Employee Ownership Trusts (EOTs) are well established in the UK, Canada and other markets. They could be an ideal solution for Australia’s SME succession crisis. Michael sits down with Andrew Clements, Co-Chair of Employee Ownership Australia (EOA) to talk about where Australia is with EOT's.
As thousands of Australian small business owners approach retirement in the coming decade, the question of succession looms large.
Selling to a competitor or on the open market are familiar paths, but what about selling to the people who know the business best—the employees?
@Andrew Clements from @employeeownershipaustralia talks about;
Whether you are looking to retire in five years or simply want to build a more engaged workforce today, this episode provides a clear roadmap for exploring employee ownership.
In This Episode, We Cover:
The looming SME succession crisis and why traditional exits aren't working for everyone.
The fundamental differences between allocated employee share schemes and unallocated EOTs.
How overseas markets like the UK and Canada have successfully mainstreamed employee ownership.
Why EOTs are a perfect fit for professional service businesses, and how to structure them for asset-heavy businesses like farming.
The "tax dodge" stigma and the urgent need for clear ATO guidance and legislative recognition in Australia.
How employee ownership drives remarkable productivity and builds stronger local communities.
Andrew’s top three actionable tips for founders looking to transition out of their business in the next five years.
TIMELINE:
00:00 Introduction: The Looming SME Succession Challenge
01:12 What's Changed in Employee Ownership in the Last 5 Years?
07:40 Understanding Employee Share Schemes: Allocated vs. Unallocated Plans
14:55 Are EOTs a Genuine Asset Class for Small Business?
21:19 The Push for Legislative Recognition and ATO Guidance
27:39 Building Community and Retaining Local Businesses
31:33 Why Professional Service Businesses are Perfect for EOTs
38:13 Financing the Exit: Staged Sell-Downs and Managing Risk
45:22 Boosting SME Productivity Through Employee Engagement
49:23 Structuring EOTs for Asset-Heavy vs. Low-Capital Businesses
55:46 The Gap in Professional Advisor Awareness
59:28 Top 3 Tips for Founders Retiring in 5 Years
01:01:20 Andrew’s Vision for Simplifying Small Business Regulation
About Our Guest:
Andrew Clements is the Co-Chair of Employee Ownership Australia (EOA), an advocacy group dedicated to facilitating and promoting employee ownership across the country. Andrew is a passionate advocate for reducing regulatory complexity and creating simple, robust succession models for Australian SMEs.
Read the full, searchable transcript of this episode here: https://ownertoownerpodcast.com.au/episodes
Michael (00:01) Australia is facing a looming small business succession challenge. Each year in the next decade, thousands of small business owners employing tens of thousands of employees will be asking a very similar question: who's taking over when I'm ready to step away? Selling to a competitor or on the market is familiar options, but what about selling to employees? Employment ownership trust, EOTs have made it and employee ownership more broadly have made significant traction overseas, particularly in the UK, yet here in Australia on the EOT front I think feels to me like we're still behind. So we want to talk about are EOTs and employee ownership more broadly a genuine solution for Australia's SME succession challenge. How far down the pathway are we until it becomes mainstream? To explore these questions I want to welcome in Andrew Clements, Co-Chair of Employee Ownership Australia. Welcome in Andrew.
Andrew (01:08) Thank you, Michael. Thank you for the opportunity to talk.
Michael (01:12) Let's get underway. We chatted almost five years ago on a previous iteration, so if you hadn't listened to that or haven't been following employee ownership, what's changed most since that time, five or six years ago, if anything?
Andrew (01:36) I think Michael, it's a good news, bad news moment. I mean, what hasn't changed is largely the structural underpinnings that afford access to employee ownership. So that structural underpinning has largely not changed. I think what has changed is probably two—
Michael (02:00) By structure you mean the legislation.
Andrew (02:03) Yeah, the legislative underpinnings through both the corporations law and the tax law. I think the part that has changed is—and this is driven largely through the UK experience, but now the experience in other jurisdictions—we've seen employee ownership trusts obviously in the UK being very, very successful, but also we've seen them being adopted in Canada and we're seeing them now being examined in a lot of detail in places like Ireland. So there's a lot of awareness around an employee ownership trust as one form of a succession option. And I think that awareness has generated a discussion, certainly amongst small business owners looking to understand what options they have available to them.
The Employee Ownership Trust is one version of dealing with employee ownership within a small business. It doesn't have to be the only one, but it is certainly one. The part I think again that hasn't changed, unfortunately, is we haven't had in the same way as Canada did, an awakening within government to see that employee ownership is a key driver to generating both small business succession, but also the flip side: access for younger Australians into ownership of small business. So that is not a theme that we've seen developed and it's something that we've been pushing very, very strongly for some time.
Michael (04:03) Yeah, and we've had an upheaval in where things might head for trusts in the last budget. We do have a lot of SMEs and however they're going to be treated, the success in transitioning them is an opportunity for new owners, younger owners to build a successful business and also to build wealth out of a business as an employee.
Andrew (04:38) Yes, absolutely. I guess the thing, Michael, that strikes me most is the strong cultural underpinnings of the organizations that we deal with. Most of them come to us saying we want to get our employees more engaged in the business, but almost in every case, they've already got a high degree of focus on engaging their employees. What they don't have is a mechanism and process for facilitating both the generational change, but also using employee ownership as a growth opportunity, not simply as a transition opportunity.
Michael (05:53) That's true. And partial ownership of businesses, having a blend of age of owners, founders staying in for a lot longer as a minority shareholder, these are all incredibly valuable. Because the challenge of selling a whole business when you're ready is incredibly difficult. It's very hard for anyone to borrow for it when you're carrying a mortgage.
Andrew (06:36) It is Michael, just to pick up on that, there's a compounding effect around the very topical issue of housing. We're looking at a younger generation of workers with a strong focus on getting access to the housing market, which then creates real competition for them when saying, "Well, you have an opportunity to buy into this business." They've got very competing goals and even with the best design may not be able to accommodate it in a traditional financing sense.
Michael (07:40) With employee ownership, there's a lot to it. There's four or five models that I've seen. We are going to focus on employee ownership trusts, but there are other employee share schemes. Have they been more successful with larger businesses?
Andrew (08:19) I think it's really important when we talk about employee ownership to understand that there's not one version of it. Clearly, there are listed companies looking at broad-based employee ownership, and startups where ostensibly you're looking largely at enterprises that are cash strapped, selling the dream of future equity. When you move away from those sectors into unlisted SMEs, there are ostensibly two bookends.
The first is allocated plans, where particular employees are allocated a particular number of shares. That is very much the traditional version. It's framed around the equity return while you're there, potential for some upside, and potential engagement in management. The challenge is the word "allocated." Because there's a fixed number of shares, when someone leaves, you need to create a market, a price, and an exit mechanism. All of those things create structure and complexity.
The EOT is different because the key word is unallocated. It's an unallocated plan. What you have is an equity stake being held for a group of employees collectively. No individual employee has a particular number of shares. That then gives the flexibility that you don't need some of these issues around creating the market when you leave. It provides a lot more flexibility to engage and bring employees into the organization without them having the funding obligation.
Michael (14:55) Do we have hope for small business as a genuine asset class with employee ownership EOTs facilitating that?
Andrew (14:55) I'm a huge optimist. The answer has to be yes. It's a structure that we've seen work globally, and there is nothing different in the Australian market that says it shouldn't be effective here. For so many founders, it's not about eking out the last dollar on the business transition process. It's about accommodating a methodology to provide their business, their employees, and their way of doing business a way into the future.
Michael (16:33) It's a theme that comes up all the time. There's always more to it—legacy, staff, community. You talked about the UK, Canada, Ireland. Are they doing anything differently with their economy that has slowed our progress towards EOTs?
Andrew (17:31) I think in a sense there's a little bit of history. Unfortunately, in the late 90s, early 2000s, employee ownership was used largely as a mechanism to improve tax returns for founders. That has had a longstanding impact. Our rules carry that mindset.
Michael (18:31) It's a tax dodge.
Andrew (18:32) It's perceived as a tax dodge. EOA's mantra is "promote, not prevent." Employee ownership is not about some sort of tax arrangement to get a tax benefit. Success for me is that conventional employee ownership structures are taken off the shelf and used in a simple, accessible way. It must be accessible to everyone and easily understood by all advisors. The mindset change where it's a common version, something you do and it's understood and promoted, is where it happens.
Michael (21:19) There are opportunities to diversify wealth for younger business owners and buyers of established businesses. You do that on some scale, and we stabilize the SME share of the economy.
Andrew (22:14) We need a simple business structure that people can use and operate with certainty and properly reward their employees. We've worked with a series of founders who are looking to transition using an EOT. We largely can get there, but the road is a little less direct and a little more complicated.
We tried to get ATO guidance around some of the core issues associated with EOTs. We put a complete package of documents to the tax office that people could use to establish an EOT with a form of assurance. Unfortunately, we weren't successful. The feedback was, "there's not enough demand." But there won't be demand until the product is well known. Ultimately, a form of legislative recognition of the structure is critical. It doesn't have to be with lots of concessions, just safe harbors so you get the same tax result you would have had if you sold to a third party.
Michael (27:13) A lot of businesses will not sell. Employees might well be the most logical buyer. The further you go out of big cities, the more important everyday businesses are to that community. They aren't targets for private equity.
Andrew (28:01) It's a really interesting observation around the impact in rural Australia. My mindset when I first came to this was very much about business succession. The bit that actually struck me is, we've seen this now through a series of organizations where it's actually not so much about succession as building a business community.
There's a very good example in a dental practice. Rather than the traditional version where a dentist develops and sells just before retiring, this founder is focused on engaging everyone and building it as a sustainable, long-term community dental practice.
Michael (31:33) For a 10-person skilled services business, the most logical buyer is somebody from within the firm. I see through the eyes of SME owners that employee ownership is in the zeitgeist, but it has layers of complexity.
Andrew (31:33) We get a lot of questions from architects and engineers who fit very clearly in that dynamic of a founder with a particular ethos, engaged employees, and a desire to create a future. In a sense, it has the advantage that they're largely not capital intensive, so they don't have the competing needs of external finance to maintain the business.
Michael (32:32) I think of that one million employing businesses—services, technical, professional—are a very natural environment for employee ownership. The employees are the most natural buyer. You introduce a larger multinational as a buyer, and if the staff fundamentally don't like the culture, the probability of selling is impacted.
Michael (35:10) You might get an attractive headline number in an offer, but if you have to stay for five years through an earn-out period in a corporate hierarchy you hate, it's a horror story for some. The effectiveness of EOTs is that it's paced to what the business can afford to take out and give you over a number of years, with clear governance.
Andrew (36:59) You've hit on one of the great challenges: managing the conundrum of financing the exit, providing certainty to the founder, and ensuring they receive their payment. There is a tension under existing tax rules that don't give us the flexibility to afford an exit over a period of time in a staged way without accelerating a tax event and exposing yourself to credit risk.
Michael (38:13) We need the next generation of business owners to take over these businesses. It's a big step up from being an employee to an owner, but without that, the SME base shrinks.
Andrew (44:23) There's always the anecdote that stays with you. For me, it was someone in a warehouse after they went through the transition process, who came to management and said, "Do you realize how much stock we waste because we do A, B, C, and D?" Their focus as an owner changed their perspective. It meant they were much more driven to bring that forward, and it made a difference. It's organizational change where everyone is working for one success.
Michael (45:22) At a small business level, the biggest influence on success is your staff. If they're all engaged and can see a link between what they do and a better, more stable business—and maybe a cut of the booty in the form of a dividend—that is productivity. It's a hell of a leg up.
Michael (48:50) Can you give us an overview of the types of businesses better suited to employee ownership and EOTs?
Andrew (49:23) The one thing all the enterprises that have come to us have in common is a strong engagement with their employees already. They wanted to develop it further. Those that have fewer capital assets are more easily accommodated, like consulting firms. Where we get more challenges is where there are significant hard assets. The obvious regional example is farming, where it's a small business run from a very large single asset.
To make it work, you need to disaggregate the operation and management of the enterprise from the asset itself. There might not be a funding mechanism for the employees to buy the principal asset, but by separating the business run from the asset, you can make it work. An infrastructure investor can hold the asset, while the employees run the business in a different entity.
Andrew (56:08) I have no doubt the demand exists. It's a supply issue constrained by complexity. The other constraining element is we don't have a bank of professionals in Australia—lawyers and accountants—with an interest and focus on the development of this area. It's a chicken-and-egg moment. We must get to a point where all advisors talk about employee ownership as a standard alternative option when discussing succession, just like they talk about small business tax concessions.
Michael (57:20) There's an industry called exit planning that does great work, but there needs to be another layer of advisors who look beyond the exit event to a transition event that has ripple effects through the community and employees.
Michael (59:28) If you're the owner of a profitable SME hoping to retire in five years, what would you be telling them to do today in advance of leaving on their terms?
Andrew (59:28) It's probably three things.
Understand your goals: What is the reward you want out of this business and the exit?
Determine your involvement: How long and how much do you want to stay involved in it?
Engage early: Look at your workforce now to identify the leaders who can take the business forward. Give them authority and scope to grow and understand the business so there is a natural transition. Early engagement is key.
Michael (01:00:51) That was an excellent answer, and not one bit of legal or tax advice in it!
Michael (01:01:20) Final question: If they plucked you to run Australia's federal small business department next Monday, what would you do straight away to shore up our SME economy?
Andrew (01:01:54) I think it is to create robust succession models that are identifiable, understandable, with a strong focus on removing complexity. I look at the level of complexity people have to manage. We should have a world where our structure is simple enough and principles-based enough that if you're largely doing the right thing, it doesn't go wrong.
So often, small businesses haven't done anything wrong, but they get caught and strangled by the complexity of tax regulation. A large element of that simplicity has to be structural simplicity—operating within a form that doesn't have too many permutations that trip you up.
Michael (01:03:48) Reducing complexity and increasing awareness is a longer-term project, but we're both optimists. Thank you so much for taking the time to come onto the Owner to Owner podcast, Andrew.
Andrew (01:04:18) Pleasure. It's great to share thoughts. If any listeners have an interest, please reach out to EOA. We are an advocacy group focused on facilitating employee ownership. We'd be very happy to talk.
Michael (01:05:18) Much appreciate your time. Go well.