How to Encourage More Employee Ownership to Australia

Myself and several associates through our actual experiences  over the last 7 years are advocating for change:

RECOMMENDATIONS FOR THE FEDERAL GOVERNMENT

1. Provide new tax incentives

The Government needs to consider encouraging owners and employees to evaluate the benefits of adopting employee-owned cooperative structures.  Just one such enticement could be by providing assistance with the repayment of “patient capital” to retiring business owners.

“Patient capital” is the equity usually provided by business owners who are willing to balance the current return on their investment against the long-term value and the continuation of their business.  (In C-Mac’s case, the owner of the premises was prepared to delay payment of rent for the first 12 months to boost the Cooperative’s cash flow and chances of economic success.  It was agreed that the 12 months of rent would be paid back over the next five years.)  In essence, these monies owed to the Owner by the new employee-owned cooperative are a form of vendor finance and can be paid back over some time.  They can be repaid in one of several ways:

  1. The patient capital repayment could be treated by the ATO as a tax-deductible expense (that is, taken from cooperative members before-tax income, representing salary sacrifice for ownership). This would represent “sweat equity” and encourage the adoption of the cooperative model
  2. The cooperative could repay the patient capital to the owner from after-tax income simply as a loan repayment. This helps with the cooperative’s cash flow (no third party lending institution having any influence). It encourages the cooperative’s members to look after the owner; the owner gets regular income every month rather than a lump sum.  It also keeps the owner interested in the ongoing success of the cooperative.  A win for both parties
2.  No Capital Gains Tax

Capital gains tax should not be applicable on transfer of a business to an employee owned cooperative.

3. Federal Minister

A Federal Minister is appointed to oversee Employee Ownership, responsible for the implementation of an Australian version of the UK Nuttall Review[1].

4. Share Structure and Taxation

Since inception the C-Mac Cooperative has followed the principles outlined in the Spanish Mondragon Cooperative model, utilising “Internal Capital Accounts”.

The way C-Mac has structured profit distribution to members differs substantially from the capital structure in a conventional business corporation.  The net worth of a traditional corporation is reflected in its share price.  If the company is profitable, the retained earnings, the net worth of the company and thus the value of the shares in the company increase over time.

If a cooperative records its value in the price of a share, then the appreciated value of these shares might make them too expensive for new members to purchase, thereby barring their entrance to membership.  In the past, the high value of shares has provided an incentive for demutualisation.  Historically, the use of such capital shares has led to the demise of this democratic structure in a variety of employee-owned firms.  To counter this C-Mac is employing “Internal Capital Accounts” where the cost of a membership share is kept at an agreed amount, and the increases and decreases in the business value are reflected in the individual’s “Internal Capital Account”.

Under this method, internal capital accounts reflect the return accruing to the individual based on their contribution as an active member of the cooperative.  An active member of the C-Mac Cooperative is defined as someone who works eight hours a week or more.

These internal capital account accruals in other parts of the world are termed “patronage dividends” rather than capital dividends. They differ from capital dividends in several ways:

  • They are not paid in cash
  • They represent a return on labour patronage rather than a return of capital investment. Traditional firms are subject to taxation at both the firm and the ownership level.  I argue that the cooperative is a collective agent of the members and that earning the income only occurs and becomes taxable when it is in the hands of the members when they leave the cooperative
  • The cooperative allocates the patronage dividend entirely on paper and retains the profit for the use for any cooperative purpose. This addresses one of the significant challenges faced by cooperatives, raising equity capital
  • The cooperative pays interest to the members each year, at a rate determined by the Board, for the cooperative’s use of their patronage dividend

Issues that need to be resolved:

  1. The patronage dividend is the balance in a member’s personal internal capital account, which is paid to the member, only when they leave the cooperative. These dividends retained by the cooperative build up working capital.  When paid to members, they should be franked at the cooperative’s taxation rate.
  2. National Cooperative Legislation should be less restrictive, and amended to allow distribution of positive and negative profits to members using “internal capital accounts”.
  3. Presently internal capital accounts create a liability on the balance sheet in Australia. This needs amending, so these retained earnings are treated as an equity account.  If left on the Balance Sheet the accumulated liability/debt will mount in the business from unpaid ICA’s over several years (if staff don’t leave) creating a negative current ratio, i.e. current liabilities being greater than current assets and could cause the cooperative to appear insolvent.
5. Cooperative Bank

Employee-owned firms have historically had great difficulty obtaining adequate finance.

A key reason for the high rate of overseas start-up success and ongoing survival is the development of “support institutions”.  This will be most important in the next few decades here in Australia when employee owned cooperatives are being established.  It is crucial that a financial organisation that understands and caters to cooperatives be established.

To my knowledge, there are no cooperative banks in Australia; they are all Mutuals.  To establish a bank solely for employee owned cooperatives is too tricky as they fall under APRA Regulations and Rules and face restraints.

The Federal Government needs to provide “Cooperative Business Development Funding” to assist business owners and employees in the creation of employee owned cooperatives. This funding would take the form of providing patient capital, not a cash grant.  This patient capital would be paid back over (say) 5 years at a concessional interest rate, supporting the new cooperative in their crucially important first five years of operation.

There could be two sources of funds:

  1. A potential source of funds for could be the unutilised franking credits from businesses turning over less than $100 million that have shut down leaving unclaimed franking credits. (This would not apply retrospectively, but only commence at the time of legislation.)  These funds have already been allocated to business and could be utilised for the good of the economy.

Franking credits are a type of tax credit that allows Australian companies to pass on tax paid at the company level to shareholders.  The benefits are these franking credits can be used to reduce income tax paid on dividends or potentially be received as a tax refund.

Allowing franking credits from the old business structure to be transferred to the newly created employee-owned cooperative, to provide immediate much-needed working capital for the new entity, would be helpful.  As an example, C-Mac possessed several years of accumulated franking credits that had to be abandoned when the new C-Mac Cooperative was created.

In the ordinary course of events, these franking credits would have been available to the owners, and they would have been able to use them had they drawn down dividends.  In many cases, these credits are not drawn down when a business is sold or becomes a cooperative.  Business owners who are passing on a company to the workers in the form of an employee owned cooperative should be able to give these credits to the new cooperative entity.  This legitimately acknowledges the previous owner’s contribution to having built the business and ensuring its ongoing survival.

  1. The existing “Future Fund Management Agency”[2] be given a mandate from the government to support investment in employee-owned cooperatives by providing security and distributing funds through a current bank that would be sympathetic to the ideals of employee ownership. That selected bank would process loan applications from cooperatives and distribute and manage the approved loans.

The Australian government’s $139 billion “Future Fund” objective is to invest for the future generations of Australians. Recently their chief investment officer stated:

“Small businesses in Australia have significant growth potential but suffer from limited access to financing.  We are actively considering ways we can invest in these types of opportunities in an efficient way, and we will hopefully have more to say on this in the near future.” [3]

The selected Cooperative Bank would need to offer low-interest loans (without guarantees) for patient capital, and facilities to purchase assets such as property, buildings and equipment.  Overdraft facilities should also be made available, supported by strong balance sheets and quality management, something most mainstream banks won’t consider.  The selected bank would cater to both new employee owned cooperatives as well as existing employee owned cooperatives experiencing difficulties.

Australian Data on employee owned cooperatives, rating their structures and associated credit risks, is needed for banks to assess loans.  Currently, this information is very sparse.  If government sources start to underwrite credit for banks, data will begin to accumulate automatically.

6. Competition object be added to APRA’s mandate

To remove financial impediments to innovation and progress in the recognition and encouragement of co-operatives and mutuals as viable alternatives to investor-focused companies limited by shares, a competitive object should be added to APRA’s mandate.

7. Federal or State Cooperative Development Agency

Another critical supporting role would be to create a “Cooperative Development Agency”.  Its purpose would be to promote the establishment of employee-owned businesses by providing business management training, legal and financial consulting, and cultural change advice to new and expanding cooperatives, as well as cooperatives experiencing difficulties.  This Agency would feature:

  1. A $1 million annual budget, as proposed in 2010 by the Rudd Federal Government initiative labelled the Australian Employee Buyout Centre. This could initially be established in NSW and expanded to other States as the model proves successful
  2. After initial 5 year funding the Agency could morph into the “Cooperative Entrepreneurial Group”, a self-funding organisation that charges for its services (as has happened in Mondragon, Spain

Eventually, the market will encourage independent consulting agencies which will sell their consulting services to cooperatives and other organisations.  Some of these could be similar to Baxendale in the UK[4], providing commercial intelligence, appraising options, preparing financial models, and presenting submissions to the selected Cooperative Mutual Bank for provision of low-interest loans.  Additional services could include the provision of consulting services in the fields of management, financial reporting, technology, legal advice, architecture, engineering, urban planning, construction and infrastructure, marketing and promotion, and real estate consulting and design.

8. A Watch Dog Auditor

Would be needed to oversee the Cooperative Mutual Bank, and Cooperative Development Agency ensuring the appropriate use of funds.

9. Professional advice – Education

A campaign should be launched to educate accountants and professional organisations about employee-owned businesses and cooperatives.  If the federal tax incentives were sufficient, this would happen automatically.  Business advisors need to re-think their answers to standard questions from clients, such as:   “What ways are there to sell my company?”  “What ways can I incentivise and provide for my staff?”

Experience has shown that the longer a cooperative operates the more education suffers; it is often seen as an unnecessary expense.  In Brazil, cooperative laws require 4% of their cooperative’s turnover to be allocated to education. Perhaps such a condition could be added to the National Cooperative Legislation.

10. Federal and State legislation encourages demutualisation

Australian markets are entwined with regulation causing unintended consequences, which then influences Boards to demutualise.  Existing regulation encourages the experts at the big end of town to promote demutualisation.  Conflicting legislation between tax and corporate laws is confusing and need fixing.  Legislators need to become aware of employee owned cooperatives when creating or modifying legislation.

11. Cooperative legislation should provide protection from corporate takeovers

In France and Spain, cooperatives are protected by legislation and cannot cash in their equity on closure, that is, asset sales cannot be distributed to members. Liquid assets are returned to the cooperative movement (Cooperative Mutual Bank).  Amendment to the National Cooperative Legislation is needed.

12. Federal Funding Assistance Eligibility

Make cooperatives eligible for Federal business assistance programs via the Enterprise Connect or Entrepreneurial Program.  These could provide dollar for dollar funding up to $20,000 for business succession costs incurred in establishing a manufacturing employee owned cooperative.  Currently, cooperatives do not have ACNs and are, therefore, ineligible.

13. Federal Government Procurement Policy

A mandatory 3% procurement policy under the legislative instrument of the Commonwealth Procurement Rules to leverage the Commonwealth’s annual multi-billion procurement spend to drive demand for 100% employee-owned businesses goods and services, stimulating employee-owned cooperatives development and bring this business entity into the mainstream of business. (Similar to the existing Indigenous procurement policy)

14. Federal and State Government Forms

The word “Cooperative” should be added to all Government and private business “forms” as a selectable option.

15. Employee ownership Review needed

Similar in nature to the Nuttall Review undertaken in 2012 in the UK.

16. Employee Ownership Trust (EOT) incentives to be introduced into Australia

It is interesting to note that Graeme Nuttall’s Review refers to shares “held by or on behalf of employees”.  In other words instead of shares being owned directly by employees, either in their own name (as in a workers cooperative) or through a mechanism such as an ESOP, shares can be held indirectly on behalf of employees in an employee trust.

This is a long-established and successful way of creating employee-owned companies in the UK.  The flagship UK employee-owned company is The John Lewis Partnership which has been owned by an employee trust since the 1920s.  As a result of the Nuttall Review, the UK government introduced tax incentives to further encourage in particular, this model of employee ownership.  The tax incentives apply to what is known as an Employee Ownership Trust or EOT.

Australian trust laws are basically the same as the UK, but incentives similar to that of the UK would encourage SME employee ownership.

Australian authorities should look closely at this idea as an alternative to employees owning shares directly.  The UK evidence is that this trust approach avoids many of the difficulties of establishing ownership directly by employees.[5]

RECOMMENDATIONS: FOR NSW STATE GOVERNMENT

17. No State Stamp Duty

Stamp Duty should not be payable on the sale of business and assets, C-Mac was directed to a specialist ATO assessor based in Wollongong, because our circumstances were deemed to fall “outside the box”.  There shouldn’t even be a box!

18. NSW Fair Trading – more model rules

Create several versions of the Model Rules to cater to different types of cooperatives in Australia, making it easier and cheaper to start a cooperative without reinventing the wheel each time.  In the UK, they have fifteen different models[6].

19. State Government purchasing

Procurement Policies should contain a requirement whereby 3% of all State government purchases are placed with 100% employee-owned businesses.

20. Advocating for Cooperatives

All cooperative members should be encouraged to sing the praises of the basic benefits of their style of business entity:

  1. Cooperatives add an important variety and diversity to the business world and facilitate the integration of assets into the community
  2. Cooperatives can open up local supplier chains and create a more sustainable and balanced community
  3. Cooperatives can improve competition and choice
  4. Cooperatives spread wealth through the community
  5. Cooperatives encourage political will, support and understanding
  6. Examples from around the world demonstrate that employee owned cooperatives are slow to start but once operational survive economic fluctuations better. They also tend to be more innovative and less likely to carry debt.

 

[1] www.gov.uk/government/publications/nuttall-review-of-employee-ownership

[2] www.futurefund.gov.au/about-us/who-we-are

[3]www.futurefund.gov.au/news-room/2018/03/01/22/58/20180302—dr-raphael-arndtspeech-avcj-forum?page=0&itemsPerPage=15

[4] www.baxendale.co.uk/services

[5] For further information on UK EOTs is available from Graeme Nuttalls firm, Fieldfisher and in various articles written by colleagues.

[6] www.uk.coop/resources/model-governing-documents