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Employee ownership: A panacea or passing fad?

20/06/2019
A recent acceleration in the number of companies adopting EO structures has widened the debate about the future of business ownership models in the UK. Neil Palmer, corporate partner at Fieldfisher...

Employee ownership (EO) has enjoyed a significant amount of media attention in the last 18 months.

This is largely thanks to a number of well-known businesses, including Wallace & Gromit creators Aardman Animations, high street electrical store Richer Sounds and nationwide vegetable box delivery company, Riverford Organic Foods, announcing their moves to EO and voicing compelling reasons for doing so.

The categories of business that have embraced EO are many and varied, ranging from manufacturers of precision tools to recruitment firms.

But the model is proving most popular among staff-rich businesses such as architecture practices, designers, creative consultancies and engineers.

When most people talk about EO today, they are usually referring to companies where all or most of the shares are held by employee ownership trusts (EOTs).

Introduced in the Finance Act 2014, EOTs are trusts established by a company to hold equity on behalf of its employees.

The concept of the EOT was the result of recommendations put forward by Fieldfisher tax partner, Graeme Nuttall, in his 2012 report The Nuttall Review, commissioned by the then Department for Business, Skills & Innovation.

Business owners will usually seek the assistance of lawyers, accountants and HR consultants in setting up these trusts – or indeed other EO structures.

As well as structures where 100% of the shares are held by a trust, there are also hybrid EO models, where a certain percentage of the company's equity is held by a trust, with the rest belonging directly to employees, or the company's founders, for example.

 

Choosing an EO model

Since every business is unique, advisers will conduct a thorough review of a company, taking into account what its owners and the wider business want to achieve in the medium-to-long term.

They will also analyse the management structure and recommend what type of EO model will work best for that particular company.

Although not an exhaustive list, there are six key elements we suggest clients should be thinking about prior to implementing a transition.

These are:

  • Culture

  • Finance

  • Tax

  • Design

  • Implementation, and

  • Making EO work

 

Six key elements

  1. Culture

Before making any decisive moves, business owners thinking about changing a company's business model should first ask themselves: Are you and your employees ready for EO?

This is not just a transaction backed up by some legal documents. If done properly EO will result in a fundamental shift in the way a business is run and how staff engage with management, customers and themselves.

A good starting point for gauging this is to look at other EO organisations, especially any in similar sectors that might be competing for your recruits, and decide whether or not you like the ethos of those companies.

Typically, the kinds of companies that would consider a cooperative ownership model already have an inclusive management style and some form of profit sharing, and so are culturally ready for EO.

But although awareness of EO, and the benefits it offers, is increasing, many employees, and indeed shareholders, may not be familiar with the concept, so it may be necessary to educate your workforce appropriately to allow them to make an informed decision.

If not everyone is ready to make the change, then provided that there are no significant time pressures – such as the age or health of key stakeholders – then companies can afford to take some time to get used to the idea of EO, before taking the matter further.

In any event, decisions about EO should never be rushed.

Close analysis of how a company is run is also a worthwhile exercise as it will help you assess who the business most relies on and how to best incentivise different groups of employees.

It may also become apparent that existing shareholders fall into different categories and that perhaps retaining some participation by a founder will continue to benefit the company after its move to EO.

 

  1. Finance

It is helpful to get an indicative value of a company early on.

If the business is still growing, it may be in the best interests of the business owner and the employees to realise more value under its existing ownership model, before moving to EO.

Once you have an idea of the company's value, you need to think about whether your employees can afford to buy shares or whether their "buy-out" of the equity will need to be financed, wholly or mainly, from company profits – and, if so, how long this will take and whether a bank loan is needed.

It is important to budget carefully for the buy-out process, taking account of cash flow, salaries and bonuses and how this remuneration will be replicated, or ideally improved, under an EO model.

 

  1. Design

Deciding what kind of EO model will work best for a business involves careful consideration of the advantages and disadvantages of different EO structures.

As discussed above, this involves considering whether shares should be held by a trust for the benefit of staff, or directly by staff, or a combination of both.

You should also consider the proportion of shares that will be sold – do you want to sell a majority interest, or a minority stake, or sell all of the shares in one go?

It is important to note that a controlling interest in the shares of a company must be sold to a trust to constitute an EOT (with the consequent tax reliefs).

A minority stake can still be transferred to employees, but the structure will be different and the same tax reliefs will not be available.

Once business owners are clear about what they want to achieve from EO, they then need to select an appropriate adviser, whose priorities are aligned with theirs.

 

  1. Tax

It may dismay some business owners to learn that introducing EO comes with some complex tax rules.

However, complying with these rules is a positive obligation, as most of the rules exist to enable HMRC to support the proper use of tax-advantaged share plans and EOTs.

It is therefore essential to respect the spirit as well as the letter of the law in this area, as HMRC has wide-ranging anti-avoidance investigative powers and penalties which it can deploy if it feels the system is being abused.

Although EO has not generally been a target for HMRC anti-avoidance crackdowns, as these models become more popular, scrutiny is bound to increase.

A good adviser will be able to guide you through the tax rules as well as published and unpublished HMRC policy, to ensure the business remains compliant and is not exposed to any unforeseen tax risk.

 

  1. Implementation

Once a business has chosen an EO model to adopt, implementing it requires some administrative effort.

The EOTs model requires a disposal of ordinary shares in a company, so partnerships, LLPs and associations will need to reconfigure their businesses as an initial step to pursue this model.

As usual with a business-level transaction, there is a fair amount of paperwork involved and good document management by the company will help lawyers to conduct the process as quickly and smoothly as possible.

Although, normally considered a benign transaction it must be remember that a controlling stake in the business is being sold.

Customers, landlords and major suppliers may need to be liaised with to reassure them that not only is it business as usual but that a positive change is being made.

Time will need to be set aside to participate in a valuation process, to attend meetings to finalise the proposals and brief employees.

 

  1. Making EO work

This is where the rubber hits the road for EO companies. Advisers will get you to the starting gate, but from then on it is up you to make a success of it.

Business leaders need to ensure that the EO structure delivers on its promises for employees.

Where an EOT has been established, there is usually a "repayment period", during which a fair proportion of the company's profits are paid out to the former owners in return for the shares they have sold to the EOT.

It can be difficult to manage employee expectations during this period, which is why paying some employees bonuses from year one is often helpful.

If business leaders have not brought their staff on board prior to adopting EO, this is a crucial engagement period.

Good client communications are also essential, as most businesses will want to inform their customers about their change of ownership, so motivating your employees to help "sell in" the news is worthwhile.

Like any relationship, you need to keep working at it to maintain the connection between employees and the EO concept, by instilling pride of ownership and regularly demonstrating the tangible benefits.

With enthusiasm and commitment, EO will evolve and strengthen over time to act as an engine for growth and innovation in your business.

 

This article was authored by Fieldfisher corporate partner, Neil Palmer, with assistance from tax experts Mark Gearing and Tamsin Nicholds. For more information on the firm's EO, tax, corporate and employment expertise, please visit the relevant pages on the Fieldfisher website

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