The Ownership Effect. Consultation Response. July 2017

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1 Consultation Response July Introduction 1.1 We congratulate the Employee Ownership Association and its partners for undertaking this extremely timely review. If there was ever a moment to make a concerted effort to evidence the case for employee ownership it is now. 1.2 Co-operatives UK is especially pleased to have this opportunity to ensure the ownership effect in the UK s 454 employee owned co-operatives is recognised and understood. We hope that in doing so the findings will at least in part reflect their growing economic and social contribution. 1.3 In this response we do the following: Provide a very quick overview of co-operative employee ownership in the UK (see part 2) Provide some evidence of the productivity and performance of employee owned co-operatives (see part 3) Provide some evidence of how co-operative employee ownership impacts on corporate governance and behaviours (see part 4) Provide some evidence of the wider social value created by co-operative employee ownership (see part 5) Provide a very quick overview of co-operative entrepreneurship as a route to creating employee owned firms (see part 6) Answer a number of questions the inquiry has asked specifically to advisers of employee owned businesses (see part 7) 2 Co-operative employee ownership 2.1 The distinctions between co-operative employee ownership and other kinds are not always easy to see and not always relevant, though in certain analyses the differences can be important. All employee owned co-operatives are without exception employeeowned business; as similar or distinct as any others but with some additional cooperative characteristics. The key characterises of co-operative employee ownership are as follows: Ownership is open to all employees Employees have at least 51 percent ownership and control of the firm Employees exercise control of the business on a one person one vote basis, rather than a one share one vote basis

2 2 Employees can influence the strategic direction and core values of the business Arrangements are in place to ensure the Board is accountable to and at least partly appointed by the employees and has a duty to privilege their interests as employees not just as shareholders Corporate purpose and mission includes benefiting employees Profit shares are distributed based on people s contribution to the business as employees, not their shareholdings (though employee shareholding can be incentivised through reasonable returns on shareholdings as well) 2.2 Leading examples of employee owned businesses that we recognise as being cooperative include firms like John Lewis Partnership and Scott Bader, and also businesses using worker co-operative models such as Suma, a leading food wholesaler and distributor, with a turnover of 41.8 million and winner of this year s prestigious Queen s Award for Enterprise (Innovation). 2.3 Employee owned co-operatives currently trade across a diverse range of industry sectors, with particular strengths in wholesale, retail and service sectors, with the latter notably in digital and social care. That said there are a growing number of employee owned co-operatives involved in manufacture, including high-value manufacture and making Worker co-operatives can be considered a subset of employee-owned co-operatives, in which particular governance models are used to enable workers to exercise collective ownership and control of the business as members of the co-operative, rather than solely as individual shareholders or through a trust. * Thus the relations of ownership in a worker co-operative are both very direct and highly collectivised. For this reason they do not fit into the widely reproduced direct, indirect, and hybrid categories of employee ownership used, for example, in the 2012 Nuttall Review for government Worker co-operatives tend to form through the agency and entrepreneurship of a small group, rather than through employee buyouts (see part 6). This means key values associated with the worker co-operative model, namely: autonomy, democracy, equality, fairness and solidarity, in the workplace and in communities, tend to be central to corporate mission and deeply embedded from the outset. 2.6 The UK s worker co-operatives have a combined turnover of 239 million and are owned by 2,885 worker members. 2.7 It is important to note that worker co-operatives are incorporated as companies limited by guarantee and by shares, as limited liability partnerships, as community interest 1 Ibid * For more on the worker co-operative model and its governance, see here: 2

3 3 companies and as co-operative societies, with the company and co-operative society legal forms being the most popular. 2.8 It should also be noted that for these co-operatives the phrase worker ownership is generally regarded as more accurate than employee ownership, as it describes a set of relationships between partners in a venture, rather than relations of employment between individuals and a corporate entity. Employee ownership is perhaps better understood as a subset of worker ownership, especially given that co-operatives today are increasingly owned and controlled by the people that are self-employed and workers (official status) as well as employees (official status). However, in the context of this submission we will describe worker co-operatives as a subset of employee owned businesses in general. 3 Productivity and performance Productivity 3.1 Virginie Pérotin, (Professor of Economics at Leeds University Business School) has published an academic review of a diverse body of international research into the relationships between worker ownership and control and productivity. She concludes that there is evidence to support the fact that employee ownership can boost productivity. But by diving deeper into the evidence base, Pérotin finds a closer correlation between more participative, democratic worker control and higher productivity. She also finds that the stronger and more participative the worker control, the more likely it is that firms will see a productivity boost from profit sharing and other aspects of beneficial ownership. She writes: The evidence to date, therefore, is remarkably consistent in showing that the key feature of worker cooperatives, increased worker participation, never causes performance to deteriorate in these firms, contrary to many theoretical predictions. Across countries, firm samples, and methodologies, studies find that greater participation in governance is a factor of increased productive efficiency in worker co-operatives, both in itself and perhaps in boosting the incentive effects of participation in ownership and/or profit Pérotin has found that when total factor productivity is measured, that is technology and capital inputs being equal, the evidence base suggests that worker owned firms are more productive than firms in general. 4 This is an important point, as analysis of productivity can depend heavily on factors such as technology, which are not in themselves very pertinent to analysis of the ownership effect. 3.3 Separate research, conducted by EURICSE (the European Research Institute on Cooperative and Social Enterprises), comparing the performance of Italian co-operatives and other Italian firms in the lead up to, height of, and aftermath of the late 2000s crisis, has found that between 2008 and 2011 productivity in co-operatives increased by 8.2 percent. It also found that between 2006 and 2010 the growth in value added for co- 3 Virginie Pérotin (2012) The performance of worker co-operatives 4 Virginie Pérotin (2015) What do we really know about worker co-operatives?

4 4 operatives reached 25 percent as opposed to only 7 percent for shareholder corporations It also found that between 2006 and 2010 job income growth for co-operatives was 30 percent, contrasting with just 13 percent for shareholder corporations The researchers are confident that the ownership and control structure of Italian worker co-operatives is the key factor in their success comparable to other Italian firms: Breaking down the possible determinants of these growth rates (location, sector of activity, ownership structure) confirms that the differences observed are due almost completely to the difference in ownership structure and only marginally to other factors. 7 Survival 3.6 Pérotin has also reviewed the body of research into the survival rates of worker co-operatives and has found that evidence points to better survival rates among worker co-operatives than firms in general: Worker co-operatives survive longer than other firms overall when industry and starting wage, size and year of creation are taken into account, and this is due to their much lower closure risk (hazard), all else being equal, than conventional firms in services A deep-dive into the evidence suggests that worker co-operatives can be particularly good at surviving long-term with employee ownership intact because of the relations of ownership are collective. This is especially found to be the case when part or all of the underlying capital in the business is held in common ownership, rather than being distributable to shareholders. 9 This benefit of collective ownership was also recognised in the Nutall Review, though in relation to employee ownership trusts. 10 Employment 3.8 The EURICSE research comparing the performance of Italian co-operatives and other Italian firms in the lead up to, height of, and aftermath of the late 2000s crisis, found that between 2007 and 2011 employment in co-operatives increased by 8 percent Pérotin has also reviewed the evidence on the performance of worker co-operatives in relation to employment. On employment protection in a downturn, the evidence suggests that as worker co-operatives are controlled by the people whose livelihoods are at stake, pay and profit shares are very often sacrificed to retain jobs. This behaviour is made 5 EURICSE (2015) 6 Ibid 7 Ibid 8 Virginie Pérotin (2015) What do we really know about worker co-operatives? 9 Virginie Pérotin (2012) The performance of worker co-operatives EURICSE (2015)

5 5 easier by the fact that workers know that when things do pick up again they can benefit from any boost in profits. Pérotin writes: The available evidence, which is quite robust, is therefore once again remarkably consistent. It indicates that worker cooperatives adjust pay (at least for members) rather than employment to changing market conditions and generally preserve jobs better This propensity to save jobs has also recently been highlighted in primary research on the MONDRAGON family of worker co-operatives in Spain. In response to microeconomic pressures, these businesses invest in deploying workers across MONDRAGON, rather than laying people off. This involves both helping workers reskill and helping them to start brand new co-operative ventures Corporate governance and behaviours 4.1 Employee owned co-operatives must have corporate purposes, missions and related duties for directors that orientate the firm at a strategic level towards privileging the interests of employees. 4.2 Worker co-operatives in the UK have a distinct code of governance (the Worker Cooperative Code ) that establishes a range of governance norms, behaviours, values and objectives. These overwhelmingly promote governance in the interests of a sustainable business, run for the benefit of its workers and with regard for their community. 14 In practice worker co-operatives adhere to this code in a variety of ways. 4.3 Some worker co-operatives have very flat decision-making structures. When more hierarchical decision-making structures are used, there are usually significant amounts of shared and rotating responsibility for fulfilling management functions. Management is treated as a function, not a status. This means that by necessity there is a lot of investment in personal and professional development, so that everyone is equipped to take on the responsibilities of membership. 4.4 A lot of attention is given to pay ratios in worker co-operatives here in the UK and around the world. The UK s largest worker co-operative Suma has a totally flat pay and profit share structure. Others will pay on scales, for example for different roles, or for showing greater commitment in terms of years of service. But the presumption is always towards low inequalities wherever possible. Notably, the world s largest worker co-operative group MONDRAGON manages to run a 12 billion manufacturing conglomerate while keeping its top to bottom pay ratio at 1:9, compared to the FSTE 100 average of 1: Ibid 13 Young Foundation (2017) Humanity at Work Young Foundation (2017) Humanity at Work

6 6 5 Social value 5.1 Beyond the evidence that worker ownership has range of economic benefits for firms, for workers and for the economy more widely, it is also increasingly understood that worker ownership can contribute to the creation of significant social value for individuals, households and communities. 5.2 We draw particular attention to new in-depth primary research by the Young Foundation into the social value created through worker ownership and control in the MONDRAGON family of co-operatives, found in the Basque region of Spain. The Young Foundation crucially suggests that there is a strong causal link between the critical mass of worker ownership in the Basque region and the fact that it enjoys a much lower gini coefficient than the rest of Spain, closer to Sweden s, while also benefiting from a tax burden below the EU average. This is achieved because opportunity, wealth and power are more efficiently and effectively distributed at the level of firms and communities Co-operative entrepreneurship 6.1 Most employee owned businesses will acquire that status gradually, or as a result of a planned employee buyout (or both). Yet as Virginie Pérotin s research shows the vast majority of worker co-operatives in the UK and elsewhere in the world were formed as worker owned firms from the outset, by a group of what could be termed co-operative entrepreneurs. 17 Through our own work in charting and supporting new co-operative development in the UK we know this to be the case. 6.2 The motivations behind co-operative entrepreneurship are varied and complex. Worker co-operatives are generally formed by people motivated by a sense of fairness, solidarity, concern for the community and a desire to shape and control the ethical dimensions of their work. As one co-operative puts it: Workers co-ops give us a chance to change a small but significant part of how things are. They re one way to take back an important part of our lives and gain control over how we work, not to mention the impact our work has on others and our environment We also hear a lot from co-operative entrepreneurs that a desire to retain autonomy and control over their livelihoods, while being able to collaborate with others in a flexible way with high degrees of trust and reciprocity, is an important motivation. This seems to be especially true of worker co-operatives emerging in the digital and creative industries. 6.4 Employee buyouts in the UK have tended to result in non-co-operative firms, or occasionally with employee owned co-operatives using the trust model (meeting the criteria set out in paragraph 2.1 above). There are good practical reasons why this might be the case. But, conversely, when it comes to creating businesses that are worker owned from the outset, the worker co-operative model has proven far more practical. 16 Ibid 17 Virginie Pérotin (2015) What do we really know about worker co-operatives? 18

7 7 Crucially, we believe that as work becomes more fluid, co-operative entrepreneurship can spread the economic and social benefits of worker ownership beyond the payrolls of established businesses, so that there is an organic growth in ventures that are co-owned and mission-led from the outset. The worker co-operative model needs to be better understood as a tool for making this happen. 7 Answering questions the inquiry has asked specifically to advisers of employee owned businesses 7.1 In this final section we answer some of the questions asked via the on line portal to organisations that advise employee owned businesses. We do so as a national trade body, with hundreds of worker owned co-operatives in our membership, to whom we offer a range of services. Q: For what other reasons, other than succession, have your clients considered employee ownership? 7.2 Co-operative models are overwhelming used to start new worker owned firms, and this is where Co-operatives UK and our programmes, and wider networks, provide support to clients. For a discussion of the motivations behind co-operative entrepreneurship see paragraphs 6.2 and 6.3 above. Q: Compared to other succession routes, what do you consider are the principal differences of employee ownership succession to other succession routes? 7.3 Employee ownership succession requires the vendor to think more seriously about values in business, what they would like to happen to their firm after they have left and what the economic and social impacts of their legacy should be. 7.4 This is not about making a less commercial choice but about having a clearer conception of what they want, or do not want, to happen, and how this best to achieve this through a commercial process. 7.5 Aside from the fact that it is the route that delivers all the benefits of employee ownership in terms of economic value for the firm and employees, it also: Keeps local control of the firm, it s capital and strategic direction Helps to keep jobs, skills and capital local Enhances the local economic impact of the firm, particularly through employee profit distributions Helps to protect and enhance the culture, values and mission that may have built up in the company Q: What regulatory, institutional, financial or other changes would contribute significantly to more companies benefiting from employee ownership for succession or other reasons? 7.6 An assessment of the arrangements in other countries that have significant numbers of employee buyouts suggests that the best frameworks supporting employee buyouts tend

8 8 to combine legislative arrangements and specialised financing mechanisms with a patient long term commitment to co-operative development, led by an autonomous and mutually supportive co-operative sector. 7.7 Statutory arrangements include preferential bidding rights for employees ( Right to Bid) as part of succession and insolvency processes and forms of incorporation that allow for the straightforward facilitation of employee buyouts. 7.8 Financial arrangements include government schemes that allow unemployment benefits and enterprise start-up funds to be used as risk capital by employees to help fund buyouts. For example in Spain employees can receive the equivalent of three years unemployment benefit to use as risk capital in an employee buyout. 7.9 Crucially this financial support from the state for buyouts is best accompanied by proactive support for the process on the part of local authorities and enterprise agencies In France, Italy and Spain, which lead the way on employee buyouts, we observe the development and use of specialised financial instruments used in buyouts. These include debt and equity instruments to facilitate investment by employees, banks and non-bank institutions in and around co-operative sectors In Italy and France we also see non-state arrangements for financing buyouts deployed by the co-operative sectors themselves. Particularly, we observe investment funds managed by co-operative federations that are created through pooling small amounts of profit from co-operatives. Some of these institutions can also crowd-in private venture capital to increase the funds available for employee buyouts Crucially this investment for buyouts from within the co-operative sector is accompanied by a strong, long term advisory and peer support element Success also seems to depend on having enough familiarity, understanding and expertise of employee buyouts in the professional services and legal professions At present Scotland leads the UK in the number of employee buyouts. We think this is in no small part due to the existence of a public service tasked with providing specialist professional assistance for this route, Co-operative Development Scotland. The impact of Co-operative Development Scotland suggests what can be achieved by well-funded and properly focused support programmes. Q: Which factors, if any, do you consider are limiting the growth of employee ownership succession? 7.15 Firstly, it is notable that, apart from the great advisory work done by Co-operative Development Scotland and the 2014 employee buyout tax reliefs, the UK lacks all of the statutory, financial and institutional arrangements we mentioned in the question above A lack of awareness and understanding among business owners, employees and advisors holds us back There may also be cultural aversions to employee buyouts, among business owners, employees, financiers and public authorities in at least some parts of the UK.

9 It is possible that the complexities inherent in the UK s employee ownership trust model puts people off employee ownership succession Employee buyouts in the UK may also hampered by the well-documented prevalence of foreign direct investment in our economy, and in particular the buying out of smaller domestically owned firms by overseas investors and asset managers. Q: What is the scope of the funding or financial advice you offer to companies with employee ownership? 7.20 Co-operatives UK provides our members with professional and legal advice on how to raise and manage funds in a co-operative way. Where the co-operative society legal form is used this extends to helping members ensure their financial arrangements comply with regulations under the Co-operative and Community Benefit Societies Act. Where the company legal form is used we advise co-operatives on how to use the finance-related features of this legal form in a co-operative way We also advise on how to comply with aspects of UK tax law that relate specifically to the finances of co-operatives. This tends to be particularly relevant to worker owned cooperatives. Q: In what ways, if any, do the financial needs of employee owned businesses differ from those of conventional private sector clients? 7.22 Because of the need to retain autonomy of ownership and control, employee owned cooperatives have considerably less recourse to external investment and outside equity in particular. This need stems from a desire to be employee or worker owned, adherence to co-operative principles and for co-operative societies from the need to comply with regulation under the Co-operative and Community Benefit Societies Act Thus employee owned co-operatives have a greater reliance on retained earnings These features can impact on the types of borrowing they can access. Some lenders see this limited room to manoeuvre financially as a risk factor. Q: What could the employee ownership sector do to make itself a more attractive funding partner for the financial sector? 7.25 Examples of very strong employee owned sectors around the world demonstrate the benefits of co-operation between firms, where intermediaries are created to pool risk for lenders ( mutual guarantees ) and also to achieve better securitisation in capital markets It is however crucial to note that the main strength of financial co-operation between worker co-operatives is the creation of their own financial institutions, bespoke to their needs, rather than in efforts to please the wider financial sector.

10 10 James Wright, Policy Officer Co-operatives UK Holyoake House Hanover Street Manchester M60 0AS About Co-operatives UK Co-operatives UK is the network for Britain s thousands of co-ops. We work to promote, develop and unite member owned businesses across the economy. From high street retailers to community owned pubs, fan owned football clubs to farmer controlled businesses, co-ops are everywhere and together they are worth 35.7 billion to the British economy.