Solving succession woes with Employee Ownership Trusts
When it comes to the issue of planning business affairs for the unexpected, the decision-making of what should happen in the future doesn't need to be as dramatic as an episode of 'Succession'
When it's time for a business owner or founder to exit their organisation, it's not quite as simple as picking out the right farewell cake for the goodbye party. Indeed, as demonstrated by Jeff Bezos' move from CEO to Chairman of the Board at Amazon, any sort of ownership transition or succession planning requires careful planning and execution.
Issues that can arise from a hasty exit for small and medium businesses include preserving the legacy of the organisation; protecting the jobs of employees; finding a third party willing to take it on; or (a thorny issue the black-comedy TV series, Succession, makes abundantly clear) picking which family members to pass the company on to.
But according to Andrew Pendleton, Head of the School of Management and Governance, and Professor of Employee Ownership and Reward at UNSW Business School, there is another viable, and possibly more attractive, option for businesses: Employee Ownership Trusts (EOTs). And their benefits don't just extend to solving issues of succession for businesses – from potential bonus payments to share of voice, they extend to employees as well.
What are Employee Ownership Trusts (EOTs)?
"Employee Ownership Trusts are a very simple structure," Prof. Pendleton says. "An employee trust owns all or some of the equity of the company for the benefit of its employees. The principle is that it's a trust that collectively owns the company for the benefit of the employees."
An Employee Ownership Trust differs from other employee benefit plans, such as an employee stock ownership plan (ESOP), in that in an ESOP, individual workers come to own company shares, maximising retirement benefits. An Employee Ownership Trust seeks to maximise benefits for current and future employees.
While there is an array of benefits to implementing this ownership model, a major one is that the sale of the shares to the Employee Ownership Trust (at least in the UK) is free of capital gains tax (CGT). The capital gains exemption kicks in if the trust is hitting certain criteria, such as possessing a controlling interest in the company.
For businesses, it can be a matter of succession
But even without a CGT concession – as is the case currently in Australia – the Employee Ownership Trust still provides benefits to owners and workers, says Prof. Pendleton.
He adds that another major advantage of the EOT model is that employees are protected during business succession. "The big danger is that if the owner wants to retire, and the company is sold to private equity or some other third party, they'll take the goodwill and shut the company down or move it to another part of the country. The EOT very much maintains and protects the company as it is, while facilitating future development and growth."
According to Janna DeVylder, Co-Founder of Meld Studios, an Australia-based design studio, the choice to set up an EOT at the company was based on the issue of succession.
"For the past 10 years, a lot of people that we know that own smaller independent design studios have been acquired by much larger organisations. That felt antithetical to us – we still wanted to be doing the work, we still wanted to be in it. But we didn't want to lose our independence."
DeVylder, who is now a Board Member at Employee Ownership Australia, says the team instead looked into ways that Meld could make their 'Meldsters' owners, and contacted Employee Ownership Australia. From there, Meld Studio started on the journey to becoming the country's first 'test case' for an Australian-originated business as an EOT.
How does an Employee Ownership Trust (EOT) work for the company?
Business owners need to seek the advice of qualified business advisors to start the process of setting up an Employee Ownership Trust in Australia, while Meld Studios chose to take to move to this ownership structure using company profits to buy the co-founders' shares back over time. "So, our equity in the company will decrease over time, and equity for the trust to hold will increase over time," explains DeVylder.
In terms of setting up EOTs, Prof. Pendleton says the owner is largely in control of the process: the EOT mechanism enables owners to control the pace of the transaction and to make a phased withdrawal if they wish.
"The employees themselves are indirect owners," he says. "It's the trust that owns the company, for the benefit of the employees. So, employees individually don't get shares in the company, meaning there is no danger that ownership will eventually drift outside the company."
Big changes: A share in profits and employee ownership
Then there are the various actions the trust might take to involve employees. For example, they might then choose to share the company profits with the employees. "In the UK case, the profits shared with eligible employees are tax-free, as long as they're below the equivalent of about $7000 a year (around £3,600). In the Australian case, as things stand at the moment, they still want to get a taxable profit share," says Prof. Pendleton. "It's also commonly the case that employees would be represented on the EOT."
DeVylder says that for Meld, the choice was made to make it 100 per cent employee-owned from the beginning, despite the co-founders' still owning some of the equity. "We're actually saying, 'No, from the very beginning, we're employee-owned and we're going to behave as if the shares are already over there. Because otherwise, we're waiting five or 10 years to get to a place where people are like, 'Okay, now all the effort I'm putting in is actually going to see a return.'"
What are other benefits of Employee Ownership Trusts (EOTs) for workers?
Aside from bonus payments that are linked to shared profits, there are other potential benefits that the employee (the beneficiaries) – and the company – might accrue in terms of company culture, explains Prof. Pendleton. For example, employees could gain some influence over how the company is run, through increased employee engagement.
"The great thing about EOTs is that it's very flexible in what you choose to do," he says. "You can have employees on the trust. You might decide to put a worker on the company board, or to set up an employee council. They tend to be much more participative businesses after the event."
For Meld Studios, the decision was made to make significant changes to how the company was run to involve their Meldsters in the more formal structures of the company. "We have a Meldster representative that's on the company Board of Directors, and a representative that's on the Trust Board of Directors; they were selected from their peers. We also have what we call a Meldster forum," says DeVylder.
"It's a way to actually create space for your employees to have a say; to shape and shift on where the company is going, and then also to bring up things as well and feel like they have a say." She adds that this process has been important not just in terms of employee involvement at Meld, but helping Meldsters figure out who the company is and what they will become.
EOTs have taken off in the UK – will it happen in Australia?
While the EOT model of employee ownership is yet to really take off in Australia, the model has proved popular in the UK where it has been actively promoted by the government since 2014.
"EOT in the UK has a specific meaning," explains Prof. Pendleton. "It was set up as a tax-advantaged vehicle in 2014 and has a very distinct legal identity in the way that we don't yet have here in Australia."
"In the UK, it was very much based on the John Lewis model," he says, referring to the famous British department store company. "John Lewis has been owned by a trust for the benefit of employees since the fifties. Its employees typically get a share of the profit each year."
Prof. Pendleton says that having the role model gave wind to the effort to try and replicate this to a broader economy in the UK. Today, there are over 730 EOTs operating there, with a 30 per cent increase in 2020 across all sectors of the economy.
While there aren't the same tax mechanisms or tax incentives in place to reap the full benefits of EOTs in Australia, the House of Representatives released a report this August with recommendations to promote employee ownership in Australia. It concluded that in Australia, frameworks to make Employee Share Schemes (ESS) attractive to companies did not exist yet.
"They've called for the Productivity Commission and the Australian Government to take a good look at employee ownership trusts with a view to promoting them here in Australia," explains Prof. Pendleton. "At the moment, you can set up an employee ownership trust, but there aren't the particular tax benefits that you get in the UK."
So, are Australian employees and business owners likely to see a similar EOT setup in the near future? Prof. Pendleton says this is hard to predict (though several companies are currently looking to follow Meld's example). "The Australian Government and the Opposition are generally sympathetic to forms of employee ownership," he says. "But whether they'll go the extra mile and establish a set of specific tax advantages for EOTs, it's just too early to say."
For more information about Employee Ownership Trusts, please contact Andrew Pendleton, Head of the School of Management and Governance, and Professor of Employee Ownership and Reward at UNSW Business School.