Employee owners: a view from across the Pond

The Chancellor made some surprising and welcome announcements in his Budget this year. A £50m fund will be allocated to promote wider employee ownership in business, some of which will be used to fund tax incentives for owners selling to their employees.

It’s not difficult to understand why the Government is keen to see more employee ownership. The benefits are proven: businesses owned by their employees are likely to be more productive and profitable, with happier staff and even customers than conventionally structured firms. In the UK, Scotland has been at the forefront of growing the model, with some spectacular success stories across different sectors. These include Aquascot in Alness, Woollard & Henry in Aberdeen, Stewart Buchanan Gauges in Kilsyth, and Clansman Dynamics in East Kilbride. Yet despite this, Scotland’s adoption of the model is still far behind that of the US, where employee ownership has really taken flight.

New screening

Co-operative Development Scotland (CDS) is the agency responsible for promoting collaborative working models in Scotland. As a subsidiary of Scottish Enterprise, and a partner to Highlands & Islands Enterprise, CDS champions employee ownership as a means of securing companies, and therefore jobs and skills, in the local area. Mary Ann Beyster is a leading exponent of employee ownership in the US. So when she came to the UK to launch a new film extolling the benefits of employee ownership, Sarah Deas, chief executive of CDS, invited her to address Scotland’s professional advisers, lawyers, accountants and corporate bankers.

Meetings were held in Glasgow and Edinburgh, featuring an excerpt from the film followed by round table discussions. Managing directors from Scottish employee-owned firms also attended to give their perspective. They were lively and informative sessions, looking at what Scotland can learn from the US experience of employee ownership.

The film, We the Owners, tells the story of three US-based, employee-owned companies. Each company is quite different, but with many similarities. The film’s executive producer, Mary Ann Beyster, described to the groups how employee-owned firms, mainly using the Employee Stock Ownership Plan (ESOP), had grown in the US. There are currently 11,000 plans in place and it is forecast that this will treble by 2020. Sarah Deas told the groups that she is looking for a 10-fold increase in employee-owned businesses in Scotland. How achievable is this?

General picture

One of the more oft-quoted concerns about employee-owned firms is that decision making can be protracted. Interestingly enough, the companies represented at each event refuted this viewpoint. Stephen Nicol, from Stewart Buchanan Gauges was emphatic that the firm is not slowed down by having employees at its helm. The firm does not operate by consensus: that would be impossible in its competitive sector. Woollard & Henry’s Fred Bowden agreed. The company has to be able to react quickly. However, Fred’s perspective is that in an employee-owned business there has to be more accountability for decisions. This keeps the management team on their toes.

There was a lot of interest in the group in how share value is realised. Many companies only allow share trading amongst employees, which means that shares cannot be sold externally. “The disincentive to sale means that the only way employees benefit is by growing the share price. It is therefore in everyone’s interest to make the business as successful as possible,” explained Fred Bowden.

Appropriate vehicles

Despite the many advantages enjoyed by employee-owned businesses, Stewart Whyte, corporate finance partner at McClure Naismith LLP, acknowledged that obtaining growth or development funding for such businesses can be difficult, and a potential obstacle to attracting external investment. In current times, banks were being very cautious about lending without such guarantees, and in employee-owned firms there was commitment but not that individual financial accountability. However he believes that there has never been a more encouraging climate for a range of alternative and innovative funding options for businesses.

Just as with the employee ownership model itself, he continued, it is often a case of understanding the options which are available, overcoming challenges, and taking advantage of these new opportunities if they are right for a business. He was keen to explore what the experience of employee-owned businesses in the US had been. However, Mary Ann Beyster suggested that the banks' concerns might be misplaced; the default rate for US ESOP companies is less than 1%, which suggests that these firms might be better investments.

Nigel Watson, head of employee benefits at Brodies, described himself as an advocate of employee ownership in business, but said that there were various technical obstacles to making employee ownership work within the existing legal framework. Whilst employee benefit trusts (EBTs) remain an ideal vehicle for operating in conjunction with employee ownership, since the introduction of “disguised remuneration” (new legislation designed to tackle abusive tax avoidance involving offshore trusts), operating EBTs has become more problematic. He also identified the challenges facing international firms. Tax regulations can make it difficult to give an ownership stake to employees in other countries. These issues are not insurmountable, but do need addressed if the Government wants widespread takeup.

Managing director of Macdonald Henderson, David Beveridge, has seen a fair bit of activity in employee share ownership, albeit not what might be recognised as full employee ownership. EMIs are seen as a good vehicle for share distribution, and more commonly this is being used to reward a wider group of staff beyond the executive teams. David cited the example where his firm advised a high profile technology company involved in the data capture sector, in which almost all staff members, from junior to executive level, had been enfranchised with EMI options in advance of a highly successful exit to the company’s principal investor in early 2011, an event from which all staff members benefited.

The group were sceptical regarding the Government’s proposal that employees should forego employment rights in return for a shareholding. Austin Flynn, corporate partner with Morton Fraser, called this “giving with one hand and taking away with the other”. He described the initiative as detracting from all the positives that employee ownership brings.

Incentives

Would tax incentives make a significant difference to the takeup of the model? Mary Ann Beyster explained the tax advantages of the US ESOP. The company can buy the business from the vendor with pre-tax dollars. There are CGT exemptions for the vendor who sells to employees, and there are tax advantages for the employees on share distribution. Despite these seemingly generous incentives, research demonstrates that the result is net positive; i.e. the increase in corporation tax compensates for the discounts. John McLeod, director at RSM Tenon, echoed others when he hoped to see some incentives coming from Westminster that would support the model.

Sarah Deas summarised the sessions as enlightening, informative and productive, leaving all who attended with plenty of food for thought. “Scotland is behind the US, but we are seeing more enquiries and an increasing number of employee buyouts”, she said. “It is encouraging to see the support from the professions, and their level of knowledge. I accept there are challenges, and it is good to have this open and honest discussion.

“The model will not fit every business. It is our aim that the employee ownership option is presented to clients alongside the trade sale and management buyout. Today’s feedback suggests that this is happening increasingly regularly, and that can only be good for the Scottish economy.”