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Setting up local authority companies

Shared professionals iStock 000009503395Small Newsletter pic 146x219After 21 years as author of Local Authority Companies and Partnerships (‘LACAP’) and practising as a local government lawyer, Rob Hann provides some practical tips for local authorities setting up LACAPs.

It dawned on me recently that my loose-leaf handbook which I update twice yearly (LACAP) was first published in 1996, which means the next edition will mark LACAP’s 21st birthday. Much has changed in the intervening years about the attitude of both central and local government toward the setting up of new companies and/or other types of partnership vehicle by local authorities.

For example, when I first wrote the book, there were widespread concerns around local authority powers to take interests in companies. Several cases had come before the courts casting doubt on local authority vires to establish companies. Nowadays, such doubts appear to have dissipated, perhaps because of the so-called power of general competence contained in the Localism Act 2011. Many local authorities nationwide are establishing, or have already established, a range of corporate vehicles (hereafter referred to as ‘companies’ for brevity although the actual nature of the corporate vehicle will vary) for a multitude of reasons.

One common reason is to explore the potential for generating additional income from commercialisation or so called ‘trading’. Legislation (some of which can also be found in the Localism Act 2011) requires the establishment of a company if the authority acts for a ‘commercial purpose’.

Some local authorities set up companies to take over existing functions formerly run ‘in-house’. Libraries, museums and leisure services are good examples but the list of former functions now being carried out through companies is long and varied. Tax, rate relief availability, VAT and other fiscal reasons and/or the availability of additional income streams often drive such initiatives.

In other circumstances, corporate vehicles have been established to enable joint ventures or collaboration to occur by and between the authority and another party. This could be through partnering with another public body, or collaborating with a private sector investor or partner perhaps in the housing and property development sector.

One thing I have learned on my LACAP journey over the past 21 years, is that setting up companies to perform functions or activities which previously may have been carried out within an authority is not for the faint-hearted. Such a step brings with it certain consequences which are not always clear at the early business planning stages of a venture. If a Newco is to take over an existing in-house service, for example, this will instantly create new relationships, interests and objectives which will flow both ways - from the ‘parent’ local authority to Newco and from Newco back to the local authority. Where a joint venture is set up with a third party, Newco will also owe, and will be building new allegiances with, other key stakeholders, partners, investors and those who govern its funding and day-to-day business.

The governance structure of a company is also very different from the governance structure of a local authority, yet individuals appointed to run a new company are frequently drawn from the local authority. This creates the potential for conflicts of interest to arise. The authority should be focused on considering whether there are likely to be problems having individuals who hold dual roles (e.g. a director of Newco who is also a chief officer or leading councillor). How can these interests be properly split and managed?

By the formation of a company, new duties and relationships will have been created all of which need careful management. There are different tasks and roles which need to be performed and which did not exist before; for example:

  • Director and board appointments: with legal responsibilities to manage the day-to-day functions of the new organisation;
  • Shareholder and investor interests: to attend general meetings and help protect members interests through shareholder protections and reserved matters;
  • Contract management: often these companies will be set up to provide a service back to the parent authority and the contract will require careful management by both parties;
  • Client: representing the local authority’s client interests, whilst avoiding duplication of any functions provided by the new organisation.
  • Customer-facing: for example, a local authority may be acting as a supplier of services to the new organisation for certain business support purposes and will therefore need to manage and monitor performance across all relevant support services provided.

Local authorities are public bodies and as such they are governed by rules not faced by businesses wholly in the private sector. When a local authority owned company is set up, the parent authority will need to navigate and be aware of potential elephant traps such as state aid infringement. It and the company it owns will need to find ways to mitigate possible difficulties around state aid compliance. Allied to this is the vexed question of EU procurement compliance and what support the authority might be able to provide within the somewhat narrow confines of the so-called ‘Teckal exemption’. To comply (in simple terms) the company must do more than 80% of its business with the authority (or authorities) which own it (otherwise more changes to structures may be required). This somewhat artificial but crucial limitation on generating external revenue should not in any way restrict the search for new business by a new trading company. It just means the relevant board in each case may need to seek to restructure the company or else take a fresh look at the group structure if breaching the Teckal threshold becomes an issue. The important point is that this issue needs to be fully understood and very carefully monitored and managed.

On top of these public sector specific issues, a new local authority company will have to face the same sorts of challenges which commonly impact on any new start up business. For example, the Newco is likely to need staff, arrange salaries and pensions and will have to deal with a range of other HR issues. It will have to get to grips with these challenges pretty much immediately on set up whilst, at the same time, continuing to perform the core service or activity for which it is has been set up to perform. In some instances (assuming the Teckal rules have been navigated), the parent authority will provide HR, ICT and other back-office services to Newco to facilitate hand-over and continuity of service delivery. This scenario introduces a range of issues which, going forward, may impact not only on Newco but also the parent authority and how it intends to deliver back-office and other centralised support (ICT, payroll and so on) to its remaining undertaking.

With the establishment of a Newco, a degree of independence and freedom comes with the territory. Sometimes this will be the point of setting up the entity, but it can also come as a shock at some later date, if and when, the Newco decides to stretch its wings and ‘go to the market’ for those same services to save costs. Pressure on budgets mean Newco will be looking to make savings. Back office arrangements, quality and cost of services supplied to them could be key areas impacting on available funding and the delivery of the core service. So, it is important for the parent LA to consider carefully in advance of establishing the Newco, the potential impact on the LA corporate centre of significant numbers of staff transferring out into Newco and whether, and for how long, the Newco is likely to want to re-procure services directly from the authority.

For new companies set up to take advantage of some sort of trading opportunity outside the LA’s geographical boundaries, such entities will be expected to ‘hit the ground running’ and seek new income streams, secure new customers and explore new markets, with the common aim being to reduce reliance on council funding. However, this is a big ‘ask’ for any start-up with limited experience of winning work in the market. Will the newco recruit people with marketing, PR and other skills needed to secure the anticipated new work? Or will it rely on existing staff developing such skills and learning on the job? If the latter, Newco will need time to establish itself and its people, to refocus into new markets and customers.

As LACAP reaches its 21st year, local authority companies are becoming ever more common-place and the issues covered in the book remain valid and pertinent. It is important for local authorities to fully understand the implications of setting up a company and how this may differ from previous practices and/or in-house service delivery.

Rob Hann is a solicitor and author of Local Authority Companies and Partnerships (‘LACAP’), local government’s essential guide to setting up and running LACAP’s. Several leading law firms also contribute chapters to LACAP on a variety of topics. If you need an independent review of your local authority company or partnership, please contact Rob (This email address is being protected from spambots. You need JavaScript enabled to view it. – 07768 906391).

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