The four pillars of ownership transition strengthen your firm and provide a foundation for success.
The time has come for you to start planning for your eventual exit. But where do you start? Ownership transition is one of the most sensitive topics because it involves two things: money and people. As we know, the human condition involves a whole spectrum of emotions, good and bad. If you add money into the equation, you arrive at a mine. Whether that’s a minefield or a gold mine, you choose! Depending on the culture you have fostered and the people you have hired, you either get one or the other.
Whether you decide to transition ownership internally or externally, preparing yourself and your firm is critical for the success of the succession. There are four pillars that hold the ownership transition in place. They strengthen your firm and if you’re missing one out of the four you will not be as successful. Take one out and you debilitate your firm. It’s like walking on one leg. These four pillars are a foundation that gets your ownership transition infrastructure into alignment. The four pillars include:
1. Financial. The two components that make up the financial portion of your ownership transition are the valuation and the payout.
First, no matter what exit method you take, it all boils down to how much the company is worth. Value is based on your firm’s ability to assess risk. Here are some of the drivers of value:
- Growth rate.
- Profitability.
- Quality of financials. Are they just from QuickBooks or Deltek, do you have audited or reviewed statements?
- Consistency of your performance.
- Diversification (size, geographic, client).
- Quality of management.
OK, now let me ask you this: How much is your company worth? If you don’t know the answer to this, I implore you to find out by hiring an industry-specific expert who can help you answer this million-dollar (literally!) question. If you are selling your company internally, there will have to be a balance to make it affordable for the upcoming owners. There is typically a 15 percent to 25 percent discount on the final valuation when internally transitioning. On the flip side, there is generally a higher transacting value for your ownership interest when you go for an external sale. But it depends on your vision and purpose for your company.
Secondly, understanding how the payout is structured will tell all the parties what is being bought and for how much. This will create cohesion and will provide for a smooth transition.
- Once value is agreed upon, everyone must have a clear understanding of the timeline for the exiting owner(s), and for when the incoming owners will start purchasing and for how long.
- All parties must understand if the firm will finance the transaction (indirect financing), or if the buyer will need to secure their own financing (direct financing).
- Is the financial vehicle to execute the transferring of ownership going to be a structured note, an installment payment, or deferred comp?
For an external transition:
- The selling owner must know the mechanics of the deal structure. Whether that be through cash, promissory notes, stock, balance sheet adjustments, or earnouts.
2. Management succession. When a firm owner or head of a department is transitioning, it is crucial for there to be a replacement. And that all depends on how the firm handles leadership development. If training and development is of importance, you will have ready leaders. Making sure that every exiting owner has their successor in mind demonstrates to everyone that there is a plan in place. Grooming the right individual(s) is key. That is why planning way ahead of time gives everyone some breathing room. It allows the existing owner to mentor the incoming owner and pass on the necessary experience to lead. Every management succession will show your staff what it means to be an owner in your firm. How so? The individuals you promote to principal will have some sort of values/characteristics about them. This will spotlight to everyone the definition/traits to become a principal at your firm. So choose carefully!
3. Corporate governance. This encompasses how decisions are made at the firm and how the principals and leaders align their vision for the firm. That is why having a strategic plan in place is essential in all firms. Strategic planning is there to help provide alignment at the highest levels of the organization and provide purpose and direction for leadership and for everyone across the firm to steer toward. When owners do not agree on something, they need to make decisions under the lenses of the values in which the company stands for. Good decisions create value!
4. Cultural continuity. Every generation of owners is different. Each brings new ideas and different styles, but no matter who is in charge, the essence of your firm must never disappear. Cultural continuity is the secret sauce that will give your firm a competitive edge. If this is your first time transitioning, you have the opportunity to create an efficient succession structure that will facilitate ownership transition for all the upcoming leaders of your firm. You will set the precedent for all the transitions to come. So, be an example and get it right the first time!
Firm owners have a lot on their plate, but the best ones prioritize ownership transition. Now is the time to take action. Each pillar deserves its own article as it is fundamental not only to your future but also to our industry’s overall well-being, and I will delve into the details of the four pillars in upcoming articles.
Ezequiel Tovar is an analyst within Zweig Group’s ownership transition team. Contact him at etovar@zweiggroup.com.
