Employee ownership: adding trust

Not so long ago, employee ownership was one of Scotland’s best kept secrets. Despite some stellar success stories, not many business people or professional advisers would be aware of the model, much less consider it as a serious option for startup or exit. Recent years have seen a dramatic change in attitudes, and now employee ownership is seen as not only a feasible structure, but is viewed by many as a very attractive one.

Numerous research studies show that companies owned by their employees can be more productive and profitable, with happier and healthier staff than their conventionally-owned peers. Employee-owned firms are more innovative, and it appears that customers like to deal with them. The number of employee-owned firms based in Scotland has doubled in the past four years, and this growth is forecast to accelerate. Why is this?

In Scotland, Co-operative Development Scotland (CDS) is tasked with promoting employee ownership as a structure. CDS is the arm of Scottish Enterprise which works to raise awareness of employee ownership with the business community and their advisers, offering free support to business owners looking to adopt the structure.

CDS chief executive, Sarah Deas explains: “For many business owners looking to retire, a sale to employees is an attractive option. They can control the pace of their own exit and influence the shape of the business for the future. Companies such as Clansman Dynamics, Stewart Buchanan Gauges, Woollard & Henry and Highland Home Carers are all excellent examples of firms which have flourished with an employee-owned structure.”

Headline speaker

CDS has ambitious plans for a 10-fold increase in 10 years.

Deas believes this is achievable and sees the legal profession as being instrumental in reaching this goal. “Our work with advisers, particularly within the legal profession, is critical to our success. We ran a programme of expert briefings last year which attracted good audiences, and have a number of events planned for this year. It’s very encouraging that we now have advisers advocating the model to their clients.”

As well as the expert briefings, a number of employee-owned businesses hosted open days for business owners interested in finding out more about selling their company to employees. This inspired a number of owners to take the plunge and start the process.

Both streams of activity are continuing in 2015 and the programme can be found on the CDS website at www.cdscotland.co.uk. A forthcoming highlight will be a seminar led by Graeme Nuttall OBE, tax and structuring partner at Fieldfisher and government adviser on employee ownership.

Sarah Deas comments: “I’m thrilled that we have Graeme Nuttall coming to speak. As the architect behind the new legislation to support employee ownership, I’m very interested to hear his views on the impact of tax changes and how he sees the model developing in the future.”

Graeme Nuttall has, throughout his career, combined life as a tax practitioner at Fieldfisher with championing the employee ownership business model. This passion was ignited when he was asked to co-author the first legal and tax guide to the structure. He worked closely with Robert Oakeshott, co-founder of the Employee Ownership Association, and was involved with Oakeshott on a number of early initiatives.

Now recognised as the leading expert in this field, Nuttall was appointed government adviser on employee ownership in 2012, publishing the groundbreaking Nuttall Review in July of that year. He was awarded the OBE last year in recognition of his services to employee share plans, public service mutuals and employee ownership. Since the Nuttall Review there has been a surge in interest in new ownership structures, yet employee ownership is a long way from being mainstream. Why is this?

Breaking down barriers

Nuttall identifies three main obstacles to wider adoption of the employee-owned model:

• lack of awareness of the concept of employee ownership;
• lack of resources to support employee ownership;
• the perceived complexity of employee ownership arrangements.

The Nuttall Review found there was a lack of awareness of the model amongst advisers, and many prospective employee-owned businesses experienced difficulty in finding advisers sufficiently knowledgeable about the model to advise on it. Indeed, the review found that there was resistance to employee ownership because it challenged deeply entrenched beliefs about how businesses are best owned and run. This lack of awareness was also found in banks, with employee-owned businesses stating that banks were unwilling to support them because they did not understand the structure.

The report contained 28 recommendations to counter these hurdles, and it is a testament to the persuasion of the Nuttall Review that a good number of these recommendations have already been implemented.

Possibly the most significant achievement in legislative terms was the inclusion in the Finance Act 2014 of some very bold moves to support the growth of employee ownership. The Act introduced a new instrument, the employee ownership trust, designed specifically to hold a controlling shareholding in an employee-owned company, together with associated tax exemptions to support this particular form of employee ownership.

An employee ownership trust contains special features to ensure that employee ownership benefits all employees and not just a select few. There is a considerable incentive for business owners to consider selling to an employee ownership trust. Vendors can benefit from an unlimited complete exemption from capital gains tax if they sell a controlling stake to an employee ownership trust. Employees also benefit from this new structure – bonuses can be paid to staff free of income tax, up to a limit of £3,600 each tax year.

Essential engagement

Nuttall insists that these changes comprise only part of the picture.

“Tax incentives should not be the main driver to adopt employee ownership”, he states. “The employees' stake in the business must be more than a financial interest. It must underpin genuine employee engagement in how the business is run. It’s when employees understand and acknowledge this that we see the benefits delivered.”

There are several advantages for an owner pursuing an employee buyout. A sale to employees provides a succession option for business owners whereby they can control the pace of their own exit and have much more say in the level of input they want to maintain. The outgoing owner also has a degree of influence over the shape of the business post-transaction. It is not unusual to incorporate provisions in the deeds of an employee ownership trust to ensure the business will operate with a defined partnership or co-ownership culture, or should remain located in the area of origin. The tax incentives are important to attract attention to the employee ownership business model, but other factors are more likely to start the business owner on this route.

Employee ownership can work at any stage in the life cycle of a business, although it does fit particularly well as a means of exit for business owners. Where an owner has built up a successful enterprise rooted in the community with a distinctive identity, it is often unpalatable to sell to a competitor. By choosing to sell to employees, the owner can influence the timing of the transaction, without pressures from market forces, external investors or the competitor’s business plan.

Employee ownership should not be viewed as the “option of last resort” in a distress situation, but Nuttall agrees that an employee buyout could be a good solution to rescue a business.

“You have to be convinced there is a viable business on offer”, he says. “Often it’s the employees who are the best judge of that. They know their customers and they know what’s possible – so they might be prepared to accept changes in terms and conditions to support the survival of their firm.”

Growth potential

From an economic perspective, employee ownership has the potential to stimulate growth in the SME sector. Effective employee engagement has a positive impact on many aspects of business performance – for example productivity, creativity, employee recruitment, employee retention, and satisfaction at work. These proven benefits to business performance lie behind the public sector push to see "EO" adopted more widely in Scotland.

Scotland has seen several businesses take advantage of the new employee ownership trusts. Derek Hamill, of Gilson Gray, worked on one of the first transactions featuring the trust. His client, Midlothian-based Mike Stoane Lighting, completed the transition to employee ownership in October 2014. Hamill describes himself as an enthusiast of the model. “For some companies, the employee ownership trust is the perfect exit solution. It’s not for everyone, but for a vendor who is looking to retain an interest in the business post-transaction and who has a specific desire to involve the employees in the governance and operation of the business, it can fit well.”

CDS is advising and supporting a growing pipeline of companies at various stages of considering or implementing the model.

Deas explains: “We’re often asked which sector, or what size of company, is most suited to employee ownership. The answer is that any healthy business is a candidate. If the vision is there to create a structure that ensures continuity of a successful company in the long term, we can work with firms to achieve that.”

Will employee ownership become mainstream? Deas is confident.

“The potential for employee ownership in Scotland is huge – although like other models it doesn’t suit every ownership transfer. Our aim is that in every relevant instance, EO should be considered as a mainstream option alongside other forms of business transfer. The already strong and growing interest from within the Scottish legal profession will be fundamentally important to achieving that goal.”