AVOIDING PITFALLS IN YOUR OWNERSHIP TRANSITION PROGRAM
Many architectural firms have embarked over the years on an ownership transition program. Unfortunately, some ownership transitions fail. In firms where ownership transition was not successful, there are four primary reasons: (1) the ownership group was not committed to the transition process; (2) there was not enough time to allow for a successful transition; (3) the next generation did not have sufficient leadership and entrepreneurial qualities to replace the departing owners; and (4) the firm valuation model was not developed to match expectations. Avoiding these pitfalls at the outset can save your firm time and money – so let’s take a look at them.
Pitfall 1. The current ownership is not committed to the process.
Most owners are initially unsure about transitioning ownership of the firm they have nurtured and developed over many years. This is understandable, as the firm typically represents a lifetime of personal investment by the current owners. However, as senior leadership faces the prospect of retirement, ownership transition allows them to begin phasing down, while the next generation of employees is groomed to take over the ownership and leadership of the firm.
While ownership transition may seem attractive, there are alternatives to ownership transition, such as bringing in leadership from outside the firm, selling the firm to an outside party, implementing an Employee Stock Ownership Plan (ESOP) and if all else fails, liquidating. Each of these should be thoughtfully explored by current owners before launching an ownership transition program.
If the owners are committed to firm continuity, maintaining services to clients and retaining a workplace for current employees, then ownership transition may be the right choice. Ownership transition is a long-term process, in which the current owners must hold the long-view. They must be prepared to take the time, spend the money and work through the thorny problems that will arise when developing an ownership transition program.
Pitfall 2. There is not enough time to implement an ownership transition strategy.
Unlike an acquisition, where a firm’s owner may simply turn over the keys to a purchaser at closing (and collect his or her check), in an ownership transition program, the new owners assume leadership and ownership of the firm over time. Ideally, a firm should have at least five and preferably seven to ten years to implement an ownership transition.
The current owners need time to assess the next generation’s performance in their new roles as owners and transition client relationships. While many new owners will develop and thrive, some who are selected as owners will not fare well under the pressure of new ownership responsibilities. This can only be seen with the passage of time. Therefore a program that does not have adequate time for the new owners to mature under the mentorship of those who are selling starts out behind the proverbial eight ball.
Pitfall 3. The next generation does not have leadership and entrepreneurial potential.
A successful ownership transition program will replace the current ownership group, over time, with the next generation of owners that can successfully operate the firm. These owners must have a core skill set, or the transition will fail. The new owners must be able to market and sell the firm’s services, provide future capital, manage the firm’s operations successfully, lead, motivate and inspire employees and maintain quality of services. Without next generation core skills, the firm will not have a viable path forward.
While each member of the next generation need not have all the core skills, the group of next generation owners must have them collectively. Firms should always be cautious when offering ownership to those who clearly do not have the core skills. Some firms mistake employee loyalty or longevity for leadership and entrepreneurial qualities. This is a serious mistake, which can leave the firm adrift and at risk when the departing owners retire.
Consequently it is important for current owners to define the core skill set needed to own and operate their firm successfully and select new owners according to those skills. Once the new owners are in place, it is essential to evaluate them periodically to ensure that the right group is in place and to make adjustments, if necessary.
Pitfall 4. The firm’s valuation is too high or too low!
When transitioning ownership, the current owners must receive sufficient value for their interest in the firm from the next generation to motivate the current owners to sell internally. Otherwise, they will sell the firm to an outside buyer, if feasible. At the same time, for ownership transition to work, the price must be affordable for the new owners, who often have financial constraints of their own. If current owners establish a model that results in a much higher value for their stock than the next generation is able to pay, ownership transition will not work. Those differing expectations can doom an ownership transition program.
While these pitfalls are common, the good news is that they can be avoided. Successful transitions occur if:
-owners are motivated by firm continuity and loyalty to current clients and employees,
-owners have five to ten years to develop the next generation,
-the next generation has, or can develop, core skills, and
-the valuation model achieves acceptable and affordable results.
Keeping the pitfalls in mind, and planning for success, your firm can achieve an ownership transition that will serve both the departing owners and the next generation well
About the Author:
Laura Howard has specialized in the Architecture and Engineering (A/E) community for 12 of her 23 years of practice. Laura and her partner Bill Mandel have assisted more than 100 A/E firms in the development of ownership transition programs. The duo have handled M&A transactions on behalf of A/E clients that range in size from $1 million to $250 million in enterprise value.
Laura’s corporate expertise includes ownership transition mergers and acquisitions, and corporate finance. She is a graduate of Emory University (Phi Beta Kappa, magna cum laude, 1975) and the University of California, Berkeley School of Law (J.D. 1987), where she was a member of the California Law Review. She served on the Board of Directors for the Architectural Foundation of San Francisco.
