A clear understanding of how your firm will be managed after a large shareholder’s exit can greatly increase success going forward.
What does it take to feel comfortable selling ownership below 51 percent? What needs to be in place for you to feel comfortable going below a control level equity interest? So many firms are going through leadership succession and ownership transition planning right now that the industry can barely keep up with the constant passing of the baton. This can be seen in lots of hard data as well as anecdotal evidence, but perhaps the most indicative marker of transition activity is M&A closings. As of mid-July, there have been 305 transactions in the AEC industry. On that date in 2020, there were 192, and over the full calendar year of 2020, there were 377 total transactions. To be fair, COVID-19 slowed closings considerably, but year over year, M&A activity is still way up over Q1 2020, with about 150 transactions closed in Q1 2021 and 120 in Q1 2020.
Many firms are not looking to sell externally, but the market is rife with buyers knocking on doors. And with tax incentives, an aging leadership pool, and the impacts of COVID-19, it only seems natural that M&A activity is accelerating, but it’s also spurring lots of conversations around internal transition across the industry. At Zweig Group, the calls for valuation and ownership transition planning are consistent right now. People want to know, “How do other successful firms do this?” It gets asked a lot. The real answer lies in the existing culture of each individual firm.
This industry is highly fragmented, and each firm has its own nuanced approach to management and communication. These can drive or stifle transition planning. Now more than ever, we are seeing founders and majority owners looking at full sail exits or 100 percent transactions via internal transition. Leaders and majority owners are accelerating exits instead of the more traditional sell down and phase out process. This is a different dynamic than in years past and (among other impacts!) it presents cultural and organization hurdles.
Transition planning brings plenty of challenges to the table, but when you layer on time constraints, knowledge gaps, and the thirst for control, the process gets increasingly difficult. Though it can be done successfully in short order, one of the variables that can get lost in the initial activity is the change of control. Who is in control and how do we as an organization manage? How do we approach performance management? What strategic initiatives have priority? Is there alignment on owner incentives? What policy changes do we pursue? How do we manage debts and liabilities on and off the balance sheet, etc.?
By many measures, it’s easier from a leadership transition perspective to get bought via acquisition than it may be to elevate insiders to an ownership/leadership position. By promoting professionals in the firm to a leadership position and possibly one of control, firms face the difficult task of shifting existing lines of authority. Standing relationships that were formerly tight-knit teams may be curbed or altogether severed as new roles and responsibilities are established. With additional authority and control comes additional accountability and the need for emotional intelligence which is required to manage change. Leadership needs to be able to make clear-minded decisions and remove emotions from the equation. This can be one of the trickiest things for firms in transition to navigate as the need for control can outweigh the best interests of the business.
In the case of an owner/founder looking to exit quickly, the dynamics surrounding a new organizational structure and leadership team may not have had time to congeal. In any transition, the authority and allegiances that once existed will ebb and flow with the change. But sometimes, these variations and their association can move more aggressively than anticipated. The importance of exiting owners and leaders to carefully select, groom, and signal who will run the firm should happen years in advance of the actual transition. It’s not an instantaneous process and it’s important to identify, encourage, and cultivate the next round of leaders. This is essential.
The understanding of who or what is in control of the firm is something completely different than the appointment of new leadership. Whether 51 percent ownership is the threshold or if there is a more formal board of directors or management committee that drives decision making, establishing the firm’s structure, and having a clear understanding of how the firm will be managed and controlled going forward can greatly increase the success of a large shareholder exiting the firm.
Will Swearingen is director of ownership transition advisory services at Zweig Group. He can be reached at wswearingen@zweiggroup.com.
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