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Ask the Expert: Keys to Successful Ownership Transition Planning

Planning for ownership transition is important for all businesses.  This importance is magnified for Architectural, Engineering and other professional service firms who will also rely on future owners for everything from management to rainmaking and project performance!  As a result, it is critical that A/E firms have a robust ownership transition plan that is updated on a regular basis.  Following are five key steps to successfully transition ownership.

Understand your goals for ownership transition
One of my favorite Yogi Berra quotes is “If you don’t know where you’re going, you’ll end up someplace else.”  Unfortunately, this often applies to ownership transition as many A/E firms just move along with no particular destination in mind.  It is critical that the most important goals are defined if you even hope to get there.  Things certainly won’t happen exactly as planned but if you can outline your goals and see if a plan can work on paper then there is hope for it to work in the real world.

One of the biggest questions to answer is whether it will be an internal or external ownership transition.  Most firms look first at an internal plan as it provides for a continuation of the firm, access to a pool of buyers who are in the firm, and ongoing control until retirement.  While an external sale might provide for a higher price and greater liquidity, firms will most often look at an external sale only after an internal transition fails or when they are approached by a potential buyer.

Obtain a proper valuation
When you transition ownership within your firm, you are really transitioning value.  To understand the amount in dollars that must be bought and sold, as a starting point, you must know the value of your firm.  From there, you can begin to consider how to best plan for transition of that value.  There are a number of different ways that A/E firms determine the value of their stock.  These range from educated guesses to values based on an established formula to detailed valuation reports prepared by qualified appraisers.

We have found that in practice the best valuation method is a hybrid approach that considers both the firm’s adjusted book value and an earnings factor based on historical income.  This hybrid approach was developed years ago by Dannible/McKee and Associates and is commonly known as the A/E Approach.  It has been successfully utilized to value hundreds of A/E firms across the U.S.!

Consider the non-financial aspects of the plan
Often one of the most challenging non-financial aspects of the plan is determining how the selling owners will eventually “let go” of their myriad of responsibilities.  Criteria for ownership must also be established to help understand how key employees can progress on their path to future ownership. The plan must also address the transition of firm management and other key operational roles and client relationships.

Evaluate the mechanics of the plan
A proper plan is one that will mesh the goals of the selling generation and that of the buying generation and address the key concerns of timing, affordability, tax-efficiency, and cash flow.  While it is critical that the plan be financially beneficial to the sellers, it is equally important that the plan be affordable to the buyers.  This will often lead to a plan that involves gradual cross purchases of ownership and funding with payments over a period of years.  Other possible vehicles to consider include deferred compensation, stock bonuses, and stock redemptions.

Formalize the plan
A mandatory step in the plan for ownership transition is the adoption of a comprehensive agreement among the owners that is often referred to as a buy‑sell agreement.  For firms with existing agreements in place, the agreement should be reviewed to ensure the firm’s ownership transition planning objectives are being met and the agreement is current with respect to the current economic and tax environment.

A buy‑sell agreement should be a “self‑executing” agreement that will accomplish all of the following objectives:

  • Provide for the orderly transfer of ownership interest upon the death, retirement or disability of an owner,
  • Create a market at a fair price for the interest of owners who desire to transition their ownership in the firm for expansion or in contemplation of retirement,
  • Fix the value for sale and/or purchase and the related payment terms, and
  • Reasonably assure the continuance of the business and reduce the risk of dissolution and loss of value.