There are many variables to consider when planning for an ownership transition in an AEC firm.
Over the nearly 34 years Zweig Group has been in business, we have assisted more than a thousand AEC firms with their strategic business planning and ownership transition planning and processes. We have even been through our own transition twice – once externally to a private equity firm, and the second time, after buying the company back from the private equity firm’s lender, internally to a group of principals already with the firm.
It’s not uncommon to have a great deal of discussion and debate about what kind of ownership works best for these businesses over the long haul. When I say “what kind of ownership,” I am primarily referring to the big decisions about who owns the company and how many owners they should ideally have, or whether to sell externally.
Most AEC firms start out the same way. Either one person or a small group of partners breaks away from either another company in this business or a government organization where the principal(s) worked, and the first employee(s) are also the owners of the enterprise. From there, other employees are added, and if everything goes well, the business survives and grows. Then, at some point in the future, as the company grows and the founding partners age and start looking forward to their eventual exit, that’s when all of the debate starts about where they should go from there.
Should more internal owners be added? If so, how many and who? Should they sell to a much larger group of employee owners? Should they do an ESOP? Should the firm sell to a larger firm and become part of a larger enterprise? Should the firm sell to a private equity firm and use the capital to buy other companies and fund more expansion?
These and many other questions need to be answered, so I thought it might be appropriate to share some of my observations about ownership transition from over the years of working in the AEC industry:
- Many founders do nothing at all and end up with a problem. Some owners in this pot may have good intentions but they just never seem to get around to doing something. Then it’s a big problem when they are 73 and calling us because they have no viable successor(s) and want to get out. I was actually out to dinner with a 67-year-old client one night, who told us he was going to wait four more years before he started his transition. He died of a heart attack that night. The longer one waits to start the process, the less likely they will be able to accomplish it seamlessly. That is for certain!
- Some founders have one or more of their children take over when they are ready to get out. The main “pro” of this approach is that it’s easy and you can keep it all in the family. The main “con” is the heirs of the founder(s) may not understand the business at all and may not be respected by the other people. That said, there have been successful firms that did it this way. LEO A DALY was owned by the founder and his heirs for many years. There are other examples of the children taking ownership of the business where the second generation did much more with the business than the first. WD Partners is an example. Wolfgang Doerschlag exited his firm when it had about 25 employees. His son, Christopher Doerschlag, grew the business dramatically into what it is today.
- Too many owners can be bad. My experience is that when you have too many owners, the company becomes one that no one owns. What I mean by that is if all you own is a quarter of one percent of the company, you are bound to become more short-term oriented. There won’t be any significant long-term gain opportunities so that is a logical orientation to assume – get what you can out of the company now. So they strip the working capital each year through bonuses. And that does not lend itself to long-term success! The other problem with too many owners is that sometimes, that can really bog down decision-making, and, in really extreme cases, any owner will have veto rights over virtually any decision – large or small. And that is a horrible position to be in – one that assures almost no one would be happy no matter what you do.
- Too few owners can be bad. I have seen very large companies in this business that are still owned by one or a couple people. The problem with that is that when you don’t have ownership as a carrot, you have no viable way to tie key people down to the company. You will also have to pay everyone more. No long-term equity appreciation opportunity means good people will work there, but they will expect big annual incomes. That can be hard for the business to sustain.
- There are pros and cons to ESOPs. Employee stock ownership plans can be an effective way to buy out a founder or major owner with pre-tax dollars. That’s a big deal. There is a minimum amount of ownership that the ESOP has to buy in order to get those tax advantages, however. And the company has to have been in existence for some time and have a big chunk of money in the 401(k) or profit sharing fund to be able to use to fund this buyback. The shares are held in a trust versus owned by individuals. And then some people will complain about annual costs for an appraisal and transparency requirements for reporting. Again – however – some of those requirements are a plus, in my opinion. Transparency is always good management, and the annual appraisal required for the ESOP can be used to value transactions outside of the ESOP. Plus, if you do an ESOP, everyone will potentially be tied to the performance of the company – which can be a plus. I just discussed a situation with one of Zweig Group’s top ownership transition experts the other day where we may recommend that a founder do a partial ESOP, and then pursue an internal transition to a smaller group of key people with the rest of his ownership stake. The reason for this approach is that it knocks down the overall number that has to be sold directly to other partners and makes that more affordable.
- Would it be best to sell and become part of a larger firm? Once considered not as desirable or a fallback position for owners to take if they fail at internal transition, external sale options should always be a possibility as far as I am concerned. Sometimes selling to a larger firm may be best for everyone – clients and employees – because the new company has more capabilities and may be better managed. They may have a better brand and more geographic diversity. And they may also have a better ownership transition program! The fact is today, external sale options are more abundant and may be better than ever for many firms in this business.
One thing I am certain of: There is no one best solution for transition. I have seen just about every method available for transition work out. I have also seen every one of these ownership transition methods not work out! There are many variables to consider when planning ownership transition in an AEC firm.
Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.
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