Successful AEC firms treat succession planning as a strategic priority from the beginning, not a last-minute retirement decision.
Imagine you are five to 10 years into your career. You appreciate all that you have learned but are brimming with ideas on how you can do it better. Now you and one or two of your colleagues have decided to form your own firm. Congratulations on your bravery and enterprising spirit!
As a founder, you will probably start off with your mind spinning. You decide you will only work with clients that you like and only work on projects that inspire your creativity. You will treat your future employees with the highest ethics, be a more empathetic mentor than you had, and give back to the community. With all these thoughts racing through your head, the last thing you are thinking about is how to exit from the firm you are building!
However, in architectural and engineering firms, succession planning is not a retirement issue – it is a valuation, growth, and risk management issue. I would argue that the question of how you will eventually exit from your firm is among the most important things to consider when starting out, or even if you are many years into building your own firm.
The answer will be essential in determining what kind of firm you will build, how you will build it, and how you approach your evolving strategic plan.
Let’s discuss the most common succession strategies and how each will determine your strategic plan:
Close the doors
This is exactly what it sounds like. The owner will run the firm until they are ready to retire and then simply close the business down. Choosing to close the doors is still a strategy, just one that transfers all remaining value away from employees, clients, and the marketplace. When the end is near, the firm will stop taking on new projects and terminate employees as the work runs out. This is most common in a sole proprietorship.
Outside sale
In this scenario, the owner wants to sell the firm for a market rate price. Owners on this path are motivated by profit, as an outside sale typically results in the highest price possible. This exit requires significant strategy.
As a CPA, I have seen all kinds of business owners in many different industries attempt to use this exit strategy only to end up surprised when they go to market and cannot command the price they expected. The usual culprit is waiting too long to build a desirable acquisition.
For this strategy, owners need to focus on what a potential buyer will want to see: steady growth (could be customer base, geography, service options, employee count), reputation, workforce stability, and founders’ participation. The latter is the most important. The founders are the firm’s chief rainmakers or technical authorities, and when a founder wants to simply sell and walk away, the price a buyer is willing to pay will decrease. The buyer is looking for founders who are willing to transition their relationships and stay long enough to make sure the acquisition is a success.
Two firms with identical revenue can sell for dramatically different prices depending on whether leadership transition has already begun and will continue past closing. If your goal is to sell for the highest price possible, waiting until you’re ready to walk out the door will not give you that result.
Inside sale and employee trust
I am combining these two exit strategies because they involve similar tactics. An inside sale involves selling to one or more employees of the firm, and an employee trust involves selling to a trust whose beneficiaries are the employees of the firm, most commonly an ESOP. These tools are used when a founder wants the firm to go on in perpetuity past their personal retirement rather than being acquired and absorbed by a larger entity. This type of company is often referred to as a “legacy firm.”
Creating a legacy firm requires significant strategic planning that takes years to put into place because future leadership is developed internally and grown organically. Mentorship of future leaders and transition of customer relationships play a huge part in the success of this strategy, as well as a founder’s willingness to reinvest in the next generation.
What does this mean exactly? An internal sale, whether to individual employees, a trust, or a combination of the two, almost always involves selling the firm at a discount, as well as financially supporting the sale through means such as company-held promissory notes with favorable terms. The motivation of the founder goes beyond money – they care more about continuity of culture, employees, clients, and reputation of the firm. The owner cherishes what they built and consciously makes the decision to financially support its longevity.
The question that often arises is, why the discount? First, employees seldom have the wherewithal to purchase a firm at its market premium. They have been employees – not investors – and have not built up the reserves needed to purchase a firm at its market rate. Often in these situations, they are asked to use their bonuses for the purchase of their stock in the company. But even more importantly, stock transacted internally is known as “closely held,” which creates discounts. In a closely held firm, only employees can be owners, thereby limiting who can purchase stock and resulting in a “lack of marketability discount.”
ESOPs and other employee trusts require audited marketability valuations used for transacting stock, and these valuations always include a lack of marketability discount. Non-ESOP transactions are based on the valuation approach provided in a company’s buy and sell agreement.
Time is of the essence
Ultimately, thinking through your desired exit sooner rather than later will help you navigate your firm toward your goal. The most successful architectural and engineering firms don’t wait until succession is urgent; they treat it as a living part of their company’s strategy. Ask yourself these questions:
- Do I know how I want to exit the firm?
- Have I built the framework to ensure my exit strategy will succeed?
- If not, what one thing can I accomplish this year that will bring my firm closer to meeting my succession goal?
Remember, your succession plan is iterative, not permanent! By asking yourself these questions regularly as you develop and implement your strategic plans for the company, you will ensure your goals are met when the time comes, and you can walk away to your next adventure knowing you finished what you set out to accomplish.
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Elizabeth Nilsen, CPA, CGMA is COO and a senior principal at HLB Lighting Design. Connect with her on LinkedIn. |