Family ownership to employee ownership

Ken Mccracken  is director of Family Business Solutions Limited. kmccracken@familybusinesssolutions.co.uk
Acknowledgement: This case study was written with the support and encouragement of David Erdal, formerly chairman of Tullis Russell Group Ltd and now director of Baxi Partnership Ltd.

An employee buy-out enabled Tullis Russell Group to quadruple productivity and double its turnover. But, as Ken McCracken discovers, the value of ownership can be a lesson hard learned

Tullis Russell Group, based in Fife, Scotland manufactures high quality, engineered paper products for customers worldwide. After six generations of family ownership the family's inherited ownership values and an unlikely family business leader resulted in the business becoming employee-owned in a pioneering capital reorganisation that was the first of its type in the UK.

The original paper mill was founded in 1809 by Robert Tullis, to cope with the impact of Napoleon's blockade of Britain on the supply of paper to the family's printing and publishing business. His successor William Tullis and his wife Agnes Russell had no family, and so in 1874 William passed the business to his nephew Robert Tullis and his brother-in-law, David Russell, who became equal partners. After Tullis Russell Limited was formed in 1906, David Russell's interest passed to his son, Sir David Russell, and in 1924 the Tullis family sold their shares to the Russell family.
 
Sir David Russell was a liberal Presbyterian with a paternalistic view of ownership responsibilities that included providing pensions and healthcare for employees at a time when business owners did not view these innovations as desirable. His successor as leader of the business, Dr David Russell, did not share his father's religious beliefs but agreed that the owners had a duty to "show love to every employee". Dr Russell's views had been formed by his experiences in the first world war, during which he had been decorated for valour at the Battle of Alamein. Sir David's other son, Patrick, was killed during the war, but Sir David still decided to divide ownership of the business equally among his surviving son, two daughters and a charitable trust in memory of Patrick.

With the approval of the other owners, Dr Russell continued to run the business as a quasi-controlling owner. The shared view of leadership succession was to find a family member to assume his role, but Dr Russell was concerned that the next generation, who had all enjoyed growing up in the liberal moral atmosphere of the 1960s, would not be safe custodians of the family's ownership values.

He investigated models of employee ownership developed in the UK by the Rowntree Trust and John Lewis Partnership, but eventually decided that outright employee ownership might not achieve the desired goal of continuity and stewardship of the business. In 1969 ownership was instead reorganised into voting and non-voting shares and Dr Russell and his wife created another trust and transferred a significant block of voting shares to the trustees. In 1975 they 'gifted' more voting shares to the trustees and merged their trust with the trust created in memory of the late Patrick Russell – what became known as the Russell Trust.
 
The Russell Trustees now controlled the majority of voting shares and Dr Russell gave them a 'letter of wishes' expressing the desire that in future they should exercise their ownership powers in the best interests of all the employees. With the ownership legacy apparently secure, the problem remained of identifying a family member who could become the next business leader. After others had excluded themselves from consideration for various reasons, attention turned to the most unlikely candidate Dr Russell's nephew, David Erdal.
 
David Erdal's early political beliefs had been shaped by an awareness of the contrast between his privileged upbringing and the decency of his poorer friends in the Highland communities where the family spent holidays. On leaving school, he entered the construction industry, eventually becoming a trade union shop steward and in 1972 joining the Workers Revolutionary Party. He then accepted a two-year contract teaching English in China, which gave him the opportunity to study at first hand the impact of revolution on ordinary people.

He arrived in China towards the end of the Cultural Revolution when the Gang of Four controlled the country. Contrary to his hopes, David found a population who were terrified of their leaders and the benefits of revolution to workers were far from evident. After 18 months David resigned his appointment.

David returned to the UK, unemployable in any conventional sense. During his time abroad, however, he had corresponded regularly with Dr Russell, notwithstanding the gulf in their political beliefs. In 1977,  David agreed to join the family business.

The first task was to learn about the business. After a year's training in different parts of the business, it was acknowledged that David represented the last hope for continuity of family leadership. To address his lack of business experience, David applied to Harvard Business School to study for an MBA. His uncle, however, was suspicious of this development. Through a series of dealings Dr Russell had developed a loathing for traditional capitalism that, in his view, put profit above everything, and especially above the welfare of employees. He was worried that David would lose touch with these family values, but eventually he relented and agreed to support his nephew's ambitions.

After graduating, David returned to Scotland and joined the Tullis Russell board. During the UK manufacturing recession in the early 1980s, the family's values were challenged by measures that were needed to protect the business, including redundancies and cost cutting. By 1984 David had developed his ideas on changes in the management style that he felt would be necessary to gain the commitment of the employees. He did not feel he had the right to impose his views simply because he was a family member, and he offered to resign. His uncle persuaded him to stay, and Dr Russell decided to step down at the end of 1984 and appoint David as executive chairman. The non-family chief executive took early retirement at that point, and David assumed control over the business. Two non-executive directors, who had held senior positions with major UK listed companies, joined the board and a period of transformation in the company commenced. As well as continuing action to increase business efficiency, David promoted transparent and open communication with employees.

The board started regular consultations with employees and their trade union representatives and a bonus scheme was established under which 15% of profits were shared among employees in proportion to their salaries. An all employee share scheme was set up and a further 7% of profits were contributed to this scheme and used to buy shares from family members. An electoral college made up of employees who had been elected by their peers was given the right to appoint half of the share scheme trustees.

Initially the employees were suspicious and anxious about these changes. It was difficult for them to reconcile wider share ownership and increased participation in the business, with redundancy programmes and cost cutting that made many feel that the current owners were sacrificing Dr Russell's "love for every employee."

The family's relationship with the business was indeed changing. The opportunity to sell a limited number of shares to the share scheme trustees was timely since some owners wanted to access their inherited wealth and had been advised that the best ways would be the traditional routes of a trade sale or public flotation. In a decision that Dr Russell would have approved of, the family rejected these ideas because of the potential damage to the interests of the employees, as well as the substantial fees that would have been paid to advisers.

Instead, it was decided to set up a new employee benefit trust to buy approximately 15% of the shares from family members. In contrast to the first share scheme that distributed shares to existing employees, the employee benefit trust was to be a long-term holder of shares.

While the owners attachment to the family's legacy of ownership was undoubtedly diminishing, there was growing interest in ownership among the employees who were beginning to believe in the benefits of owning "their" business. The family and the employees looked to Erdal to resolve the dilemma in a way that would satisfy their understandable, but potentially competing, needs and ambitions.  

The way forward was to go back to the ideas about employee ownership first explored by Dr Russell. David received support for an employee buy-out from the Russell Trust. The price for shares was agreed among three independent advisers acting respectively on behalf of all the family owners, the company and the Russell Trust. In settlement of the price, the owners agreed to accept loan stock and non-voting shares in a new company, Tullis Russell Group Limited (TRG). The loan stock would be redeemable over 15 years at an escalating price that gave TRG every incentive to pay back the debt as soon as possible. This meant that on completion of the deal Tullis Russell would become a wholly owned subsidiary of TRG, which would be owned outright between the Russell Trust and the trustees of the employee benefit trust who had each agreed to accept TRG voting shares in return for their Tullis Russell holdings.

At this critical stage an unexpected volte-face by the family's adviser threatened to destroy the deal. The family had chosen an adviser who seemed to understand the historical, deep-rooted relationship between the family and the employees. The adviser initially performed this role sensitively, but then unexpectedly he advised the four largest family owners to reject the deal and suggested that it was a ruse by David to con his relatives to sell the company for a lot less than it was worth, so the employees could then realise its full value on the open market.  

The family felt betrayed by the adviser who was duly sacked, but this development undermined the trust that had been painstakingly constructed around the innovative idea of an employee buy-out. Worse was to follow. The adviser leaked confidential details of the proposed buy-out to a competitor of Tullis Russell who, not feeling in any way impeded by the underhand way in which this information had been received, offered to buy the company at a price 10% higher than the price agreed for the employee buy-out.

The Russell trustees faced a dilemma in which it seemed their duties to act in the best interests of the employees required them to accept the higher offer. Given that the competitor's intention was to close some of the Tullis Russell mills, the trustees concluded that they should reject the competing offer. Not even Dr Russell could have realised how important his letter of wishes would become in protecting the family's ownership legacy.

The employee buy-out was completed in June 1994. As it turned out the competitor's offer would have been disastrous since within a short time afterwards their share price had collapsed. In contrast the family's loan notes were fully redeemed by TRG for cash within seven years instead of after 15 years as was originally envisaged.

The decision to make the transition to employee ownership was a financial success for the family. The decision to back the employee buy-out ensured continuity of the business in accordance with values that stretched back to the late Sir David Russell. The deal secured a tradition of paper-making in Fife and continued employment for local families that had provided loyal service to Tullis Russell. The TRG employees now owned their own business.

The case illustrates the strength of ownership values in a family business and how these are developed across generations. The transmission of these values ultimately depended on a simple letter of wishes and a serendipitous link between a benevolent, Presbyterian Knight and a successor who two generations later arrived in the family business via the Workers Revolutionary Party, China and Harvard Business School. Instead of leaving it to chance, a family assembly might have been a useful forum for helping family owners – and their advisers – to ensure that whatever was done during this ownership transition accorded with the family's deep-rooted values and traditions.

Since the buy out TRG has quadrupled productivity and turnover has doubled to £134m. In contrast to its main competitors, the company has been consistently profitable. An important element in this success has been the recruitment of good managers. TRG has attracted senior managers from large quoted companies who were disillusioned by the repeated disruption caused by mergers and acquisitions and were attracted to a company where the employees have every reason to be committed to its success and to keeping it independent. Just as Dr Russell would have wished.