Employee ownership in law firms
By Robert Postlethwaite, Managing Director, Postlethwaite (Guest blogger for Cogence Search)
Why do it?
One of several nuggets from Cogence’s recent survey on The Future of Law was that when asked how the structure of law firms could be improved, 20% of respondents suggested employee ownership as an alternative model. At first sight this might seem a surprising, arguably radical, view in a traditionally conservative profession where early adopters are often in short supply. But since law is a business whose main asset is people who place a high value on fulfilment and purpose as well as financial return (another feature of the Cogence survey), the argument quickly looks to make a lot of sense.
Whilst the traditional partnership model may continue to serve many law firms well, for many others there is an opportunity to improve. Here are some reasons why:
- Times have changed and continue to do so. Younger entrants to the profession feel, quite rightly, that a work life balance trumps high levels of reward. They may not want, or be able, to take on the risks and financial commitment of partnership.
- Many legal practices depend for their success on a wider pool of people than the traditional partners.
- Limiting the rewards for success to the select few personalities who are the most visible face of service delivery and winning clients leaves out many who are also important members of the team.
- New ownership models have been developed which are often a good fit with law firms.
What does ownership mean?
In any traditionally owned professional services firm, ownership means two main things: a right to a share of profits and a say in how the business is run. When you become a partner you buy your way into these rights and when you leave you get that money back. Whilst in other businesses ownership might also mean you have an investment which you hope to sell for more than you paid, this has historically rarely been part of the deal in a law firm or other professional practice where the value is the people. However, a firm which is able to build value beyond its people, so it becomes greater than the sum of its parts, may successfully create a third ownership dimension: the prospect of capital growth. Building a collegiate and team-based culture, investing in technology and successfully developing a strong brand are all potential routes.
What does employee ownership look like?
There are probably as many versions of “employee ownership” as there are craft beers in East London, but the overriding theme is that at least some of the ownership goes beyond traditional partners and, if it’s going to achieve the intended benefits, a lot of energy is put into engaging employees in what makes their business succeed.
Some firms are prioritising the involvement of senior associate lawyers and non-lawyer members of the senior management team. Others are going a major step further and involving their wider staff in the ownership. In all likelihood this will involve shares in a limited company. The purest view of employee ownership, the so-called John Lewis model, involves universal ownership by all those working in it. Everyone receives a salary and a performance based reward but there is no major concentration of ownership in a select few hands.
Let’s look at each of these a little more closely.
Ownership for your key people
A company wishing to involve selected key people as owners could consider simply inviting them to purchase shares, and/or grant them share options. Option gains can be exempt from income tax and NI, being only subject to capital gains tax on eventual share sale. Alternatively, employees might receive their shares free (and can currently do so tax free in limited circumstances).
Ownership for all your employees
For a company wishing to make all its employees shareholders, the Share Incentive Plan (SIP) enables employees to buy or be given shares, in each case with tax relief. Any subsequent growth in share value is exempt from CGT.
It’s essential to think it all through most carefully. Involving large numbers of employees in personal share ownership can become complex and require much future administration to deal with leavers or those wishing to sell. Also, if share value does rise significantly over time, it risks becoming a victim of its own success as funds have to be found to fund buying shares back from those wishing to sell.
For these reasons, an alternative to individual share ownership might be trust ownership, in which a block of shares is held in an employee trust for the benefit of employees. In practice the financial benefit to employees is most likely to be an annual profit share, although if the business were ever sold they would also share in the sale proceeds.
The John Lewis model
Which brings us back to the John Lewis model. I’m not yet aware of a law firm that has gone down this route, although a number of other professional practices have. It may claim the attention of valuable existing practices whose owners are looking to retire. A sale of a controlling interest to a statutory employee ownership trust will be free of capital gains tax, and it will then be possible to pay bonuses to employees free of income tax.
Does employee ownership need to involve a capital stake in the firm (shares, partnership of LLP membership?). It depends on your view. If ownership is really about profit share and employee engagement, then arguably not. But if capital ownership is also a feature but is the preserve of the elite, that looks like two tier ownership, and you would need to confident that’s going to work in your practice.
And be wary of smoke and mirrors – “employee ownership” is a positive force which makes it vulnerable to misappropriation!