Ownership Transition Blues

Mar 03, 2003

Let’s face it. The economy of the last couple of years has led to diminished expectations and in some cases, declining values, not just in our 401(k) plans and stock portfolios, but also in terms of the investment stakes we have in our own firms. This is leading more than one A/E and environmental firm to re-evaluate their ownership transition plans. We’ve had a number of frantic calls and private discussions with firm owners of all sizes and types who are concerned about the viability of their current plans. Here’s some of my thinking on this subject: If you don’t like what’s happening to your stock value and rates of return on your investment it doesn’t necessarily mean you need to change your ownership transition plan. We frequently see the drive to change the plan for one reason or another. Specific changes include valuation methodologies, stock purchase financing arrangements, and profit allocation formulas. Sometimes it’s legitimate and sometimes it’s not. Often the problem is not with the plan but with the performance of the company, “performance” being broadly defined as profitability, growth, and debt. My point is if these things are out of whack, fix them first. Then take a look at your plan. You may be surprised to find that it is (or would be) viable if the critical performance metrics were where they should be. Do what it takes to make your stock attractive to purchasers. If profits are low and subsequent returns for shareholders are down, demand won’t be there for the stock because it will be hard for people to buy. If the only measure of the stock’s return is dividends or dividends disguised in the form of bonuses you may have a hard time paying out enough to make it a worthwhile investment. The other measure of the stock’s value is equity appreciation. The things that make a firm more valuable are revenue growth, cash flow, and balance sheet, in addition to profitability. Get those things going in the right direction and stock won’t be hard to sell. Get those going in the wrong direction and you will have to give the stock away, one way or another. Sometimes it is necessary to change the rules of the game. There are times that the valuation formula or other elements of the plan are crazy and need to change. You have to be willing to explore these options and open minded to the logic behind the change. On the other hand, you need to be very careful when making these kinds of changes. Changing the rules of the game mid-stream can be very dangerous and can undermine the faith that any investor might have in plunking his or her money down. If a change needs to be made, study it carefully, don’t rush into it, sell the logic behind it, and consider phasing into it over a period of years instead of radically changing it at the brushstroke of a pen. Occasionally, radical (and instant) change is in order. We have worked with companies that embarked on ownership transition plans that were never thought out. No modeling of various scenarios was ever performed that could tell the company what kinds of growth and profit and debt levels were necessary to sustain the plan. As a result, sometimes firms find themselves in a real crisis where no more money can flow out to departing shareholders and buying shareholders are threatening revolt or considering abandoning the ship because the obligation they have inherited is greater than the asset. In these cases radical change may be in order. Departing shareholders need to be educated on what the situation is facing them and the companies that they founded and/or built and about how the other shareholders are feeling about things. There are times these people need to give up something they thought they had. It’s never easy. The entire ownership transition puzzle is often very frustrating for the both the buyers and sellers. It’s important that each has a positive motivation and understanding of not just what is best for them as individuals but what is best for the overall company that they are entrusted with managing. Good outside advisors can make a real difference in exploring alternatives, helping formulate options, and imparting realism. This is one place that the “do-it-yourself” mentality of the A/E industry may need to be reevaluated! Originally published 3/03/2003.

About Zweig Group

Zweig Group, a four-time Inc. 500/5000 honoree, is the premiere authority in AEC management consulting, the go-to source for industry research, and the leading provider of customized learning and training. Zweig Group specializes in four core consulting areas: Talent, Performance, Growth, and Transition, including innovative solutions in mergers and acquisitions, strategic planning, financial management, ownership transition, executive search, business development, valuation, and more. Zweig Group exists to help AEC firms succeed in a competitive marketplace. The firm has offices in Dallas and Fayetteville, Arkansas.