Worker takeover
Aardman, creator of Wallace & Gromit, is one of the latest businesses to go for the increasingly popular empoyee-ownership option. Marc Mullen asks if it's a long-term trend or just flavour of the month.
Second-tier employees may not have any significant equity stake, or the means to re-mortgage their house to acquire such a stake. “Owners must have a succession plan,” says Deb Oxley, chief executive of the Employee Ownership Association (EOA), who was awarded an OBE in the 2019 honours for services to employee ownership. “And that plan must be about changing ownership and managing leadership succession.”
Buy-outs are tricky without a proven management team. And buy-ins or trade sales might not appeal to a founder, because they may want the firm they have created to retain its identity. They will also feel protective of the employees who helped build it and fear the impact on loyal staff. Employee ownership, which in many ways was pioneered by the John Lewis Partnership, can address many of those issues. The EOA has been trumpeting about this way of doing things, but word of mouth and what seems like a greater appetite for employee ownership has seen the number of such businesses increase. Since the UK government’s introduction of the employee ownership trust (EOT) schemes in 2014, uptake of the model has grown by about 10% a year, according to EOA figures.
John Lewis is the largest employee-owned company in the UK. The model is mostly popular among architect firms. But a scan of the UK’s 50 largest employee-owned companies shows a broad range of industries: engineering consultancies (Mott MacDonald, Arup, CH2M, BMT, Black & Veatch); logistics (Unipart, Steer Davies & Gleave); social care and healthcare services (Shaw Healthcare, Bristol Community Health, Medway Community Healthcare, Locala Community Partnerships, Care & Share Associates One); retail (Riverford Organic Farmers and Oldrid & Co); manufacturers (Gripple and Scott Bader); and leisure (Alfa Leisureplex). In November 2018, Aardman made a high-profile transfer to employee ownership. The Bristol-based stop-motion animation studio behind Wallace & Gromit and Shaun the Sheep transferred 75% of its shares into an EOT.
In a joint statement, Peter Lord and David Sproxton, who together founded the company in 1972, said: “We’re not quitting yet. But we are preparing for our future. The creation of an employee trust is the best solution we have found for keeping Aardman doing what it does best – keeping the teams in place and providing continuity for our highly creative culture. Those that create value in the company will continue to benefit directly from that value.” Sproxton will continue as managing director (MD) for now, accountable to the EOT, but a new MD will be appointed some time this year, when Sproxton will move into a consultancy role. “Employee ownership requires two things,” explains Oxley. “There must be a mechanism where the ownership can be shared among all employees.
Equally the business has to have a culture and a structure where employee influence and voice can be shared. The two are intrinsically linked.” Otherwise all of the benefits will not be achieved.
Not a panacea
In July 2018, the business-led Ownership Effect Inquiry published its report, The Ownership Dividend. Chaired by Baroness Bowles of Berkhamstead, the Ownership Effect Inquiry is overseen by a number of business organisations, including ICAEW. According to the report, the employee-owned ‘sector’ accounts for well over £30bn of turnover in the UK. In her foreword, Baroness Bowles wrote that the sector is “thriving and fertile”, but noted that the model is not necessarily “ideal”. Nor is its impact automatically and universally transformative – it “must be worked for”. The report found that among employee-owned businesses, there were increased levels of productivity and efficiency, improved workforce retention, easier recruitment and employee-driven innovation. And longer-term decision-making seems to lead to greater resilience.
What's not to like?
One EOT characteristic for the selling founder is that they usually will not get full payment on completion. Another is that a philanthropic owner may compromise on price. And then there is how the deal is funded. Richard Cowley, a director at RM2 Corporate Finance – a specialist adviser on EOTs – explains: “With an EOT, the trading company effectively funds the transaction itself, so the majority of transactions are funded by vendor loans or deferred consideration. “These are repaid by the trading company, although excess cash could be used to make a repayment at completion. A minority will also get third-party bank debt again taken out by the trust, which will also be repaid by the trading company. Taking on third-party debt will allow vendors to receive a larger payment on completion. Vendor loans would be expected to be subordinated to the third-party lender.” Because of the leverage the trust – and by extension the trading company – has taken on, raising capital for growth can be limited. Being people-heavy and asset-light, there may be little security against which to raise debt for growth.
However, providing it is well structured, there will be headroom in the repayment schedule, which allows for operating cash to fund growth. “In almost any exit, be it an MBO or employee buy-out, debt coming into the structure somewhere does limit the ability of the business to invest,” says Ewan Hall, director at Baxendale, which advises on employee ownership transitions. “It is inevitable, and it will be the case for a period of time.”
Another solution, says Andrew Rutherford, commercial director at Arbuthnot Commercial Asset Based Lending (ABL), is to use an ABL facility to fund growth. “It’s good that employees are investors in the business, and by working harder can grow,” he explains. “The capital requirements for that work well with our facilities because they are revolving and grow as the business grows. The challenges are making sure the management team are locked in so that they can drive the business forward to repay us.” Martin Cooper, RSM director, says: “One potential disadvantage is the inability to get cash out. It may be too early to see the sales of EOT businesses. But it’s long-term patient capital, which is what the founder wants, because they want to see the name remain and their business continue to grow.” This is a sentiment echoed by Anna-Louise Shipley, a corporate finance manager at Buzzacott. She says the employee ownership model is presented as an alternative option when speaking to owner-managers: “Rather than just being a stepping stone to a trade sale or a private equity buy-out, it’s an alternative succession option.
An EOT offers an attractive route for those prioritising the legacy and culture of the business. It’s more a philosophical decision than a financial one.” Hall says EOT businesses are approaching an interesting point: “There was a bubble of businesses that transitioned to an EOT structure in 2014 (as most organisations looking to transition in 2013 waited until 2014), that are now coming out of the repayment period. It’ll be interesting to see what those businesses do now they have more cash. They can take some more risk and invest for growth, save some for a rainy day or crank up the dividend. Or they can do a blend of all three.”
About the author
Marc Mullen