Lessons to be learnt by those exploring employee ownership models

The John Lewis Partnership, as the UK’s largest employee-owned businesses with around 80,000 employee owners, has for many years been the standard-bearer of employee ownership, with its success serving to encourage others to explore and, in some cases, adopt a similar model for their own businesses. The recent news that it is considering raising investment that could potentially cause it to no longer be 100% employee-owned has drawn a varied response but it highlights an important point of for others exploring an employee ownership model.

The difficulty in accessing equity funding is at the heart of the challenge for not only John Lewis, but some other employee-owned businesses in similar situations now and in the future. For companies structured to meet the 2014 legislation offering tax incentives for owners of businesses becoming employee-owned, the ‘controlling interest’ requirement means that the employee ownership trust (EOT) needs to maintain a majority equity stake in the company (>50%) at all times to avoid adverse tax consequences.

Whilst a minority equity investment is a possibility, and some EOT-controlled companies have gone down this route, the fact that this cannot be a majority stake (without triggering tax charges) limits the range of potential investors. Most UK equity investors have a relatively short investment horizon (typically three to five years) and high expectations in terms of their return on equity and this can be difficult to align with the objective of long-term employee ownership. Patient capital, investing on a much longer time horizon for an expectation of dividend income and/or steady growth, is relatively scarce. For these reasons, whilst debt finance is common in employee-owned businesses, equity finance is much less widespread.

Whilst John Lewis has of course been owned by its employees for many years, this does highlight some circumstances where an EOT may not be the most suitable form of transaction for shareholders considering an exit. In the right circumstances, employee ownership can bring continuity, protect the position of employees, provide for employees to share in the fruits of their efforts and protect the legacy created by the founding shareholders. An EOT may not, however, provide the capital investment that some companies need to grow (or even survive) and therefore is more likely to suit cash-generative and profitable businesses than those in need of investment in the short or medium term.

It should also be accepted that a company’s circumstances can change over time and for some employee-owned companies an alternative form of ownership may, at some point, become the right solution for the business and its employees. This could be the result of strong performance, which may result in the trustees deciding that it is in the best interests of beneficiaries to realise value for their shares, or less favourable circumstances which mean that the company needs to take on board an investor holding a majority equity stake. 

Since 2014, RSM has advised almost 100 companies moving into employee ownership; the vast majority of these have thrived under the EOT structure and it remains an excellent model for ownership for many companies and a succession solution for shareholders. However, in many other circumstances, we have advised businesses that an EOT may not be the right ownership structure for them; choosing a succession strategy and ownership model is a significant decision and should not be driven by tax factors alone.