Azhar Ghose considers the factors which make the difference between a public sector company succeeding and failing.
Today, limited companies and other alternative vehicles have become an accepted and staple part of the public sector. Recent additions to the growing ranks include the local authority owned Alternative Business Structures (ABS) delivering legal services and the Local Capital Finance Company promoting alternative local authority funding, led by the Local Government Association in conjunction with 37 local authorities. We also have a renewable energy company to look forward to having received the ‘green light’ from Bristol City Council.
However, the increasing use of these alternative delivery vehicles by public bodies means that the public sector is still coming to terms with the legal, financial and governance issues related to these corporate entities and their relationship to that public body.
Let me first assure you that the phrase ’public sector companies’ is not a new form of company. Neither should it be confused with public limited companies that are listed on the London Stock Exchange. I have adopted this phrase for convenience and as a blanket term to mean the ownership, use or participation by the public sector of the private company structure and other legal forms. The companies used under the Companies Act include the private companies limited by shares or guarantee and in some cases a community interest company (CIC). The other option used by local authorities includes Limited Liability Partnerships (LLP) as a joint venture model exclusively for property development or regeneration.
However, be aware that this is an area where there is a predilection for jargon and acronyms as well as generating new ones. If you are involved in this area be sure to be familiar with terms such as social enterprises, special purpose vehicles, spin offs, mutuals, joint ventures (JV), charitable trusts and so forth.
I think you get the picture!
The range of companies and sectors
You may be aware of one or two companies being run by your own local authority. However, the extent of their use is far more widespread and they have pervaded the whole of the public sector, it seems, including central and local government, the probation service, fire and rescue, police, schools and academies as well as the health sector.
Their contagious spread throughout the country has been accelerated by the waves of academy conversions from schools and the transfer of probation trusts to community rehabilitation companies. There is even an election pledge to promote more free schools that adopt the same legal form in the event of a certain party winning the election.
There seems to be no end of new companies being established for a variety of purposes. The European case of Teckal (now codified in legislation) with its promise to make public bodies exempt from the formal procurement of goods and services created a demand amongst council services for their own ‘Teckal’ company whether or not appropriate. In recent times, the trend has extended to public bodies jointly controlling a Teckal company for specific purposes and also using this vehicle for sharing ‘back office’ services’ between partners collectively.
Key features and differences
Most will understand a public body as a creature of statute and though they may be a corporate body they have distinctly different accountable decision making processes over private companies (and specifically are not governed by the Companies Act 2006). They are funded by public money, legislated by government, openly democratic and have a fiduciary duty owed to their council tax payers.They are also very tax and VAT efficient.
On the other hand, private companies remain accountable to only their members usually as shareholders and they do not have the same level of transparency and accountability to the public as can be expected from a public body. They are subject to corporation tax on any profits unless exempt by reason of a charitable status. LLPs do allow public bodies to retain their own advantages and therefore this is a good model for partnerships with the private sector.
However, provided that a public body has some control and/or interest over a private company this could place the company into the category of a ‘public body’ for various statutes. Thus such a company could become subject to disclosure under the Freedom of Information Act or contract procurement regulations that are the reserve of public bodies.
With generally less bureaucracy private companies can make fast decisions and the processes that are then adopted should ensure that this particular advantage is not lost.
Before setting up a company for commercial purposes a public body should give serious consideration as to whether it is maximising its inherent natural tax advantages and its powers to charge for discretionary services.
As all good historians will tell you, it is essential to learn of the past so you can understand the present and from which you can then extrapolate and predict potential future trends.
In 2008, when I first advised on the set up of these companies for a council, they were still an alien concept to the vast majority. Notable exceptions included the established Norse Group of companies owned by Norfolk County Council who were clearly well ahead of their time in their confident and prolific use of their subsidiaries and joint venture companies. There were other local authorities that had set up companies for very specific purposes such as for transport or energy rather than for commercial purposes.
It was a time when the public sector came under the shadow of the ominous clouds of butchery and austerity that appeared with the onset of the credit crunch.
The news stories in the media of the latest cuts to services were disheartening as the public sector responded to austerity. Experience teaches that there are opportunities even in adversity. It seemed to me at least, that for those local authorities that wished to sustain or expand their services, a more commercial approach was inevitable. The law requires local authorities if acting in this commercial way to do so via a company. It creates more of a level playing field for others in the market where a public body would have an obvious unfair advantage.
Some authorities have been leading lights in leading the way and they have been successfully competing against the private sector for other public sector contracts such as for the provision of adult social care and library services.
There have been casualties along the way and some of these companies have spectacularly failed.
A local authority with its own company became alluring to others and somewhat of a status symbol amongst local authorities irrespective of their success. Jumping onto a bandwagon does not of itself guarantee success without consideration of the individual merits and the strength of your own business idea and plan as the map for success.
For the high level of investment and resources that have been expended and if the companies were to fail this would be a source of potential embarrassment to the promoting members. There are some companies that have been financially propped up by the parent thereby artificially prolonging their life. In other cases the companies have been quietly brushed under the carpet perhaps in the hope that they can soon be forgotten?
This is a shame, on two counts; one for the misconceived plan and two, it amounts to burying opportunities to learn from mistakes. The impact of such a failed venture leads to the authority becoming more risk averse and reverting back to primarily cost saving behaviours impacting on services and adding pressures on to its workforce.
Many successful business people will tell you that they made mistakes but they also learnt from their mistakes to become the present success stories.
I have advised numerous business and social enterprise start ups in both the private and public sector. I view local authority trading companies as business start ups because despite their obvious advantages and a monied benefactor they still have to start a new business even if it does involve an existing service. I therefore have some insight as to what could optimise the chances of success and failure of a venture. Some of these points are captured in another article ‘Trading Tips for Local Authorities’.
Overcoming the obstacles
The general powers of competence under the Localism Act 2011 permit a local authority to do anything that an individual may do. There are also charging and trading powers connected with this power. The general power of competence was heralded to give greater freedoms and there was an expectation that as a natural consequence local authorities would become more entrepreneurial.
However, arming local authorities with such wide and formidable powers may not be the full answer. Guidance is still required on how to exercise these powers and to ensure that experienced individuals with real ‘entrepreneurial flair’ are involved and supported.
Simply ‘throwing money’ at a good idea because a budget has been made available or bringing in the private sector is one of the lowest factors of success.
In addition, there may be internal or external machinations of the public body and/or with its partners that may not be delivering the best deal or value. All too often public bodies have non–commercial considerations at play such as politics, a dominant partner or the vested interests of middle management shoring up their own positions which ultimately impacts on securing the right people and providing the autonomy to make the venture a success.
What has been lacking to date is the impartial means by which the public sector can verify that it has adopted the best means to optimise its chances of success or to allow a ‘critical friend’ with the right to be candid and a right to be heard. Given that public money is being used by local authorities for these companies it would be worth while taking steps to obtain an independent review with recommendations to optimise their success.
Recognising that you need to put together the right team with the relevant skills and experience at the outset can only increase the chances of success.
The successful team would in my opinion include:
- A chairman of the board that is strong, influential and with commercial acumen. This is important to steer the board towards making the right decisions and giving the necessary support to the managing director.
- A managing director with entrepreneurial flair rather than just being a ‘manager’, someone who is good at identifying and responding to opportunities, not a ‘follower’ or an appeaser but prepared to inform the board of any radical plans or indeed any bad news with any potential solutions.
- A finance person to keep the executive and the board informed as to the current course of the company in relation to achieving its financial goals and supplementary expert advice.
- A company secretary and/or legal advisor that provides commercial advice to exploit opportunities, facilitates business delivery as well liaising with the board and shareholder and ensuring good governance. Directors may not appreciate that this is the person who ensures that their company law duties and responsibilities are being fulfilled.
Common to all the above roles is a prerequisite to have commercial acumen with public sector experience. Although this can be addressed through training, the best equipped individuals tend to be those who have run their own business as they will have the desired skill set as part of their personal behaviours and in their attitude.
It is timely that Local Partnerships, whose aim is to improve and strengthen the outcomes for the public sector, has designed a national comprehensive quality assurance check for public sector companies particularly those that are taking greater risks by going out in the market and trading their services.
Owned by the Local Government Association and HM Treasury, Local Partnerships can be that ‘critical friend’ to the public body given their ‘non-profit making’ aims and motives. They can provide independent and expert opinion on the health and prospects of success for these companies by conducting thorough expert reviews of the process, structures and systems in place.
It is also an opportunity for the public body to add value to their arrangements, by exploring other ways of operating their companies, to give confidence to interested parties and to address any concerns whether actual or perceived. The reviews can also be accessed for cases where the company may have been wound up or is going through a bad patch or is facing a great deal of scrutiny or opposition.
Local Partnerships is in a good position to identify and share best practice, knowledge and ideas across the country between different public sector bodies and companies whilst still respecting the confidentiality and Intellectual Property of the business.
The title states ‘the rise’ but not ‘the fall’ of public sector companies. This is because there is still a rising tide in the public sector of these companies despite some of the individual cases of failure.
Nevertheless, this is still not an easy path to travel including for those companies that may appear to be successful.
I have discovered serious omissions in the affairs of companies. Vital decisions were never made by the directors or there had been a failure in complying with a statutory procedure. This despite the fact that someone had adopted the company secretarial function and perhaps they had assumed that these entities were like any other private companies?
Ignorance can be bliss but now it’s time to wake up!