Employee ownership: untapped succession solution for legal firms

Succession planning is a difficult issue for any law firm to manage. If the senior partners want to retire or sell the practice, who takes over ownership and control?

The advent of alternative business structures (ABS) adds another dimension to this dilemma. Many fear the law is effectively opening the market to unqualified providers. Others see huge opportunity, for example in accessing external funding or forming innovative multi-disciplinary practices.

To date the debate on ABS has focused almost exclusively on opening law firms to external, “non-solicitor” owners. But there is another way to widen ownership within the firm while providing a sustainable succession solution: employee ownership.

Co-operative Development Scotland believes employee ownership can unlock powerful benefits for Scottish businesses, and recently invited me to present the business case as I see it to Scottish Enterprise and Scottish Government staff.

Potential

I started researching employee ownership two years ago at Demos, the independent think tank, and strongly believe that there is huge untapped potential for greater employee ownership in professional services and other knowledge-intensive industries. Law firms, accountancy practices, architects, engineers, designers and medical and financial services providers all rely on the co-operation, commitment and innovation of their employees to perform.

In a traditional partnership, a small minority of senior professionals have ownership and control of the firm and sell their stakes on when they leave.

This in itself can be complex, requiring newly-appointed partners to take on very high levels of debt to buy out their predecessors. The status and earnings potential are major attractions. But the process can generate internal conflict, suspicion and frustration.

From the employee perspective, partnerships can easily come across as business models that serve the partners first and foremost. Employees can easily end up demotivated and resentful of the partners who appear to take the majority of the financial and other rewards.

The difficulties inherent in achieving succession from one set of partners to a new set means that it is often tempting to put the business on the market. Flotation, private equity buyouts and trade sales are all effective means for the partners to cash in their stakes and solve the problem of selecting the next generation of partners. But they come with few guarantees about how the business will be managed, invested in and preserved in future.

Rationale

In contrast, an employee buyout locks in ownership and allows the business to be managed for the long term. The employees own the company’s shares directly or through an employee benefit trust, so the shares can’t be traded on the open market and can only be bought and sold by other employees.

The rationale is that, where a business relies on the knowledge of employees, ownership should be structured to ensure those employees share in the profits. Rewards at the very top may not be quite as great as those available to partners or founders of rival firms. But the payback in terms of sustainability and employee engagement is immense.

There are no more difficult transition periods when partners leave. Having a greater say in how their workplace is run increases employee satisfaction and lowers stress. Productivity is higher and staff turnover is lower as a result. More knowledge sharing at all levels means the firm is better prepared for economic ups and downs.

A growing body of evidence supports this, including a recent finding by London’s Cass Business School and John Lewis Partnership that employee-owned companies created jobs almost five times faster than other businesses during the recession.

The mechanics of an employee buyout are also simpler than you might think. Contrary to popular belief, the employees don’t have to dip into their own pockets, because typically an employee benefit trust is set up to buy the business on their behalf. This generally borrows enough money, secured by the firm, to buy all the shares. The trust then repays the debt from the company’s profits over a period of time.

In Scotland, CDS is engaging directly with legal and accountancy firms to raise awareness of employee ownership as a succession solution for their own and their clients’ businesses.

We need to reinvent succession planning for the professional services firm – and Scotland is well placed to lead the way.