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Family businesses often have a commitment to the communities in which they have grown, providing local employment and wealth. But what happens when, after several generations, the family owners want to withdraw their stake? Can they do so without jeopardizing the company's independence and local loyalties? Are selling out or a public flotation, with all the risks of take-over, rationalization and redundancies, the only routes?

One alternative is to make the workers the owners through an employee share ownership plan (ESOP), a concept most widely practised in the United States. In Britain they have been pioneered by the John Lewis and Baxi partnerships and the Scott-Bader foundation. The 1994 Finance Act gave them a further boost by extending the number of years from seven to 20 that an ESOP could transfer shares to the workforce without incurring tax penalties, till then a deterrent.

Among the first companies to take advantage of the new legislation was the Scottish paper makers Tullis Russell, based at Markinch, Fife. The company is pioneering one of Britain's first statutory ESOPs. Since 1985, the firm has been distributing shares to the 1,000-strong workforce through an annual profit-sharing bonus and trusts set up to benefit the employees. When complete, around 2009, the workers will own a third of the company and 45 per cent of the shares will be held by an Employee Benefit Trust. A quarter will remain in the charitable Russell Trust, set up by the family owners in 1947 to guarantee the company's independence.

Established in 1809, with simple beginnings in an old flour mill, the company was owned by the Russell family for four generations. For 1998-99, it had a turnover of over ?130 million with exports of ?47 million and pre-tax profits of ?1.1 million. With three plants in Britain and one in Korea, and sales companies in France, Germany, Holland and Connecticut, USA, it is one of Europe's leading quality paper manufacturers.

Sir David Russell, who became chairman in the early 1930s, had a strong paternalistic commitment to the workforce and the community they represented. Sir David's grandson, David Erdal became chairman in 1985. He was keen to maintain the firm's ethos of community involvement, and was attracted to the idea of employee ownership at a time when other family members wanted to extract their capital in order to support other business activities.

Erdal instituted a profit-sharing scheme in 1985, whereby 7.5 per cent of the profits are used to distribute shares annually to the workforce. Thirty per cent of the shares go equally to all the employees while 70 per cent are allocated according to income.

In 1994, Tullis Russell, with the help of Edinburgh merchant bank Noble Grossart, set up the new statutory ESOP as part of a major capital reorganization. Around 25 family members surrendered their remaining 55 per cent stake, worth ?19 million, in exchange for loan notes. These are being redeemed over the subsequent 10 to 15 years and converted into shares for the workforce as the money became available to buy them through the annual profit sharing bonus. The shares are now being distributed by the statutory Employee Share Ownership Trust. An existing Employee Benefit Trust acts as a market maker for workers to trade their shares, whilst also building up a substantial long-term holding to provide stability for the whole enterprise.

The scheme, building on the profit sharing bonus, depends on good annual results and Erdal says the company is achieving them, despite a high-valued pound and adverse exchange rates affecting exports. But he also emphasizes that employee ownership is no substitute for good management. 'What really makes a company work is how people behave and relate to each other,' he says. 'If management behave aggressively, owning shares in the company doesn't solve the problem. On the other hand, share ownership does provide a positive background for good management and good relations to prosper. Clearly, there is something about providing job security, and protection from the take-overs and greed which outside ownership often brings, that enables a company to be very fertile in the development of new products.'

Could the family have got a higher price by selling out to a competitor? Erdal denies there is philanthropy in the ESOP plan. 'The net benefit to the family would not necessarily have been higher because the legislation gives significant tax advantages when you sell to the employees,' he says. But he adds: 'Owning a company is different from owning any other piece of property. You can sell a table and it doesn't affect anyone. But if you own a company you are involved in a community of people.' Passing over the power that goes with ownership 'without paying attention to the interests of the people in that community,' is irresponsible, he says. 'You have to take the interests of the employees very seriously indeed.'

The ESOP satisfies Erdal's own ideals. Ever since his childhood he has searched for ways to create a more just society, he says. 'I was born into a wealthy family, owning a paper mill and living in a magnificent house on top of a hill. When I went to school I made a lot of friends who were poor. At the age of five or six I didn't understand these things. One day I went with one of my friends to his home. I was appalled at what I saw and I date my interest in improving the system from that vivid experience.' After studying Chinese at Oxford, he travelled to California. He returned to Britain and joined the Workers Revolutionary Party. He was on the picket lines with the coal miners during their confrontation with Margaret Thatcher. But it was his experience teaching in Mao's China which undermined his faith in communism. For the first 10 months he was reinvigorated in his belief in revolution as the way forward. But then he faced the fact that 'the whole system of dictatorship was very anti-human. People were living in terror.'

Back from China, Erdal joined the family firm at the age of 29, encouraged by his late uncle, Dr David Russell, then Chairman. At first, admits Erdal, he didn't feel 'legitimate' coming in just because he was a family member. But gaining his MBA at Harvard Business School gave him confidence, he says. He had spells on the shop floor and in export sales before joining the board in 1981.

Erdal now holds that a competitive free market is the best system for allocating goods and services: 'It is completely honest. You buy the best products and services at the lowest price and there is no hypocrisy in it.' But he still speaks passionately against what he sees as unjust systems of ownership. Those who already own an asset, such as a family business, have the collateral to borrow money for new investment, he says. They then receive tax breaks designed to encourage investment. But this serves to concentrate wealth in the hands of those who already have it. Non-owning employees all too easily remain in a subservient relationship, he argues.

His uncle had put voting control of the company into the charitable Russell Trust at a time when he had no obvious heir apparent. Managers, rather than family members, were appointed trustees with the charge of keeping the company independent and serving the interests of the employees.

The obvious way of doing this, as Erdal's relatives wanted to withdraw their stake, was to set up the ESOP. Erdal was particularly influenced, he says, by visiting the Mondragon co-operatives in Spain, inspired by a Roman Catholic priest in the early 1950s. There the emphasis was based on the social doctrine of the Catholic church that capital should serve labour rather than the other way round.

Another input came from Erdal's participation in the Caux Conference for Business and Industry, in 1991, where industrialists, trade unionists, bankers and businessmen were conferring on 'How management, labour, government and capital can work better together'. It came just at a point when he was facing apparent opposition to his ideas for the ESOP from two non-executive directors as well as from the convenor of shop stewards who, Erdal thought, regarded the ESOP as a 'con-trick' to undermine his authority. At Caux, Erdal was particularly struck by reading a book on industry which quoted Bill Jordan, then President of Britain's engineering workers' union, as saying, 'Working together is the most powerful tool for prosperity there is.'

In a time of reflection, Erdal thought about the two directors, whom he had decided to sack on his return home. 'The suggestion came into my mind, I know not from where, that I should go and talk to them and listen to them. I did this and had two of the most fantastic days I've ever had. I found that these directors had done their analysis and were very well motivated towards what we were trying to do--not with the ideas I was thrusting at them. We agreed on how to develop the business in a very strong way. Similarly with the trade union convenor, I had listened to rumours and had misinterpreted his behaviour without talking to him. Now I found he was genuinely trying to find the best way to resolve problems and deal with issues on the shop floor, a key part of the whole enterprise.'

The work force at Tullis Russell, initially suspicious, have since become enthusiastic about the idea of being their own owners. Erdal estimates that, on the firm's projected performance share-owning employees stand to be, on average, about ?16,000 better off over the next 10 to 15 years.

Erdal has also taken the gospel of ESOPs to Eastern Europe. Through Job Ownership, a company which advises on employee ownership, he and its Executive Director, Robert Oakeshott, have helped several companies in Slovenia and other Central European countries to be privatized into majority employee ownership.

In 1996, David Erdal handed over the chairmanship of Tullis Russell to non-executive director Howard Browning. Erdal is now Chairman of Baxi, though he remains a non-executive director of Tullis Russell. While the company has given a fillip to the concept of employee ownership, Erdal is modest about his own role. 'The story is so much more important than any individual,' he says. 'My challenge was how to run the company in the interests of the employees.'

See also 'Fife firm adopts new ownership plan', The Herald, Glasgow, 17 April 1995; and 'The boardroom revolutionary', For A Change magazine, April/May 1995. A fuller account of David Erdal's life, written by Maureen Cleave, was published in the Telegraph Magazine, London, 4 October 1997.