engine of growth

Exploding thE myths about EmployEE ownErship

SPeCiAL eDition

~world class business professionals~

theCA

in association with

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EMPLOYEE OWNERSHIP in assoCiation with

welcomemarCh 2012

So what do we mean by an employee owned business?

An employee owned business is one in which the employees, rather than external shareholders, hold the majority of the shares, either directly or through an employee benefits trust which buys the business on their behalf.

Typically this ownership model will involve a trust, set up on behalf of the employees, which buys the business with capital raised through a combination of debt and equity. The cost of this capital is then paid back over time from the company’s own profits.

Employee ownership is often combined with share or share option schemes, built into the company’s remuneration structure.

This model is quite different from a

typical management buyout. Generally, ownership is distributed amongst all of the employees, and the ownership structure is set up for the long term, not for a relatively short-term exit.

EOBs now account for more than £25bn in total annual turnover in the UK, according to research carried out for the Employee Ownership Association.

John Lewis, probably the best-known UK business with an employee ownership model, recorded revenue of £8.2bn for 2010/11 (an increase of 10.8 per cent on the previous year) and profit of £431m (also up 10.8 per cent).

A study in the UK by Cass Business School for the John Lewis Partnership also found that employee owned businesses (EOBs), particularly small to medium-sized enterprises, show stronger growth and create jobs faster than their non-EOB equivalents. The study also showed that EOBs are more resilient through the downside of economic cycles.

Employee ownership represents an attractive exit strategy for a business owner who is looking to benefit from the value they have created in the business, without

jeopardising its long-term legacy. Also, the transfer can be staged over a period of time.

So why don’t advisers know more about it? Accountants, lawyers and other professionals often don’t consider the EBO alternative because, in many cases, they have no direct experience of it.

That’s something that we, in association with Co-operative Development Scotland, set out to

address with a series of columns in The CA magazine on “Exploding the Myths”

about employee ownership. This publication brings all four columns into one guide, and also includes two case studies showing how employee ownership worked out for two very different

businesses. I hope you find it helpful!

ContentS

3 Foreword by Sarah deaS, Co-operative development SCotland

4 exploding the mythS: 1 & 25 CaSe Study: ClanSman

dynamiCS6 exploding the mythS: 3 & 47 CaSe Study: aCCord energy8 ContaCt detailS

when the worKerS Are the ownerS

robert outram iS editor oF the Ca, the magazine oF the inStitute oF Chartered aCCountantS oF SCotland

email rob@ConneCtCommuniCationS.Co.uk Follow uS on twitter.Com/theCamag

morE than just a fair sharE

between 1992 and 2011, the Employee ownership index – which tracks the share valuations of the leading uK employee owned businesses – outperformed the ftsE all-share by 200 per cent.

Handing over a company to its workers might sound like the opposite of hard-nosed capitalism. In fact, argues Robert Outram, the evidence shows that a business that is wholly or largely in the hands of the people who work there has a better chance of being profitable, and of growing, even in difficult economic conditions

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exPLoDing the MythS

looking to move on?

as many as 63 per cent of business owners in scotland plan to exit their business in the next five years, but 42 per cent do not have a strategy for doing so. deloitte Entrepreneurial business survey 2011.

the Exploding the Myths series of articles from CDS, in partnership with The CA magazine, has shared some

of the “surprising but true” facts about employee owned businesses and the potential they have to make a much wider impact on Scotland’s economy.

We have shown that employee buyouts attract support from funders and investors. We have highlighted that employee owned businesses tend to be more productive and more profitable than other business models. And we have demonstrated that an employee buyout can realise a fair and attractive deal for exiting business owners.

By concluding the series, I would like to highlight two compelling examples of employee ownership as a model that drives growth: Clansman Dynamics and Accord Energy.

Clansman Dynamics is an East

Kilbride based leading manufacturer of robotic handling equipment. The company became employee owned in late 2009, since when turnover has soared by more than 60 per cent, from around £7m to over £11m. Former owner and now chairman, Dick Philbrick, attributes the remarkable success of the business to employee ownership, saying: “Productivity, profitability and innovation have all flourished, but importantly, the employees have prospered and that is the key reason for the success of the business.”

Accord Energy is an Aberdeen-based specialist hydrocarbon accounting business that was only launched in August 2010. The company has recently begun the transition to employee ownership in order to drive productivity, innovation and growth. Turnover is on track to reach £4m next year, and

director Alan Spence says: “Employee ownership is a key factor in our drive to grow the business.”

Scotland has other outstanding examples of successful businesses that are employee owned, including Hebridean Jewellery, Tullis Russell and Woollard and Henry. Many other businesses could enhance their performance by adopting employee ownership as their own “Engine of Growth”.

Advisers have a key role to play by placing employee ownership as an exit and a growth option to their clients. We would like to see that option tabled more widely as Scotland’s economy stands to gain significantly by an expansion of this model.Sarah deaS iS ChieF exeCutive oF Co-operative development SCotland (CdS), whiCh SupportS the development oF Co-operative and employee-owned enterpriSeS aCroSS SCotland. CdS iS a SCottiSh enterpriSe SubSidiary, and workS in partnerShip with highlandS and iSlandS enterpriSe www.CdSCotland.Co.uk

Sarah Deas explains why it is so important to tackle the misconceptions about employee ownership

EMPLOYEE OWNERSHIP in assoCiation with

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It is often assumed that when a business is sold to its employees it somehow becomes inefficient and potentially less viable.

In fact, there is a growing body of evidence to suggest the opposite is true – that greater employee involvement in ownership and decision-making leads to a wide range of tangible and intangible economic benefits.

The Employee Ownership Index from law firm Field Fisher Waterhouse, for example, shows that employee-owned companies have outperformed the FTSE All-Share by an average of 11 per cent a year over the last 17 years.

A study by the Employee Ownership Association last year found that employee ownership can improve employee engagement, rates of innovation, business sustainability and productivity.

Separately, London’s highly-regarded Cass

Business School has reported that employee owned businesses are often more profitable than conventional businesses and create jobs more quickly – even in difficult economic times.

There is striking evidence from businesses themselves. Tullis Russell, the employee owned papermaker, has seen its productivity increase by 185 per cent since its employee buyout in 1994. At Loch Fyne Oysters, which was employee owned until its sale to Scottish Seafood Investments this year, staff turnover is less than half the national average. Quintessa, its employee owned scientific consultancy, has higher sales and profit growth than the largest competitor.

We now know that by having a greater say in how their workplace is run, employee owners enjoy enhanced levels of satisfaction, motivation and lower stress. Productivity

and efficiency rise because employees are empowered to make decisions.

Perhaps most importantly, customers are happier because every employee has a vested interest in the firm’s performance, leading in turn to enhanced levels of service and diligence.

For business owners thinking about retiring or exiting their business, employee ownership gives them the opportunity to safeguard the company’s future, whilst also providing a powerful platform for growth.

We now know that employee owned businesses have the power to deliver a dividend that is wider, deeper and longer lasting than many other business models.

If more business owners considered employee ownership as a succession solution, Scotland’s economy would reap the benefits – for the long term.

There are many myths about employee ownership. Perhaps the biggest is that employee buyouts (EBOs) aren’t easily financed.

There is a common misconception that the employees can’t afford to buy the business. Even if they could, they wouldn’t want to. It would saddle the business with too much debt, and the business owner would be left out of pocket.

These are misleading assumptions, and they are getting in the way of more employee buyouts.

The facts speak for themselves. Right now, Co-operative Development Scotland is seeing rising interest in EBOs and recently has helped advise those of Clansman Dynamics, the robotic handling specialist, Galloway & MacLeod, the agricultural supplier and West Highland Free Press, the Skye newspaper.

Businesses transferring to employee ownership are generally well established and profitable, with a good credit history and debt servicing record. This makes them good investment prospects.

Contrary to popular belief, employees don’t need to provide personal guarantees to secure funding for an EBO. Instead, an Employee Benefit Trust (EBT) is set up to buy the company on their behalf raising debt and equity

from specialist and mainstream providers. This can include term loans secured on the

business assets - plant, machinery, property, debtors. “Patient” equity finance is provided by specialist funders such as Baxi Partnership, who provide specialist support and investment for employee owned companies. Baxi can invest from its own fund and leverage co-investment from partners.

Sometimes the seller provides a long-term loan to help finance the deal. Employees don’t have to put money in, but very often they want to. It makes ownership “real” and drives their engagement. The trust then repays the debt from the company’s profits over a period of time. Shares can be distributed to employees directly and through share schemes.

The vendor gets a fair price. However, often this isn’t their prime motivation. Growing the business, securing its independence and maintaining employment

in the local community tend to be more important.

Employee owned businesses are widely acknowledged to be highly productive, profitable and sustainable.

In uncertain economic times, this makes employee buyouts a “win-win” for the vendor, employees and investors alike.

There is nothing really to stop more EBOs, least of all the financing myth.

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words by sarah dEas

Part s 1&2

Do employee owned businesses perform?

ExPLOdINg tHE MYtHS: EMPLOYEE buY-OutS

What financing problem?

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Clansman turnover soars 60% since eBoe

ngineering business Clansman Dynamics has grown turnover by more than 60 per cent - from £7m to £11m - since its

employee buyout in 2009.Based in East Kilbride, the company

is a global leader in robotic handling equipment for forges, foundries, steelworks and waste processing plants. Clansman exports more than 90 per cent of production to international clients including Volvo, Fiat and Kamaz (Russia’s largest truck manufacturing business). It currently employs 38 people – an increase of five since the employee buyout – and is recruiting additional mechanical engineers and shop floor staff.

Dick Philbrick, who founded the business in 1994, has long been a passionate advocate of employee ownership and its benefits. He says: “I wanted to find a form of ownership that was anti short-termism and would keep the business in Scotland. Employee ownership will allow us to focus on

long-term growth, develop an increasing range of technically difficult products and build the business in a highly competitive market.”

Co-operative Development Scotland and Baxi Partnership, the employee ownership investment vehicle, helped create a funding package to buy the business – including a tax-efficient Employee Benefit Trust (EBT) – and advised on the transition to employee ownership.

Scottish Enterprise has also worked intensively with Clansman Dynamics, offering a tailored and integrated package of business support to help the company achieve its growth ambitions.

Directly elected employee directors sit on Clansman’s main board and the board of the EBT. All Clansman employees meet monthly over pizza

and coke. “Anybody can raise anything, and

everybody is made aware of profits, sales, spares or warranty issues,” Philbrick explains.

Greater employee engagement has led to improved productivity, profitability and innovation, including improving the way Clansman orders, stores, inspects and assembles the 2,000 parts required for each machine. The factory assembly area has just been doubled in size, and two new designs of machine are in the pipeline for the company.

As Philbrick puts it: “Everybody now understands that a 5 per cent saving on the £6m a year we spend on parts is a huge sum of money. It means we’re now more focused on good financial, as well as technical, solutions.”

Engineering entrepreneur Dick Philbrick wanted to realise the value he had created in his business, but he also wanted to secure its long-term future

ClanSman dynamiCS waS Founded by diCk philbriCk (piCtured above, at leFt) in 1994. itS “manipulatorS” operate in Some oF the tougheSt manuFaCturing environmentS in the world but Continue to provide Supremely robuSt high-teChnology SolutionS For material handling in ForgeS, FoundrieS, SteelworkS and even garbage handling For energy ConverSion. the Company’S CuStomer baSe inCludeS Some oF the world’S beSt known manuFaCturerS.

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We often hear the comment that employee buyouts generally do not maximise a return to the exiting owner.

Business owners are often advised to pursue a trade sale, or to market the business to a management buyout team.

The theory is that the price will be maximised on the open market.

This is unfortunate because an employee buyout can easily match or even exceed offers from other sources.

It is often assumed that a business owner is only interested in maximising the sale price.

In fact, research shows that business owners, particularly those in the second or third generations, are greatly concerned about the future of the business.

If an employee buyout retains the business and jobs in the local community, owners will give that option every consideration. Even more so if the offer price is competitive, which is usually the case.

We also know from research that employee owned businesses can be more productive, more profitable and more able to weather the ebb and flow of the economy than other, more traditional business models. From an economic development perspective it is important that the business community

supports the creation of more employee owned businesses.

There is a growing pool of successful employee owned businesses. By helping to “explode the myths” surrounding these types of business, we hope that employee buyouts will be tabled more widely.

The employee buyout option can be a “win-win-win”.

They are good for exiting owners, they are

good for employees and they are good for Scotland’s economy.

The only thing preventing more employee buyouts is the idea that they do not provide the best financial deal.

Nothing could be further from the facts.Research shows that business owners,

particularly those in the second or third generations, are greatly concerned about the future of the business.

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Are employee benefit trusts finished?

A good deal?

Employee buyouts typically involve the use of an employee benefit trust (EBT), which raises funds to buy shares in the company on behalf of its employees.

It’s a model that has worked well for years – and continues to be a key mechanism in the creation of employee owned businesses.

But could there be trouble ahead? There is growing concern that “disguised remuneration” legislation introduced in 2011 could give rise to unexpected tax charges if EBTs are used to “reward” employees. This has led to speculation amongst advisers that the legislation could be the beginning of the end for these trusts.

EBTs have been used increasingly to provide income for employees, and to avoid or defer the income tax and national insurance contributions on that income. Consequently, HM Revenue & Customs has been examining the application

of EBTs for some time, and in December 2010 draft legislation aimed at tackling aggressive tax planning using EBTs was published. This has become known as the “disguised remuneration” legislation.

It is looking to prevent remuneration and loans being provided through third parties, such as EBTs, and thereby avoiding income tax and national insurance contributions. The first version of the legislation was very widely drafted and, as such, many EBTs would have been adversely affected.

But the legislation was substantially revised both before and after it took effect on 6 April 2011, and a series of FAQs published on HMRC’s website has considerably (although not completely) clarified the position on EBTs.

EBTs could still be caught by the “earmarking” charge in the legislation, but there are specific

exclusions from this charge for EBTs. Conditions apply to those exclusions, so they will have to be considered carefully in each case.

There is still a central role for EBTs in employee buyouts – but care needs to be taken to ensure that tax charges are not triggered as a result of the disguised remuneration legislation. As long as they are created with attention to the above, EBTs are likely to be with us for some time yet.

There is sTill a cenTral role for eBTs in employee BuyouTs, BuT care needs To Be TaKen

SARAH DEAS

ExPLOdINg tHE MYtHS: EMPLOYEE buYOutSPart 3 & 4words by sarah dEas

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Accord Energy, a fast-growing specialist hydrocarbon accounting business, is embracing employee

ownership to accelerate growth and a move into new markets, including overseas.

The Aberdeen-based company is being advised by Co-operative Development Scotland and Baxi Partnership, the employee ownership investment vehicle, as it sets up a Share Incentive Plan that will allow employees to buy shares in the business. An Employee Benefit Trust (EBT) will then be created to buy the business on behalf of the employees using company profits.

“The management team realised that our business would benefit by creating a structure and environment that attracts really talented people and supports and rewards them for helping grow the business,” explains Alan Spence, who co-founded Accord in 2010 with fellow directors James Arthur and Phil Stockton.

“We’ve been delighted with the response, from both staff and clients, and are confident that employee ownership will be a key factor in our drive to grow the business.”

Accord Energy currently employs 19 staff and ten associate consultants. Growth is significantly ahead of plan and the business is targeting turnover of £4m by 2013.

Hydrocarbon accounting is essential in tracking the ownership of oil and gas products from fields with multiple partners. Accord’s services include allocation engineering, measurement, systems delivery, auditing, operational support and training. The company has a growing client list of more than a dozen international oil and gas businesses.

The founders currently own a third of the company each. The EBT, to be set up by August 2012, will ultimately hold at least 50.1 per cent of the shares, with the remainder split between a Share Incentive Plan (SIP) and the founders. The founders will each retain a 10 per cent stake in the business, leaving approximately 20 per cent of the shares in the SIP.

The SIP will allow employees to buy shares and be rewarded for their contribution tax-effectively, and provides a mechanism for Accord to compensate “early joiners” for taking the risk. The founders will sell their shares to the EBT and SIP over a five-year transition period.

eMPLoyee ownerShiP fueLS growth for ACCorD energy

A new share incentive plan at the hydrocarbon specialist should help to motivate staff

We’ve Been delighTed WiTh The response, from BoTh sTaff and clienTs, and are confidenT ThaT employee oWnership Will Be a Key facTor in our drive To groW The Business.

AlAn SpEncEpiCtured above, From leFt to right: aCCord energy direCtorS JameS arthur, alan SpenCe and phil StoCkton believe employee ownerShip will help their buSineSS to attraCt the beSt people