Employee ownership and the opportunities arising for both co-operatives and employee share ownership from retiring business owners, who wish to sell their business to their employees, has been the subject of a new project investigating practical solutions in this area. The project has the key objective of researching opportunities in the growing business ownership succession market, and has been exploring potential new business models at the intersection of mutuals with Employee Share Ownership Plans (ESOPs).

The project group consists of experienced co-op professionals, including ACCORD associates, and would welcome any person or organisation interested in becoming closely involved and joining the group. This interest could include the future supply of services to the market.

Currently, there are three models under investigation though this number could grow. Each model is being designed so as to facilitate the transition of a small or medium sized business to more mutual ownership forms over time.

• Model 1

It is now possible for a company to transfer its incorporated status as a company limited by shares directly into an incorporated co-operative, without having to wind up. It does this by changing its company constitution to that covering "co-operative principles". Procedural Guidelines are being written by the NSW Registry of Co-operatives to support this development in future. At least one company has already completed this transfer arrangement in NSW.

The main benefits (other than not having to wind up and pay out liabilities) are that you don't have to pay stamp duty on the transfer and you keep the company name. Chapter 5A, Part 5A.2 of the Corporations Act covers "transfer of registration" matters for companies, with Division 5 of Part 2 of the NSW Co-operatives Act, Sections 22 through to 27 detailing the procedures for "change of registration" to co-ops in these cases.

Such a project could be "transitioned" to employee ownership by using two classes of shares in the co-op, one class providing co-op membership and voting rights, and the other providing "dividends". These latter shares, which, for example, could hold the "capital value" of the business in the form of co-operative capital units, will be held by the former owner, who can remain a co-op member and board member. These non-voting shares can be transferred over time to the new employee owners under various purchasing/valuation arrangements.

• Model 2

This plan would suit the owner(s) of larger scale private businesses employing 20 or more employees, where the owner wishes the employees to buy a significant stake in the enterprise - and perhaps buy the enterprise completely (perhaps in conjunction with other investors) - over a period of say five to ten years. The mechanism to do this is the Employee Share Ownership Plan (ESOP).

The ESOP is suitable only to enterprises of larger scale because of some inflexibility in the current Australian ESOP law that creates cost and complexity issues for those installing the plan. The model thus requires a "critical mass" in terms of size to make it cost effective for all the participants. ESOPs are a common mechanism in other countries for the purpose outlined.

Under this plan, employees in Australia could acquire shares in the business using a "Deferred Plan" (a qualified plan under Division 13A of the Tax Act, which can provide for tax deductibility for the employer, and tax exemptions and deferrals for the employees) as well as various "Loan Plans" to employees (through which the employer can provide loans to employees to purchase shares in the business, with the loan being repaid by way of dividends, remuneration bonuses and salary sacrifice arrangements).

These plans require the company to regularly value its shares, set up an internal trading market for employee shares and comply at the outset, if they are not otherwise exempt, with corporate law disclosure provisions. That usually means the provision of a prospectus or an offer information statement.

These plans are popular with employers and employees alike, and usually result in considerable increases in employee participation and productivity resulting from the emerging ownership culture.

• Model 3

  This model offers flexibility in the ownership of the "capital value" of the business by separating out the ownership of the assets from the operating business. This is done through a 'hybrid' co-op structure, where a newly registered co-op takes over the operations of the business while the assets remain in a subsidiary company, which is owned jointly by the new co-op and the former business owner.

  Arrangements can be made to "buy-out" these assets over time using various schemes including tax effective leasing and consultancy agreements with the former owner.

  This Plan overcomes the employees' problem of lack of immediately available capital in the case of a straight 'trade sale' of the business.

Each of these models will need to meet changing economic and social needs, and circumstances depending on size, location, ownership outlook, financial and business requirements and permanence of the workforce. They can provide those new and more flexible forms of business structure that are becoming more popular than the traditional models, and can offer a range of stakeholder ownership forms in line with social enterprise objectives. The models recognise that employee ownership can make a major contribution to entrepreneurship in Australia, as they can provide individual and collective incentives offering employees a return on the increase in capital value generated from their efforts, in similar fashion to the Mondragon model.

The Market

With the average age of the small business owner in Australia now approaching fifty years, and with this 'generational bubble' creating a 'market convergence' (too many owners wanting to offload their businesses at once), this is likely to lead to a crisis in the sector, as more owners find that they may be facing a reduction in the value of their asset.

Many business owners, who have no family succession options, start to look to their employees to take over the business, or otherwise face the prospect of a low value trade sale to competitors or liquidation and sale of assets, both of which will have detrimental consequences to employees. For example, 12% of all business sales in the US are now being made into "all employee" ESOPs.

Although the employee ownership advocacy bodies are vigorously lobbying for change, Australia, however, does not have the same level of Government facilitation (particularly tax incentives) for ESOPs as other countries. This makes ESOPs somewhat costly to install here, though this may change in coming years. The Federal Government's Employee Share Ownership Unit of DEWR is currently developing "template ESOP systems" to make the path to ESOPs easier for SMEs. As for co-ops, access to the NSW Government's "Co-operative Development Program" provides some limited assistance.

In considering the demographics of the Australian SME sector, social commentators are becoming increasingly concerned about its future, given the aforementioned generational impacts. According to CPA Australia, SMEs create 40% of Australia's GDP, represent 48% of the workforce and make up 96% of all businesses in Australia, with approximately 75% of the sector having a turnover of less than $1 million. While only 25% of Australian family business owners plan to pass on their business to family members, 45% plan to sell to others, 7% are anticipating a management buyout, and 23% are not sure what they are going to do. If just a small proportion of the last three categories can be influenced towards employee ownership, then there could be significant new opportunities for co-operatives and ESOPs.

A significant number of employers in Australia are SMEs. There are 1.5 million employees in 170,000 small businesses employing between 5 and 19 people (with 5 people being the minimum size for membership under co-op legislation). There are also 42,000 unlisted public and private businesses with 20 or more employees employing over 3.6 million employees.

Overall, the market situation highlights the opportunities for entrepreneurial 'mutualist' development in the area of employee ownership. It also highlights the need to be pro-active in developing new and flexible business models to supply to this market.

Further information

If you would like additional information or have any advice or comments on either the models or the market, please contact the author, Alan Greig of Social Enterprise Technologies (SENTECH) at: ahgreig@bigpond.com or Ph: (02) 9817 4913.