by Anthony Turnbull
We publish here an edited version of a paper originally presented at the Polytechnic of Central London as part of the CPD programme organised by the RICS Central London Branch.
I wish to make it clear at the outset that I see myself neither as an advocate for, nor as a defender of, the plc as compared with partnership or any other organisational mode. I thought, and still think, that incorporation was the right way forward for Debenham Tewson & Chinnocks. I do not know enough about the structures and finances of other practices, nor the personalities of those involved, even to guess as to whether incorporation would be the right way for them. I write strictly as a reporter — and furthermore the report is an interim one only. It will take at least five years, and probably a change of government, before anything like a full picture can be painted.
I should first like to set the context in which Debenham’s decision to go for incorporation, and later flotation, was made, and to explain what we expected to gain from it. Remembering that the decision process was set in motion barely two years ago, it is somewhat surprising to look back at how different the situation was, or was perceived to be, then as compared with now.
Early 1986 was a time of considerable economic and political uncertainty. The Thatcher Government was nearing the end of its term and trailing the Labour party badly in the opinion polls. The top rate of personal taxation was 60p in the £. If the Labour party were to be returned at the election, rates of tax would certainly be increased, especially at the higher levels, and there would be no hope of the benefits of cessation (the saving of the finances of many partnerships at the time of previous high tax regimes, disobligingly abolished by the Conservative Government) being reinstated. There could be no doubt that the provision of working capital for partnerships out of personal reserves would put partners under severe strain.
It could, of course, be assumed that borrowing facilities would continue to be available from banks. DTC, like other partnerships, had negotiated large and surprisingly long-term overdraft and other credit facilities with its bankers but the limit of this was directly related to the aggregate of the capital provided for the business by the partners. Partners could, in their personal capacity, borrow the capital required from them against other assets, particularly their homes. But the result would be a highly geared situation of personal finances, leaving little room for the satisfaction of other personal and family aspirations.
Set against these difficulties in providing capital, there was no likelihood that the demand for capital investment would reduce. Rather the reverse. Clients were requiring increasingly sophisticated advice within tighter time frames. Hunch and guess work were out. Well-reasoned and documented research was in. Furthermore, the cost of presenting and transmitting advice in ways that properly reflected the quality of that advice added additional burdens, as did the need for provision of fast and efficient data storage and retrieval systems.
On the one hand there would be a greater demand for capital. On the other there would be growing difficulties in providing it.
If the envisaged problem of providing capital was the prime reason for the decision to “go public”, there were also organisational reasons. While partnership is a suitable structure administratively for a group of three or four people, it becomes progressively less suitable as those numbers rise. With 35 partners, each traditionally equipped with the right to veto any decision made by the group, the system could become impossibly unwieldy, with, in Doctor Doolittle terms, all the attributes of a multi-lateral “push me-pull you”.
It is of course possible, by consent, to impose on a partnership a quasi-corporate mode of administration, such as an executive committee. But this still leaves the more-than-theoretical possibility of intervention, or threatened intervention, by individual partners in what may seem at times, to those given executive responsibility, a somewhat arbitrary way. I think there can be little doubt that partnership, with its emphasis on allowing people the ability to prevent change, is essentially a negative structure. Incorporation unequivocally puts responsibility for the running of the business into the hands of those unfortunate enough to be appointed to that task. Responsibility is, in time, devolved within more limited areas and with much clearer definition. But the professional “stars” are left with more freedom to concentrate mainly on what they do best — the service of existing clients and the getting of new business.
These slightly negative factors gave the initial impetus towards looking at the possibility of flotation. Further investigation revealed a number of positive factors, particularly in connection with the ability to reward and provide incentives for people within the business in several different ways. Former partners would of course benefit by having shares in the new corporate venture, the value of which would increase to reflect their hard work and enterprise. Those on the edge of partnership would be brought into partnership to share in this process. Associates could be rewarded by the grant of share options which, in DTC’s case, were withheld from founder partners. Furthermore, if these options were to be given at the time of change from partnership to limited liability company, a value could be agreed with the Inland Revenue which would be considerably less than the value at flotation. Options cannot be exercised until three years after they are granted but, if they could be exercised on flotation, all DTC’s associates would be in a position to make healthy capital gains.
Lastly, all employees could be rewarded by a share participation scheme. As in the case of share options, a greater benefit could accrue if the shares were to be distributed initially at the date of incorporation. The value of such shares could rise at flotation to the equivalent of, say, a third of a year’s salary and further shares could be distributed at the end of each year on a continuing basis. Additionally, the sale of these shares, if carefully arranged to take advantage of capital gains tax exemptions, could be arranged in a way to avoid the payment of any tax.
In short, an interest in the profitability of the business would not be confined, as in the case of many partnerships, to a very few people at the top. All partners and associates, a group of about 70 people at DTC in 1986, could receive substantial incentives by way of share or share options in a new company and the majority of staff would be shareholders to a significant degree.
If these were factors that led to our decision to incorporate and float, I would like to touch briefly and parenthetically on one that emphatically was not — limited liability. Our defence against the penalties that could be exacted in the event of a proven liability for professional negligence was, in 1986, and remains, our professional indemnity policy. There was a time in 1986 when cover was difficult to obtain and premiums have increased alarmingly over the last few years. But, although PI now ranks as the third largest expense after staff and accommodation costs, I believe that we will continue to be able to insure for the foreseeable future at levels of cover that will be sufficient to meet all claims that can reasonably be envisaged.
There were of course many other more minor factors that influenced us but this briefly was what we expected from incorporation and flotation. Now let me consider the extent to which expectation was realised.
First of all, we are not in the economic climate we considered in 1986 to be most likely. Labour lost the election. The Conservatives won and the top rate of income tax is 40% to which level capital gains tax has been raised, albeit with the benefit of a 1982 base. Would we still go if we were making the decision today?
The answer is that I think we would. There may be short-term benefits in remaining a partnership, but the long-term picture remains the same. Capital costs continue to rise and, in three years’ time, partnerships will have to make the same political assessment as we had to make in 1986. The Conservatives may again win in 1991-92 but, if they fail, the penalties of finding oneself in a partnership will be as condign as they were seen to be in 1986. History shows British leftwing governments to be more sympathetic to corporate tax payers than personal taxpayers and there is no indication in present policy that this will change. Equally, capital taxation has almost always been at a lower rate than the taxation of income. In 1991-92, as in 1986, it will be too late to go for incorporation and flotation after the unfavourable result of a general election.
The organisational results of incorporation have been very much as expected. I believe that chartered surveyors — and indeed probably all professional people — tend to be much better at looking after their clients’ business than their own. In partnership, there was always the feeling that it was faintly improper to spend much time looking after the practice’s affairs. After incorporation and flotation, there is not only an excuse but a positive duty to give time and thought to the affairs of the company. Documents such as three-year business plans, action plans and formal budgets were, as a partnership, prepared when, or if, the pressure of clients’ work allowed. And pressure of clients’ work was always unquestioningly accepted as a good reason for delay. That has changed. We now tend to write down plans in more detail, which is a useful discipline requiring the considered thinking through of important policies without short cuts. Further, we discovered that, whereas we thought we were ad idem on various matters of policy, when we came to be specific there were important areas of difference, which it was essential should be resolved. I believe that all this is to the benefit of the client as well as the shareholder because a more efficient operation will provide a better service.
I am asked from time to time whether the need to have a plc board that has fewer members than the original partnership creates a perception among those former partners not on the plc board of loss of status. There is certainly a danger of this happening, but I hope that it is not the case at DTC. All former partners are shown as directors of the principal trading company on whose notepaper we write on all occasions when professional advice is given. The holdings company notepaper is infrequently used, and only in respect of corporate matters. So, unless someone goes to some trouble to find out, he will not know who the holding company directors are. In any event, as I said earlier, the trading company directors are the real stars of the show. They are the high-wire walkers, the trapeze artists and the lion tamers. As chief executive, I see myself, at best, as a ring-master presenting the stars in their most favourable light. At worst, I am the chap who cleans up the elephants’ mess!
Another question I am asked from time to time is whether flotation, and the need to make profits that it brings, might not set up a conflict with professional standards. In general, I suggest there has always been, even in partnership, a potential conflict between the interests of the proprietors, and those of the clients, of a business offering professional advice. The fact that, after flotation, some of the proprietors are not chartered surveyors seems to me to be irrelevant unless you take the view that chartered surveyors are intrinsically more moral than the average shareholder. This would appear to be a smug assumption. In particular, I would say that we, like most other leading firms of chartered surveyors, have a good business because we have traditionally offered a very high standard of service. It would be bad business, and against the best interests of the shareholders, for us now to offer a lower standard of service.
From a business point of view there is no doubt that we have a higher public profile since flotation. As a partnership, our dealings were of little interest to other than property people. Now there is a much wider spectrum of attention. Particularly at three times of the year — at the announcement of interim and final profits and at the time of the AGM — we receive considerable publicity. When we carry off a major business coup, it is a matter of comment both professionally and financially. This higher profile is extremely valuable in getting our name across to potential clients and is something which no public relations man, however brilliant, can achieve for a partnership. This is an area, I think, where realisation has significantly exceeded expectation.
An inevitable change between partnership and corporate structure, particularly corporate structure after flotation, is the greater degree of financial openness required. The whole world, including clients, employees and competitors, knows, either actually or constructively, just about everything there is to know about your business, your salary, the level of your share holding, the company’s profit margins, the earnings per member of staff — everything. I have heard this requirement to give more information represented as a disadvantage of the corporate form and the ability to be secretive as an advantage of partnership. If secrecy is an advantage to partnerships, it is in my view a diminishing one. Clients do not generally understand partnerships, and lack of understanding breeds suspicion. They do understand corporate structure because, mainly, that is the structure within which they themselves trade. I believe that clients know much better where they stand with advisers using a corporate form and that they will increasingly prefer this mode of operation.
A final and unexpected advantage of flotation has been the contribution of non-executive directors. I suppose our initial reaction to the requirement of having non-executive directors was one, if not of suspicion, certainly of slight apprehension. We were advised we had to have these strange and unfamiliar creatures, but what good could they do us? Worse still, what problems might they cause us? I do not know whether we have been exceptionally fortunate in our choice of non-executives — I am certain we have been fortunate — but, so far as we have been concerned, their impact has been totally beneficial. They appear to be available for consultation far more freely than we expected would be the case and the different perspective that they are able to offer to our affairs has been tremendously valuable. I suppose partnerships could have non-executive partners. Perhaps they should try it.
This, as I said, is an interim report. But what can certainly be said, even at this stage, is that corporate structure is a viable alternative to partnership as a vehicle for providing professional advice and one which any practice should at least be prepared to investigate.
Anthony Turnbull MA FRICS is chief executive of Debenham Tewson & Chinnocks.