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Whether you’re looking at succession planning or for a way to boost business performance, employee ownership may be the answer, writes Douglas Roberts from Lindsays’ Corporate and Commercial team.

Employee ownership is big news right now. The Scottish Government is backing a plan to make Scotland the ‘best country in the world for employee-owned (EO) businesses’ and wants to increase the number of EO businesses fivefold by 2030.

According to First Minister Nicola Sturgeon, “All the evidence tells us that employee ownership delivers benefits to business performance, the people who work in them and the places in which they are located.… We want to make it easier for companies and workers to find out more about this model.”

Moreover, support for employee ownership comes from all parts of the political spectrum, both north and south of the border – certainly a rare thing in business and politics.

More than an exit strategy

Employee ownership is sometimes pigeonholed as an exit strategy or succession planning. It’s certainly true that it’s an excellent solution here but it’s more than that, as the Scottish Government has usefully highlighted. Numerous studies have shown how EO businesses outperform other types of business (see Box on ‘The Business Benefits’).

There are also tax benefits for both owners and employees. Owners who sell more than 50% of a company to employees receive capital gains tax relief (as long as certain conditions are met) so they pay no capital gains tax on the sale. Owners can retain a minority stake so they can still benefit from future profits and a sale. Furthermore, staff in an EO business are eligible for (but are not guaranteed!) a tax-free annual bonus of up to £3,600.

Increasing popularity

The Scottish Government’s plan involves funding an industry leadership group to drive growth in this area but there’s no need to wait for its work to be finished. There are already over 100 EO businesses in Scotland, generating combined turnover of around £940 million.

Take-up of the model is accelerating, according to Sarah Deas, a director at Scottish Enterprise and Head of Cooperative Development Scotland (CDS) which supports businesses to move to employee ownership. Deas reports that CDS has been working on a deal a month on average in the past year: “Our client pipeline is expanding too, indicating take-up of the model will continue to accelerate”.

The Scottish Government wants to have 500 EO businesses in Scotland by 2030. To support this, Co-operative Development Scotland offers businesses three days of free support to help them explore the options.

Different types of employee ownership

There are three types of ownership available, each with its own pros and cons:

  • Direct employee ownership – where employees become individual shareholders. Benefits of this include employees feeling directly engaged in the future of the company. However, each time an employee moves on the shares need to be transferred to someone else, with commensurate paperwork to be done and potentially stamp duty to be paid.
  • Indirect employee ownership – where shares are held collectively on behalf of employees, normally through an Employee Ownership Trust. This offers simpler ongoing administration and quicker decision-making than direct employee ownership.
  • Hybrid ownership – this combines the two with some of the shares being held by a trust and other shares by individual employees (and sometimes the departing owners). These structures are the most common in practice with, for example, a new CEO or other directors holding a minority stake with the trust holding the rest. The flexibility of hybrid ownership allows for the current owners to scale down their holding over time and make a phased exit from the business (good for continuity) or for shares or share options to be held by the new management team to attract or incentivise the new driving force of the business.

Each of these options is more or less attractive in different scenarios so experienced, tailored advice is important. In each case, there will be practical and commercial decisions around, for example:

  • the value of the business
  • employee engagement and incentivisation
  • how to raise finance to buy out the owners
  • the tax implications
  • the pace of the buyout
  • governance.

All decisions about moving to employee ownership also need to be made in the wider context of tax, employment law, protecting intellectual property and other assets, and the overall financial climate and landscape for raising finance (either through mainstream lenders or other sources). If the business is family-owned there may be relationship and succession issues to factor in as well. Therefore, any move towards EO should be made with advice from EO advisers, lawyers and accountants who have expertise in this area.