This post first appeared as an article in The Zweig Letter, Issue 1223
Besides the fact that an external sale will typically provide the greatest financial return for A/E owners who want to transition out of their firms, a solid majority of principals still prefer internal ownership transition.
I’ve worked in this industry for 37 years now and have seen the good, the bad, and the ugly of ownership transition. While I love talking about what can go wrong, I figured I’d take a look at what does work. -Mark C. Zweig, Founder & Chairman
My experience is that most of the time that preference is born out of a sense of duty and responsibility. They want to keep the firm intact, keeping some semblance of its current form, going forward. An external sale would be a threat to that. Perhaps because they themselves were able to buy the firm from its founders is yet another reason. No matter – internal transition is the only option considered by some companies in this business. I’ve worked in this industry for 37 years now and have seen the good, the bad, and the ugly of ownership transition. While I love talking about what can go wrong, I figured I’d take a look at what does work
- Starting early. You cannot start too early nor involve your staff in ownership at too young an age. The earlier you start the more possible it will be to actually have a transition – wait too long and the stock value gets too high for people to afford to buy much of it.
- Having a model. By “model” I mean a spreadsheet. And a spreadsheet that lays out the future and the past – looking at revenue; pre-tax, pre-bonus profit; book value, and stock value based on the company’s buy-sell agreement formula; as well as when individual owners will be leaving the company and the company buying back their ownership interest. This is super critical versus just deciding what your buy-back provisions are without regard as to whether or not you can actually fulfill those obligations.
- Having a structure and culture that separates ownership from management. This is crucial if you want to implement point No. 1 above. People may be ready to invest in the company long before they are truly ready for a management position. And too many managers is never a good idea anyway!
- Financing stock purchases through a note with regular payments versus payments tied to once-a-year bonus distributions. This way the stock purchase takes a bite out of every paycheck and reminds the individual shareholder of his or her responsibilities. A once-a-year payment tied to bonus gets all screwed up when the company has a bad year and can’t pay bonuses. You don’t want this.
- Have a business plan that relates to the ownership transition plan. The two go hand-in-hand. How much money will the firm make in the coming year. How much of that will be retained. How much paid out to all employees or to just shareholders. That affects how much stock the firm needs to sell to fund its growth. It also affects how much stock someone can buy at any one time if their primary source of funding is bonuses.
- Qualified experts are required! That means you must have an experienced attorney who understands the laws on selling ownership to employees and helps keep you on-course with realistic expectations for the process. Other experts in OT and valuation may be helpful to you as well.
Mark Zweig is Zweig Group’s chairman and founder. Contact him at firstname.lastname@example.org.