Can employee-owned firms afford to stick to their principles in a downturn?

John Lewis, the poster child of employee ownership, has been forced to consider diluting its partnership structure. It’s a momentous decision that raises tricky questions for proponents of mutuality
Q3 Illo Finance

In March, having posted a loss of £234m for 2022-23, the John Lewis Partnership announced that no annual bonuses would be paid for only the second year since 1953, warning that its situation had become so dire that jobs were at risk. 

The retail group’s 100% employee-owned (EO) model has been one of its biggest differentiators since this was established in 1929, while its stated purpose of “working in partnership for a happier world” has helped to keep its 74,000-strong workforce engaged. Its much-admired partnership structure has endured several economic downturns over the decades, but the business has fared so poorly in the past three years that the leadership team has been forced to consider a radical departure: giving up a minority stake to external investors in return for a sum approaching £2bn. 

The 2020s have been challenging for many businesses so far, serving up crisis upon crisis. Will other EO firms need to consider a similar move to recapitalise, improve their liquidity and survive this especially difficult period? And is the mutual model in general still fit for purpose?

Although research jointly published by the Employee Ownership Association suggests that EO businesses were more resilient than their conventional counterparts to the great recession of 2008-09, Chris Percival, the founder-CEO of management consultancy CJPI, believes that the EO structure tends to make life harder for firms in urgent need of a cash injection. 

“While the partnership model offers clear benefits, including long-term focus and loyalty from employees, it often limits access to capital,” he says. “This can make companies with these schemes less robust in weathering significant downturns in consumer demand and leave them facing increased financial stress.”

The challenges of raising new finance

Freddy Khalastchi, partner and business recovery specialist at accountancy firm Menzies, agrees.

“These businesses have fewer options for raising finance. They will either rely on existing stakeholders to invest their own cash or, potentially, restructure if they can’t enter funding agreements with potential investors that don’t require an equity stake,” he says. “Putting investors’ cash in the bank would be one way to shore up the finances. This would help to quell any creditor concerns that might be brewing and enable the management team to focus on improving performance and profitability.”

Percival notes that the expectation on EO businesses to share out rewards can also be problematic when times are tough. If maintaining liquidity is a concern, bonus payments are likely to be reduced or even scrapped, as in John Lewis’s case this year. This is clearly bad for morale and demotivating for all concerned. 

“Many of the benefits of a partnership structure are amplified during strong economic conditions, but they may become the perfect storm in a downturn,” he says.

The dilution of employee ownership

Many EO enterprises, including the John Lewis Partnership, are likely to be culturally invested in mutuality, according to Khalastchi. Diluting that structure may be unavoidable if they’re to survive the ongoing cost-of-doing-business crisis, but the idea of granting external shareholders a say in how the business is run and a share of its profits constitutes an unpalatable last resort for some adherents of employee ownership. 

The benefits of a partnership structure are amplified during strong economic conditions, but may become the perfect storm in a downtu

They may view it as an admission that this egalitarian ideal is impossible to maintain when the going gets really tough. Yet other keen proponents of the EO model are more pragmatic in their approach. Chris Maslin is one of them.

In 2021 he transferred a controlling stake in his accountancy firm, Maslins, to an employee-owned trust. As the founder of the Go EO consultancy, he now specialises in helping other SME owners to follow suit. 

“I don’t agree that one model somehow needs defending against another,” he says, noting that, in John Lewis’s case, “it’s simply that one type of shareholder is considering whether seeking investment from another type may be beneficial. In effect, the staff here at Maslins are the shareholders. They collectively control the business and are entitled to any profits it makes. The situation would be no different if the shares were owned by, say, a few rich individuals, a private equity house, a venture capital fund and so on.” 

Preparing to pivot

Maslin stresses that any business planning to adopt an EO model must ensure that flexibility is built into the arrangement. It should put robust frameworks in place that fully consider the implications of employee ownership when planning for various financial scenarios and conducting stress tests. 

It will also need to establish an approach to managing employees’ concerns when trading conditions deteriorate and demonstrating that the benefits of a mutual model aren’t going to vanish overnight if adjustments need to be made. The finance chief can play a key role here in reassuring people in an EO firm facing the prospect of a change in its ownership structure.

“The company’s finance leader may well be expected to put together some projections that will help to show its staff that, if a certain equity investment is taken on, yes, someone else will be entitled to a percentage of profits but this may well be a small price to pay if that investment makes the business more prosperous,” Maslin says. “Simply put, it’s better to have 90% of a profit than 100% of a loss.”