Employee ownership: stake holders

It is five years since the introduction of alternative business structures opened the door to employee ownership (EO) schemes, which supporters believe can provide solutions to problems of retention, recruitment and succession while boosting productivity. However, while firms are introducing profit-sharing schemes to give employees a stake in the business, there are just two law firms – London EO specialists Postlethwaite and West Country-based Stephens Scown – among the full members of the Employee Ownership Association (EOA).

The third trailblazer in the legal sector – Triton Global – had to wind up its share incentive plan when it was bought earlier this year by national firm DWF in a pre-pack deal (see box).

But the EO model is growing, with an estimated combined turnover of £30bn. And it is being enthusiastically embraced by other sectors such as architect practices, where it is predicted that most will be employee-owned within a generation. So why are more law firms not looking at this as a business model?

Deb Oxley, the EOA’s chief executive, says law firms may be slow to engage but she believes they will be among the next tranche, along with accountants, to join the club as they start to recognise the value of employee ownership in terms of the four ‘S’s’ – succession, scale up, start up and spin out.

‘It is about recognising that it is people that employ capital not capital that employs people,’ she says. ‘This is particularly relevant to professional services because your product is your people, so ensuring that each one feels fully responsible, accountable, trusted and involved, is very powerful.’

The problem, she argues, is that ‘not enough law firms understand that EO isn’t the same as share ownership. It tends to sit in the employee incentives and benefits bit of the firm, whereas EO is about business structures so it should be in the corporate bit. We have a job of work to do and we need to find more early adopters – the champions who go out and evangelise about it’.

So what can EO principles offer the legal sector?

Ownership of a law firm has traditionally meant two things: a right to a share of profits and a say in how the business is run. Partners buy their way into these rights and, when they leave, they get their money back – ‘naked in, naked out’, as the saying goes. But for that to be sustainable long-term, it assumes the next generation of lawyers is going to want to buy in to that model.

This is where the many versions of EO may provide an answer.

For the association, true EO exists where there is an opportunity for everyone in the business to participate in some form of ownership, regardless of their position.

‘And, collectively, that ownership must have some significance in giving employees a voice in the business,’ Oxley says. ‘We don’t attach a number to it but most of our members will have at least 25% of equity in the hands of staff.’

But binding some of the EO options on to a partnership model is not always straightforward. The new tax framework for Employee Ownership Trusts introduced in the Finance Act 2014 allows income tax-free bonuses up to £3,600, but that requires an EOT-controlled company to employ the staff receiving the bonuses. A SIP (share incentive plan) is also not available to LLPs because they do not have share capital to award to employees.

However, those advising on EO take a pragmatic view that firms do not have to tear up the rulebook to reap the benefits that come with greater alignment between owners and employees.

So how do you sell EO to partners? Robert Postlethwaite uses his own firm’s business model as a case study. He set up on his own in 2002, incorporating the practice in 2013 so he could bring others into the ownership. From two shareholders initially, there are now five – four lawyers and the practice manager – and the plan is to increase that to include everyone in the practice.

Last October, the firm became an ABS to extend its Company Share Option Plan (CSOP), which combines ownership of shares with options to acquire, to non-lawyer employees. Any financial gain is taxed as capital gain when shares are eventually sold, rather than being subject to income tax.

‘Our model works well for us because we are relatively small and individual share ownership is straightforward to manage,’ Postlethwaite says. ‘I wouldn’t rule out having employee trust ownership longer term, but that might be around succession if one or two people retire.’

It is asking partners to make ‘a bit of a leap of faith to cede some ownership’, he acknowledges. ‘But it is important not to focus on short-term profit gains. You have to encourage existing owners to view this as something that is going to build a stronger practice into the future.’

What it does require, in large part, is a passion for the idea, and the drive and commitment to see it through.

Stephens Scown’s managing partner Robert Camp led three years of painstaking negotiations with the Solicitors Regulation Authority (SRA) and the tax authorities before the firm could become a pioneering ABS, which allowed it to remain a partnership while giving staff a stake in the business.

While the scheme has been likened to that most famous of EO businesses, John Lewis, it has two key differences. Only a minority of equity in the law firm is owned by the staff; and bonuses are paid equally to everyone, from receptionist to salaried partner, rather than as a percentage of salary.

Christian Wilson, head of corporate in the firm’s Truro office, says the firm is just starting to realise how much their ‘Scownership’ scheme can achieve.

‘It has been very inspiring to realise how important this change of structure has been – we had no idea how much of a wave we would create in the EO world.’

Firms are becoming much more alive to using the financial metrics of their profit-sharing schemes to ‘stir up excitement’.

At Stephens Scown, the board sets the budget and fixes a financial threshold at which profit distribution kicks in, with half retained by the LLP and half paid equally to all eligible staff (around 250) through the employee ownership company.

This year, the firm reached that point by early February. From that point, subject to hitting a monthly figure for budgeting purposes, funds start being allocated to the bonus pool.

This is a ‘big moment’ of the year for staff, says Wilson. ‘We are using this to inspire everyone to think about the whole billing process and to talk to clients about work. It gives a real sense of ownership about the whole financial process.’

London and Birmingham-based commercial firm Gateley, the first to float shares on AIM in 2015, offers three levels of employee share scheme – a Stock Appreciation Rights Scheme, aimed at partner and director level; the Gateley Sharesave Scheme, a non-discretionary, Save As You Earn scheme, offered to all employees; and a CSOP, a discretionary scheme introduced in December for associates, senior associates, legal directors and equivalent levels within the support services team.

Group HR director Victoria Garrad says the aim is to encourage earlier and widespread equity ownership among its 701 staff while attracting and retaining talent. So far, 43% of employees have joined their Sharesave scheme, ‘well above’ the norm of 25%.

Its latest scheme targeting that vital ‘marzipan’ sub-partner layer of associates chimes with Gareth Brahams, managing partner of niche employment law specialists BDBF and the driving force behind his firm’s employee share scheme.

He recalls being an associate in a team of four partners and 14 associates. The partners left to pitch for a million-pound instruction. ‘We were all desperate for them to lose the pitch,’ he says. ‘We were busy enough and there was no financial or other incentive for us to take on another huge project just so they could earn seven times as much as us. I remember thinking then, if I were ever to run a law firm, I would not want my staff to feel that way.’

He set up his firm in 2012 so everyone was given a ‘piece of the action’ from the outset, by effectively creating an additional equity partner – the ‘employee bonus pool’. Each employee receives a fixed number of equity points from the pool on top of a fixed salary. The employees do not have to make a capital contribution to participate but national insurance contributions are funded from the pool as a counter-balance.

All staff receive a monthly report on financial performance with the current share price of a point in the profit pool as motivation.

No one can opt out. ‘Originally, we gave people a choice to sacrifice salary for more points,’ Brahams says. ‘But we tended to find lawyers’ natural caution drove people to take more salary. However, I felt that was affecting the firm’s culture and that, if you are going to have a profit-sharing scheme, it has to be meaningful.’

Salaries are competitive, with the view that the profit share will take them to above average. ‘With more junior people, I accept they are living closer to the breadline so they can tolerate less variability,’ he says.

‘But I try and push it as hard as I can, so the more senior you are, the more exposure you are expected to take so your fixed draw/salary will plateau much sooner than the points will.’

London commercial litigation boutique Signature Litigation has an open-to-all profit-sharing structure with a profit pool based on 10% of all profits generated up to a certain budget, with higher percentage allocations once the budget is exceeded. So far, the pool has delivered bonuses ranging from 21% to 34%.

The firm, set up five years ago, has grown from two to 11 partners, adding four in the last six months. It opted to be an LLP rather than a limited company, because of tax complications, or to give shared equity for all because of regulatory complications and concerns of some junior staff members about potential exposure to liabilities and risks.

But its scheme is still driving much greater financial awareness among staff. Chief executive Kevin Munslow is quizzed hard on his quarterly reports on how the firm is performing against budget and what that means in terms of the profit pool.

At the members’ meeting in December, he sets out things people can do to maximise the year-end outcome and that ‘really drives behaviour’, he says.

Having this stake in the business has proved a filter in recruitment, he notes. ‘People either buy into it and get excited or go to another firm for an easier life because it does come with a price. We are paying people 20%/30% more than other firms but it comes with a level of responsibility to contribute to that.’

There are different schools of thought about how bonuses should be allocated.

BDBF’s bonus pool is not performance-related. ‘I faced some arguments that this treats good and poor performance the same,’ says Brahams. ‘But my answer is that, like lock step partnership, there shouldn’t be poor performance and, if there is, it should be dealt with in a different way.’

Signature Litigation’s bonuses are non-discretionary and paid pro-rata to salary. ‘It is hard to do it just by people because that doesn’t recognise the contributions people are making to the pool in the first place,’ Munslow says. ‘The scheme is also fair because it doesn’t hang on any partner or group of partners influencing the outcome.’

Industrial disease specialists Roberts Jackson became an ABS in 2014 and secured a £15m investment from NorthEdge Capital, growing to more than 200 staff.

Chief executive Karen Jackson says the firm invited 24 members of staff – 16 fee-earners and eight support – to become shareholders, without liabilities or cost to themselves, as a reward for performance.

The idea, she says, is to create a sense of ownership and accountability at a time when individuals often move rather than work through challenges. What is also exciting, she adds, is that it is bringing in some relatively junior shareholders.

She does not believe a discretionary scheme is a disincentive to others. ‘The alternative is not to have a scheme, which would be a shame,’ she says. ‘This is a firm where everyone is equal and delivering results for clients and access to justice are rewarded.’

What these schemes have in common is increasing employee engagement in the business. At Stephens Scown, the employee trustees/directors do not go to partnership meetings but are invited to the monthly strategy meetings. ‘It is still early days,’ Wilson says, ‘but we are shaping the relationship between the trustees and the business so it becomes even more meaningful.’

What shared ownership schemes do inevitably throw up are regulatory issues.

Stephens Scown created a limited company – Stephens Scown Ltd – which is owned by staff through an employee benefit trust. The company became a corporate member of the LLP, giving it a partnership role. Trustees, voted in by staff, become de facto directors of the company – currently four lawyers and three non-lawyers.

An issue for the SRA if EO schemes proliferate, Wilson says, will be approving non-lawyers from very different backgrounds who may have something in their ‘dim and distant past’ which makes them unacceptable to the regulator.

Crispin Passmore, the SRA’s executive policy director, says non-lawyer directors/trustees have to be approved by the regulator as they will be managers of the trust company which is a corporate manager of the LLP, as well as being owners in their role as trustees acting on its behalf.

While the character and suitability requirements are the same as for a solicitor, ‘there is no sine die rule that says ‘if you did this, no chance’, says Passmore.

‘It depends on what sort of “minor blemish” we are talking about. People rate severity differently. People can check our guidance and the Suitability Test to see where the “blemish” fits in and how seriously we will take it and then consider the time elapsed and any rehabilitation.’

There is at least one solicitor in the profession who is a ‘pillar of their community, despite having served time for their involvement in an armed robbery’, he points out. ‘We do, however, look unfavourably if the “blemish” involves dishonesty in any way. That includes not disclosing something that we should have been told about and find out about eventually.’

What would help, he says, would be for the government to simplify the legislation to ‘give more flexibility so we can focus approval on the right people’.

Commenting more generally, Passmore says the authority is largely neutral about ownership structures because what drives risks are the type of work, how the firm is run, how client money is handled and client service.

‘Good firms are good firms whatever their structure and they tend to have good leadership, engaged staff and good client service,’ he says. ‘We see EO as one important part of an ecosystem that is increasingly interesting and varied. But it is just part of the jigsaw, not a magic wand.’

What is clear is that EO advisers are seeing growing interest from firms in how they can adapt it to their business models.

Graeme Nuttall, a solicitor and chartered tax adviser, leads the Fieldfisher employee and mutual ownership team. As the government’s independent adviser on EO, he wrote the Nuttall Review of Employee Ownership.

The issue for law firms is more around culture, he believes, because there is already a tried and tested legal model that has allowed firms like Fieldfisher to continue since 1835.

‘But does it address the cultural aspirations of younger generations who are not Thatcher’s children and want a more team-based approach?’ he asks. ‘Is it too partner-centric to engage all the professional staff you want to retain?’

This is where certain principles of EO can help in terms of sharing any profit above budget more widely and in the mechanics of giving employees a collective voice, whether through a staff committee or an entity that is a partner in the business.

Ann Tyler, an EO consultant with Lewis Silkin, has been advising on accountants Grant Thornton’s shared enterprise project, which CEO Sacha Romanovitch has described as a ‘mindset shift’ away from a model of ‘alpha control’ to one where ideas, responsibilities and rewards are shared.

‘When I mentioned EO to law firms four years ago, people looked at me as though I was bonkers,’ she says. But that scepticism is changing as people realise the extent of its marketing and recruitment benefits.

Malcolm Lynch, a partner specialising in EO at Leeds-based Wrigleys, believes the breakthrough in the legal sector will come when there is a clearer understanding of the pros and cons.

He is looking at how it would work technically for his firm. ‘Personally, I would like to work in this context but I am one among 15 partners,’ he says. ‘You can’t just be an evangelist – you need to provide the detail.’

With so much to consider, what stands out for Wilson about Stephens Scown’s shared ownership journey to date?

‘We are seeing younger graduates who are really alive to this,’ he says, ‘with applicants who would traditionally be drawn to the City and magic circle firms. The same applies at senior levels.’

Growth has also outstripped expectations. ‘Can you say that is down to our new structure?’ he says. ‘Probably not. But would it have been as good without it? No. This has definitely helped us buck the trend.’

Grania Langdon-Down is a freelance journalist