By Lisa Forster CPFA SS (prac), FAN Advisor, CIPFA
Despite George Osborne’s optimism over the UK’s economic recovery, the public sector is still in the throes of austerity measures, and will remain so for at least another few years.
Efficiency and economy are easy phrases to trip off the Chancellors tongue, when talking about public sector reform, but in reality these can be difficult to achieve in practice, especially when funding reductions are met with increased demand. So, hard line transformation of services and delivery methods are seen springing up all over the public sector landscape as a means to capture those elusive efficiencies and economies.
We have seen a number of wholly owned and jointly owned trading companies in this sphere, some successful, and some still stuttering in their start-up period. Creating a commercial entity from a public sector environment, however, can be fraught with tensions and incorrect assumptions. So, using our first hand experiences, we have listed below some of the areas to be aware of when setting up your new trading company:
When you set up a new trading venture there will be a number of set up costs, notably those of professional services. Legal costs in particular can be huge, running into the hundreds of thousands of pounds.
Companies need to be registered with Companies house. This is a small fee but beware of the many consultancy firms out there who will charge you hundreds of pounds to set up a company, when you can do it your-self, on line for £15. Full details can be found at: https://www.gov.uk/company-registration-filing/starting-company
As a company, your annual accounts need to be filed with Companies house, as well as audited externally, which the company pays for. Late filing penalties incurred in 2013/14 were £77,509,000 – of which all goes to the Treasury. You will need to build in the costs of accountants and auditors, as well as remembering that the Company’s accounts are likely to need to be consolidated with the local authority’s.
These are much more visible in a small company and need monitoring to ensure they are kept to a minimum. Cash flow is also a consideration; have you planned your spend to coincide with your income? If not, it could mean some hefty charges, or borrowing requirements.
Ongoing operations require services from support functions such as payroll, IT and human resources. A decision needs to be made over who to buy from, what quotes you need to obtain and whether there is a tie-in to the council over a transitional period.
The cost, risk and ‘means’ of transferring assets, liabilities, and staff across to the new entity needs careful consideration. TUPE in particular can be especially time consuming. For the sake of minimising risk to the council, and also the fact the new entity is unlikely to have high levels of cash, the title to many assets is often retained by the council, and an arrangement for the use of these i.e. through a lease, is made between the parent and the entity.
It must also be remembered that if the council is a major shareholder of the new entity, it would still be responsible for any liabilities of the company in the event of significant losses occurring. Regular monitoring and skilled client contract management is essential to ensure that financial progress does not deviate significantly from business plans and forecasts.
Although pensions are part of the ‘business transfer’ question, its complexity and financial value deserves a section of its own. Although staff can remain within the LGPS, (the new entity sets up as an admitted body) the new entity will take a share of the pension liability related to the workforce profile of those staff that will have moved across. The Actuary (another cost incurred!) will calculate the new contribution rates, which may be different from the current ones. Some school Academies have, for example, found that rates increased significantly and this became a major factor in deciding whether or not to move to ‘charitable company’ status.
The company should also consider whether or not it can recover VAT, and based on its profit projections what the corporation tax liability is likely to be. One recently created entity, where 60% of the staff was from an agency, found itself with an unexpected cost for the unrecoverable VAT it incurred on agency staff. Seconded staff may also attract VAT.
When a department is being transferred from LA control into a new trading entity, it is essential that a credible baseline for that section is established. This will inform you of the breakeven point, determine pricing strategies and impact on profit margins. This should highlight any hidden subsidies within the current structure. Hidden subsidies could make costs appear too low, thus giving an unfair competitive advantage which then breaches rules around state aid and transfer pricing.
If your new entity is based on having less staff over a period of time than the current set up, then the cost of redundancies needs to be built into the financial plans.
If you are a commercial trading company then you must comply with European rules on procurement. Tendering costs and expertise may need to be bought in, if not readily available within the new entity.
If a council divests itself of a number of departments, and as a result the corporate ‘core’ of such as IT, finance, payroll etc. lose a number of clients, what effect does this have on their costs? The corporate core will still have fixed overheads such as premises costs and perhaps lease costs on equipment, which need to be paid. As support service departments in the corporate ‘core’ recharge their costs out to the departments who ‘use’ their services, this means that costs are spread over a lower number of units – meaning higher charges for those remaining at the council.
One temporary solution is that the new entity must buy back into the council corporate services for a transitional period. This then gives the services time to plan and adjust for the new ‘world’.
If a new entity relies solely on a contract with it parent council – there is a danger that when the contract is up for renewal, that the entity will not win it. Losing an ‘anchor’ contract could be the end for some companies, so a plan that shows a range of income and diversification is essential for long term survival.
Although a trading company is a separate legal entity, it is also usually wholly or jointly owned by the council. This means that the council can have powers which restrict some of the entity’s freedoms; these include requesting certain company information, restrictions on remuneration of directors, directorships and banning party political publicity.
A good business plan will have considered a wide range of risks to the future success of any trading proposals. This includes internal and external factors, some of which will be beyond your control. The key point however, is that medium and long term forecasting may be difficult in the current economic and political environment, but this is not an excuse to ignore it, in fact it provides an even stronger reason for doing it
The fact that you want to trade with other public and private sector bodies, doesn’t necessarily mean they want to trade with you. The number of suppliers, and the level of competition is growing, it could be a very crowded market shortly
Despite all of this, it doesn’t mean that trading companies are a bad idea; we have seen some great examples over the years. The message here is to be prepared. Be aware of all the issues and think objectively about what will work.
CPFA, SS (prac), FAN Advisor
T: 020 7543 5600