professional advisers on the uptake of employee ownership trusts, the vehicle introduced in the Finance Act 2014 specifically to promote employee ownership within companies. The event, part of a programme organised by Scottish Enterprise to raise awareness of employee ownership in Scotland’s adviser community, was very well attended, indicating a healthy interest in co-owned business structures.
Employee ownership in the UK is in a healthy state. In 2017 the UK's 50 largest employee owned companies had combined sales of £22.7 billion, and 176,000 employees. Most of this Top 50 have no net debt. These firms come from diverse sectors: professional services, health and social care, manufacturing and retail. Employee ownership can be found in all areas of business; indeed, it is now difficult to identify sectors where there are no examples of employee owned companies.
It is estimated there are currently over 300 employee-owned firms in the UK. Scotland does appear to be doing particularly well in growing the number of employee owned businesses. It was good to learn that 2018 should see Scotland’s 100th employee owned company – a remarkable number and particularly so in light of the fact that employee ownership in Scotland is exclusively private sector, for-profit businesses. The mutual, the employee owned spinouts from public service organisations, is not a feature in Scottish public service delivery.
I believe this prevalence of employee ownership can be attributed to the higher levels of awareness that exist in Scotland. The Nuttall Review of Employee Ownership (2012) identified that lack of knowledge of this business model amongst advisers was a major barrier to the growth of employee ownership in the UK. There is evidently a real enthusiasm amongst Scottish lawyers and accountants to promote employee ownership. The cross-party political support is excellent; the recent Holyrood debate demonstrated that MSPs know what employee ownership is and were able to speak eloquently about employee owned firms in their constituencies. It appears that Co-operative Development Scotland, working with Scottish Enterprise and Highlands & Islands Enterprise, are together really making inroads in getting the message out that employee ownership offers a stable, fairer and often more successful form of business ownership.
Forms of trust
It helps to understand what the term “employee ownership” means. The Nuttall Review defined employee ownership as where there is: “a significant and meaningful stake in a business for all its employees”; and also that: “The employees’ stake must underpin organisational structures that ensure employee engagement.”
There are different ways the employees' stake may be held. A feature of many employee owned companies is the holding of shares within a trust on behalf of all employees.
Key benefits of trust ownership are that employees of the relevant company (or group) know that the shares in the trust are held on a long term basis on their behalf; and have a collective voice through the trustee of that trust, in how the company is owned and governed.
Until 5 April 2014 an employee trust would usually be drafted to satisfy the requirements of s 86 of the Inheritance Tax Act 1984 (a “s 86 trust”). The Finance Act 2014 introduced a new vehicle specifically to meet the requirements of employee owned companies: the employee ownership trust or EOT. In contrast to s 86 trusts, where a trustee may make a distribution on bespoke terms to a selected beneficiary or beneficiaries, an EOT requires, with only limited exceptions, all employees to benefit from any distribution. Moreover any such distribution must be “on the same terms”. An EOT distribution either has to be of the same amount for all employees or to differ only by reason of their remuneration, length of service, or hours worked. In this way, the EOT has equity and inclusiveness at the centre of the structure.
Many countries are actively looking to create a fertile environment to cultivate more employee ownership in their economies.
Generally speaking, the UK has the necessary legal and tax framework to support employee ownership. HM Treasury examined possible barriers, including tax barriers, to the wider takeup of employee ownership and concluded that the majority of businesses who met with HM Treasury did not identify the tax system as a primary barrier to greater uptake of the employee ownership model. Nevertheless, in order to help raise awareness of employee ownership, a capital gains tax exemption was introduced in 2014 on qualifying disposals of a controlling interest in a trading company (or group) into an EOT, together with an income tax exemption for bonuses (up to £3,600 a tax year for each employee) paid by EOT controlled companies.
This is not to say that the UK could not make further bold moves to promote employee ownership. For example, now that we have confidence in the EOT structure and it is shown to work commercially, what about reintroducing a corporation tax deduction for contributions to the EOT to fund payments of consideration, limited to where EOTs acquire or have acquired a controlling stake? Such a step would go some way to plug a funding gap that exists in structuring employee ownership transactions.
The tax landscape is important, but that isn’t what delivers the enhanced performance found in many employee owned companies. Many believe that these business benefits are driven by the enhanced engagement usually found in employee owned companies. Indeed, the influential Macleod Review on employee engagement found that “Employee ownership was a profound and distinctive enabler of high engagement”.
The key features of employee engagement typically found in employee owned companies (regardless of how the employees' shareholding is owned) include access to information, “employee voice” and a commitment to staff training and development.
Employee owned companies tend to provide more information to employees, and more regularly than other companies. The White Rose Employee Ownership Centre survey of employee owned companies found that information is provided typically on a company's financial position, its investment plans, board decisions and staffing plans. The same research shows employee owned companies tend to provide employees with a say in their business through suggestion schemes, opportunities to meet top managers, problem solving groups and team briefings. Employee owned companies also have an emphasis on staff training and development, with this being used as one of the metrics of success as an employee owned company. These features appear to be found to a greater extent in employee owned companies than other companies. These features are obviously ones that non-employee owned companies could have but, typically, they do not, or not in as much depth.
The belief in employee owned companies is that employee ownership makes a fundamental difference to employee engagement. This belief can be explained because the relationship with staff goes beyond the employment contract. In non-employee owned companies an employee's relationship with the business is usually only through their employment contract. Employee ownership helps this relationship work better. But in addition, the shareholding in their employer provides them with a voice in the business as a shareholder.
And in many employee owned companies, in addition to this voice as a shareholder, employees also have a say at board level either through an employee council or a representative on the board. Employee ownership therefore provides a much wider relationship with a business for an employee than usually found in other business models, and it is one that is built into the way a company is owned and governed.
When can employee ownership be introduced?
Introducing employee ownership at the start of the life of a business demonstrates a clear commitment to a collaborative approach to working and, in particular, it builds into a company's structure a way for employees to have both a say and a financial share in the success of the new venture. This can be done using the grant of share options, issuing shares into an employee trust or even establishing the company with 100% of a company's shares in an EOT.
As a growth strategy
In an established business, employee ownership provides a way to develop and grow a company. The Nuttall Review highlighted how employee ownership can, in particular, drive innovation in a company, as well as achieving greater employee commitment and engagement. Introducing direct share ownership by employees can align well with this aim, because an increasing share price can demonstrate clearly to employees that growth is being achieved.
Employee ownership can provide an alternative approach to management succession where senior managers have previously been expected to buy shares in a company to get promotion. The trust model of employee ownership provides a way to promote individuals to senior positions, without the need for those individuals to buy a stake in a company. In this way promotion can be based on merit rather than also, in part, on the ability and willingness to invest in a company.
Employee ownership can have clear advantages over alternative succession strategies. Better than a trade sale by a founder to, say, a lifelong competitor. Better than reshaping the business so that it is suitable for a stock market listing. More attractive than the idea that the business could, over a period of time, be wound down and all staff made redundant. A management buyout might have potential, but why sell to a few when the sale could be to all staff? Why not implement an employee buyout?
An employee buyout has a number of attractions:
the terms of the employee buyout are, to a great extent, within the owners’ control;
owners can plan in advance as to when and how the employee buyout occurs. This is a significant advantage over most other forms of exit;
employee buyouts have a good record of succeeding. This is important if there is any deferred consideration, and most founders of a business want to see their business survive and prosper; and
an employee buyout avoids some of the difficulties that arise with other forms of exit. It avoids, for example, the commercial risk of disclosing confidential information to potential trade buyers.
Also, some owners prefer an employee buyout because:
an employee buyout is a way of recognising the contribution employees have made to the success of the business;
continuity of the business can be achieved for customers and suppliers;
it can avoid the dismissal of employees or the closure of premises that often occurs following a trade sale; and
the way the business is carried on, its ethos, is more likely to continue intact.
Employee ownership can also be used in business restructuring and rescues. There must, of course, be a viable or potentially viable business. There are examples of employees accepting changes to their terms and conditions of working, including to redundancy and pension arrangements, in exchange for introducing employee ownership into the restructured business. There are, however, no special tax or regulatory rules in the UK to encourage this.
I have no doubt that we will see a significant and continuing increase in employee ownership in the UK. It is encouraging to see the appetite for the structure in Scotland. I welcome politicians who speak about the benefits of employee ownership because this is good publicity. But major growth in the number of employee owned companies is going to come from the success stories of existing employee owned companies, as well as from the professional adviser community advising clients of employee ownership as an option where appropriate. Employee ownership isn’t going to be the solution for every company. The evidence is powerful though, that when it does fit, the outcomes can be extraordinary.
The original article appeared in The Journal of the Law Society of Scotland on 19 February 2018.