Capital needs for employee-owned businesses

This article by Andrew Bibby, in a slightly different form, was first published in the Financial Times, 2002

The graphic designers who work for the Hastings-based company Wave are proud to flaunt their difference. The business, which specialises in design work for charities and voluntary organisations, employs eight full-time staff who run the business as a workers' co-operative. Each has an equal say in management decisions and each draws the same wages, which currently work out before overtime at about £22,000 a year. To remind the world of its democratic credentials, Wave's website address uses not the familiar .com or .co.uk suffixes but the new .coop tag, launched in January 2002.

Felix Lozano has worked at Wave since it was established in 1989. He describes how the business has grown steadily, if slowly, to a position where turnover is now about £400,000. The co-op recently increased from seven to eight members and Lozano foresees a further small expansion, perhaps up to 10 people. He talks of the "liberating" effect of not having a boss: "A co-operative is a good way to work for many people - though not everyone," he says.

Wave's status as an employee-owned business is shared with a diverse group of enterprises, with big differences between them in size, management structure and philosophical outlook. What they all have, however, is a need to find capital sources that are appropriate to their particular ownership model. It is an issue currently attracting considerable attention - and some head-scratching within, for example, the Co-operative Union, the national body. For the bigger businesses, the real challenge is to find financial mechanisms that can deliver capital to employee-owned businesses needing hundreds of thousands or millions of pounds.

Unlike most small businesses, Wave does not use individuals' own private capital. Furthermore, Mr Lozano says, it is co-op policy that members' homes are not offered as security, a principle that was eventually accepted by its bank. "We had to be very persuasive and it wasn't easy," he says.

The logic is that, as a co-op, the rewards of the business should be shared on the basis of the work undertaken, not used for the benefit of investors.

Wave's development has been funded partly from retained profits, partly from a conventional overdraft facility and also from two loans provided by Industrial Common Ownership Finance, a specialist source of loan funding for co-ops and social enterprises. Icof lends money, typically up to a maximum of £50,000, on commercial terms, on the basis of an assessment of the ability of a business to make repayments. "We will take a general charge on the assets of the business but we don't ask for personal guarantees," says Andrew Hibbert, Icof's development manager.

Icof administers a number of small loan funds, including several originally established by local authorities for their particular areas. A successful ethical share issue - one of a number of similar share issues, pioneered by the fair trade organisation Traidcraft, where investment returns are secondary to the main objective of supporting an organisation - in 1987 raised £550,000 of additional capital, mainly from private individuals.

More recently Icof has been arranging a series of similar share issues in conjunction with a number of the English regional development agencies. The first of these, organised with the East Midlands Development Agency, was launched at the beginning of this month.

Mr Hibbert argues that Icof's experience, based on a bad debt rate that he says is around 5 per cent, suggests that co-operatives have a better survival rate than conventional businesses. But Icof remains a source of capital only for the smallest businesses.

Lancashire-based specialist manufacturing company UBH International is a case in point. The company, which produces tank containers for transporting liquids, was formed in 1999 when 91 former employees of Universal Bulk Handling, then in receivership, each chipped in £5,000 to buy the assets and intellectual property of their old company. Since then, the business has survived what Mike Himbury, its managing director, calls an "absolutely horrendous recession" in its sector and currently has turnover of £8m.

Mr Himbury talks of the importance of the sense of partnership created by the employee ownership structure. However, he also admits that this made it more difficult to find external equity capital prepared to invest in UBH International. "First, we are in manufacturing engineering and second, there was the unusual [ownership] structure of the business. We weren't finding the enthusiasm we feel we deserve," he says. But UBH wanted funds in order to move on to the next stage in its development and also to replace a bank overdraft with equity.

The answer has been an injection of £1m provided earlier this autumn [2002] by the Baxi Partnership, a unique £20m capital fund committed to the concept of employee ownership and workplace partnership that was established two years ago. Baxi Partnership takes an equity stake of at least 50 per cent in the companies in which it invests but the terms of its establishing trust oblige it to operate specifically in the interests of the employees in those companies.

David Erdal, executive director of the Baxi Partnership, sees this device as a way of introducing a form of venture capital while maintaining the essence of an employee-owned enterprise. "One of the objectives of any company owned by its employees is to maintain that ownership. But that makes it very hard to get anything resembling patient equity capital," he says. The Baxi Partnership has also invested in Aberdeen-based Woollard and Henry, a former private company recently subject to an employee buy-out, and in the troubled internet service provider Poptel.

Poptel, in fact, went a step further in its search for capital, taking in more than £2.5m in conventional venture capital from other sources in a complex process of restructuring that left the employees in the co-op with a collectively held residual 51 per cent shareholding in the business. But even where this sort of deal may be possible, not everyone is convinced it is the best solution.

"The whole concept of venture capital is that of super-normal profits somewhere and spectacular losses elsewhere. But the motive for creating co-ops is different - people aren't seeking out super-normal profits but are trying to address social needs," says Jim Brown of social economy researchers Baker Brown Associates.

Mr Brown is working with a project team recently established by the Co- operative Union, set up to explore the potential for co-operative businesses in areas such as childcare, old age care and renewable energy.

As the group knows, any talk of large-scale new co-operative business ventures immediately raises questions of finance. Mr Brown points out, for example, that at present neither the £4bn held in Britain in ethical investment funds nor the Co-operative Insurance Service's own substantial funds can readily be channelled into co-operative businesses. "There must be a way of ethical investment going into co-ops," he says.

But the task of finding financial mechanisms that can adequately reconcile investors' interests with the principles of co-operation is a challenging one. The old adage was that in a conventional business capital employed labour, while in a co-operative business labour employed capital.

Real life, it seems, could turn out to be not quite so straightforward.

Icof 020 7251 6181 Baxi Partnership 01334 479101 Co-op Union 0161 246 2900 Baker Brown Associates 0117 925 0824

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