Co-op option can pay dividends

HAVING worked on a kibbutz in his youth, Dick Philbrick always knew he would eventually want the ownership of his own business in the hands of his employees.

He and two others founded Clansman Dynamics in East Kilbride in 1994, making massive robotic manipulators for the forge and foundry industry. Philbrick's partners, however, were not so keen on the employee ownership model. He was forced to purchase their stakes to pave the way for an eventual employee buy-out.

Ownership of Clansman, with about 7 million in annual sales, transferred to its 32 staff on 18 December. What was already a successful business has in the ensuing months gone on to increase its sales and profitability, according to its managing director.

"It was doing well before, but now it is doing even better," Philbrick says. "There weren't too many secrets before, but now there are none. The atmosphere is so good that people will confess to mistakes. There is a lot of value in recognising your mistakes."

In this context, Clansman is not unique among employee-owned businesses. Recent figures released by trade body Co-operatives UK show that despite the impact of the recession, employee-owned enterprises raised their turnover by 15.8 per cent during the past year to nearly 34 billion. During the same period, UK GDP fell 4.9 per cent.

In addition to the improved performance that comes with staff ownership, there was another key reason why Philbrick chose to pursue an employee buy-out. Though he continues to work at Clansman, the managing director is approaching his 60th birthday, and needed to face up to what would happen when he eventually retires. Trade buyers were interested in doing a deal, but all of them were located in the Far East.

"I knew that in a couple of years' time, if trading got tough, this operation here in East Kilbride would cease to exist," Philbrick says. "It would be closed and the jobs would move abroad. This form of ownership is the best for keeping it here."

Scotland has a long history in the co-operative movement, dating back to the establishment of the Fenwick Weavers Society in East Ayrshire in 1761. It is believed to have been the world's first organisation based on co-operative principles.

This was followed in 1810 by the pioneering establishment of New Lanark, where Robert Owen built a complete community for the workers in his cotton mills. His paternalistic yet visionary approach to the health, education and general well-being of the working class gained the South Lanarkshire commune a worldwide reputation.

In Edinburgh, a group of working men roused to action by widespread poverty met in 1859 and agreed to form a co-operative society. Their first St Cuthbert's food store, opened in November of that year, was the forerunner to today's Scotmid group.

Though these and other co-operative initiatives touched the majority of Scottish lives during the 19th and 20th centuries, the business community today is largely unaware of the employee ownership model.

According to Co-operative Development Scotland (CDS), the Scottish Enterprise subsidiary charged with supporting the development of co-operative and employee-owned businesses, although only about 50 of the country's estimated 300,000 firms are owned by their staff, these enterprises have a combined turnover of 700m and employ more than 4,500 people. The most famous names include John Lewis, papermaker Tullis Russell, the Loch Fyne food group, fund manager Martin Currie and advanced technology manufacturer Gore, best-known for its Gore-Tex fabric.

Sarah Deas, chief executive of CDS, says perception is one of the biggest challenges her team faces when it comes to adding to this list of employee-owned businesses. Many still recall the Meridian workers' co-operative of the late 1970s, which failed to save Triumph's Bonneville and Tiger motorcycle manufacturing operations despite heavy government backing.

"What it isn't is a model for a business in distress," Deas emphasises, adding that too many people still regard an employee buy-out as a deal of last resort.

In addition to raising awareness among business owners, Deas would like better information spread across the corporate advisory community. Often these professionals fail to raise the possibility of employee ownership when a company faces succession issues, choosing instead to stick with the tried and tested path of either a management buy-out or a trade sale.

"The easy thing is not to look beyond the mainstream," she says. "The easy thing is to go the mechanical route. My ambition is that the EBO (employee buy-out] becomes as well-known as the MBO."

One factor that often confuses the issue is the term co-operative, which is an umbrella phrase for a number of different models. In addition to employee-owned businesses, there are also consortia organisations such as the Merchant City Tourism & Marketing Co-operative, which aims to draw more people into the shops, restaurants and attractions owned by its 180 members. Meanwhile, consumer and community co-operatives are aimed at developing or saving local services, such as the Dunbar Community Bakery which launched in June last year. Activity in this sector is expected to rise as government spending cutbacks force a search for alternative ways of delivering services currently undertaken by local authorities.

Although covering the whole of Scotland, CDS's remit is to focus upon profit-generating projects, rather than the social enterprises likely to dominate the flow of activity from local government belt-tightening. Deas says activity across the co-operative spectrum is on the rise, as more than 100 new clients have come through CDS's doors since the start of April.

Carole Leslie, managing partner at Baxendale, agrees there is rising awareness of the benefits of employee ownership. She believes the fall-out from the banking crisis and subsequent recession has many looking for alternatives to traditional ways of doing business.

Leslie's firm specialises in advice to the employee buy-out sector, and is currently working on eight such deals in Scotland. Last year, Baxendale completed only three.

Though the recession appears to be driving the popularity of employee ownership, Leslie believes the trend will hold through the upturn as people discover its lasting benefits. However, she warns that just as it is not a panacea for a failing business, it also can't change the ethos of an operation overnight.

"One of the disadvantages is that people expect employees will suddenly feel like owners, act like owners, and act like entrepreneurs from day one, and that doesn't usually happen," Leslie said. "It takes time."

Selling out to the staff can also be a thorny issue in family-owned businesses, if younger generations feel they are being cut off from their future inheritance or livelihood. Leslie, though, points out that there are ways to retain an element of family control.

Robert Hannah, managing partner in Scotland of Grant Thornton, is enthusiastic about employee ownership, but concedes that many professional advisers overlook this option. He says the biggest potential hazard to a business is the creation of a muddled management structure that hampers decision-making. This can also deter future financing, as banks will shy away from lending to organisations with a tangled chain of command.

"What comes with employee ownership is that they feel they have a say in everything," Hannah says. "What they have got to accept is that the business still has a management structure - you can't drift into this situation of management by committee. If that can be avoided, there really aren't that many other pitfalls."

From the seller's point of view, the biggest drawback is the price they are likely to receive, and the amount of time it takes to get a deal done. Staged instalments over a number of months or years are the norm for such deals, as payments tend to come from profits rather than directly out of employees' pockets. While this can minimise capital gains tax liability, the total price paid will nearly always be lower than that offered by a rival in the sector.

"You have got to accept that if you sell to employees, you won't get the best price for the business," Philbrick says. "I was perfectly happy with the price I received - it was a fair market value - but it wasn't as much as it could have been."