Employee ownership: ensuring succession at your firm

23 June 2016

Stephen Chater asks: is it time to consider employee ownership to ensure succession at your firm?

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The ownership of surveyors’ businesses typically tends to follow a traditional model in which control is restricted to a relatively small number of partners or shareholders. To a large extent, this model has stood the test of time, but increasingly it is under pressure from changing expectations among younger practitioners who are less prepared to commit the same amount of time and money.

Practice owners wishing to retire and be paid for their stake may find that younger employees who are seen as prime candidates to replace them will often be unwilling or unable to make a capital contribution, removing the traditional source of funds used to buy out retirees. Furthermore, there are generally few external buyers, making a trade sale a pipe dream for all but a handful of businesses.

These issues are shared by many other professional practices. Some are addressing the problem by moving to a new model, in which all or most of their workers can acquire a stake: this model is employee ownership.

Why employee ownership?

Surveyors’ firms are no different from other professional organisations in some ways. They rely heavily on the skills of their people, a strong team culture is critical to long-term success and they take pride in providing a quality service. These reasons alone may be sufficient to consider the potential merits of employee ownership, but there are others.

Businesses are finding that giving everyone a stake in the organisation is both compatible with their strategic objectives and could help staff in their careers

1. Employee-owned companies tend to outperform their peers against a number of measures. Evidence shows greater productivity and employee satisfaction, stronger growth and more resilience.
2. The 2nd benefit stems from the 1st and takes the form of 2 new tax incentives, which are intended to encourage more businesses to extend their ownership to all employees. They have been introduced as a result of the government’s belief that a growth in the number of employee-owned businesses makes sound economic sense.

More businesses are finding that giving everyone a stake in the organisation through employee ownership is both compatible with their strategic objectives and could help staff in their careers.

Current employee-owned businesses

Employee ownership is being adopted as a new model by property-related businesses, such as the architecture practice Norman Foster, engineering consultancy Arup and construction bodies, together with other professions such as accountancy, law and patent agents. Each has their own reasons for the shift to employee ownership, but their common conviction is that their business will thrive as a result, benefiting from longer-term staff commitment and a stronger team ethos.

What are the tax incentives?

In 2014, the UK government introduced 2 statutory tax reliefs to encourage employee ownership among companies.

• The 1st is aimed at existing trading company owners and provides them with the opportunity to sell a majority stake to an employee-ownership trust entirely free of capital gains tax.
• The 2nd enables any trading company, a majority of which is owned by an employee trust, to pay annual bonuses to staff free of income tax (with a maximum of £3,600 per worker per year).

In both cases, strict rules govern how workers can gain from the trust and how tax-free bonuses can be paid, to ensure that benefit is spread fairly among employees. This does not prevent the organisation rewarding selected workers more generously than others, but any bonuses not within the ‘all-employee’ requirement will be taxable. It is also possible for chosen employees to acquire more shares than others, so long as these do not come from the trust and the trust retains control of the company.

How does it work?

Where employee ownership is introduced, the transition will often proceed like this:

• the company, partnership or LLP commissions a valuation
• once the valuation is produced, the business looks at its anticipated future cash flow to determine how long it may take to fund the purchase of shares from existing owners
• if the valuation and anticipated time period for payment are acceptable, the company sets up an employee ownership trust (if the business is a partnership or an LLP, the 1st step will be to incorporate it)
• the trust agrees to purchase a majority stake, up to 100% of the company, paying a fixed price but over a period of years, funded out of the company’s future surplus profits.

The sellers will be exempt from capital gains tax on their sale proceeds, and as soon as the company is able to pay bonuses it will be able to do so free of income tax.

Do employees acquire shares personally?

This will depend on what the company thinks would work best. Employees can acquire personal shareholdings from the trust, so long as they are each entitled to the same amount of shares or differing numbers according to their salary, length of service or hours worked. There are additional statutory tax reliefs, such as the share incentive plan (SIP), which can significantly reduce both the cost to employees of acquiring shares and the impact of any tax incurred on subsequent growth in their value.

Tax incentives are encouraging more business owners to consider a new succession route as an alternative to a sale to a 3rd party

Individual share ownership is favoured by some employee-owned firms, because it is often considered to be more easily understood and offers staff the prospect of capital gains on their shares. However, a firm might not anticipate significant growth in its value, reducing or eliminating any opportunity for employees to make a profit from their investment. It can also be time-consuming to administer, since arrangements will normally have to be made to award shares to new employees and buy back shares from leavers.

The alternative approach is for the shares to continue to be held in trust on behalf of the employees. This structure has been adopted by the architectural practice Make, engineering consultancy Arup and retailer John Lewis, with the trust managing 100% of shares in each case. The financial benefit to employees will probably take the form of an annual profit share that creates a performance incentive and organisational benefits, such as building a participative and transparent culture. This helps to create fulfilling roles and, indirectly, a financially successful practice.

What if not all the current owners want to retire?

The tax incentives attached to employee ownership can be enjoyed so long as the trust acquires more than 50% of the company, so this will often be possible if some existing owners wish to continue.

If none or not all of the existing owners intend to retire, an employee ownership trust may not be the right solution. Alternative approaches are likely to exist, including:

• allowing all employees the opportunity to acquire shares personally, for example, benefiting from the tax incentive of an SIP
• allowing a more limited range of employees to acquire shares (or to be granted options to acquire shares in the future)
• setting aside a specified percentage in an employee trust, representing a claim by employees as a whole to the same percentage of annual profits.

Conclusion

These tax incentives are encouraging more business owners to consider a new succession route as an alternative to selling to a 3rd party, and they create an opportunity for employees to receive a higher net share of any future profits. Employee ownership is not always appropriate and will not necessarily work successfully in every practice. For example, there are no doubt some firms that genuinely believe that only a limited number of partners or employees are sufficiently experienced or committed to take on the responsibilities of ownership.

It is not a matter of 1 size fitting all. A business might understand the possible benefits of employee ownership, but may want to retain stronger financial incentives for its management team. In such a case, the firm could combine employee ownership with higher-level rewards, including more significant shareholding or share options for management team members.

Stephen Chater is Share Plans Director at the law firm Postlethwaite, an employee-owned business

Further information 

This feature is taken from the RICS Property journal (May/June 2016)