There are a few ways to transition out of your firm. The internal transition is popular because it has great value and keeps the firm going.
At some point in every A/E firm owner’s business life, the question of how to effectively exit the company will arise. Hopefully that question doesn’t come up when you have hit the wall with your ownership. Rather, you can provide for a reasonable timeframe to get it done right.
Ownership and leadership succession planning are some of the biggest issues firm leaders are facing today. Many of you bumping up against your retirement window may have delayed the process due to concern about extracting the maximum value during slow economic growth in the last few years. Now that the economy is kicking into a higher gear, more economic activity should translate to more business and increased value. Essentially, exit planning comes down to three options: an orderly wind down, an external sale, and an internal transaction of the shares.
No one size fits all, and firm owners have varying reasons why they may choose one alternative over another. Following is a brief description of each option:
- Orderly wind down. In most cases, this is an owner’s last resort. It usually happens if there is a leadership vacuum for the next generation within the firm to have the ability to lead and/or buy the shares, or the firm just isn’t an attractive candidate for sale. An orderly wind down means that as the firm owner you will collect your outstanding accounts receivable, pay the outstanding bills, perhaps transfer your clients to another firm, and divest of any tangible assets on the balance sheet. Eventually, you will turn off the lights, lock the door, and go home. From a value perspective this option will usually net you the least number of dollars for the next stage of life.
- External transition. If your firm has the right set of characteristics to be attractive to the marketplace, an external sale to a strategic buyer or a private equity firm will allow for a maximum value extraction in a short period of time. In many cases, deals are completed with a mix of cash and stock and possibly an earn-out or other payout scenario. While this option is interesting to many firm owners, it requires patience as the company could be on the market for over a year. Once a buyer comes forward and makes an offer, focus is needed to make it through the negotiations and get to the closing table.
- Internal transition. For those owners who are not interested in outright selling to an outside entity, an internal ownership transition plan is in order. An internal transition involves developing a plan to sell shares held by the exiting firm owner to the next generation of leadership. Internal transitions generally are executed over a several year period. In our practice, it is typical for us to develop a plan with a five- to 10-year window for the owner(s).
Internal transition of the shares is a viable and popular option for many of our clients. The plan is based on maintaining an adequate capital structure while finding the proper alignment of leadership and ownership based on the company’s strategic objectives. Our plans meet several basic objectives, including providing the owner(s) with an exit strategy, providing for an acceptable return on investment, providing for the long-term viability of the firm, and aligning the commitment of key employees.
People are a central focus of internal ownership planning. Firm owner(s) must determine who to include in the next generation of leadership, and several key questions are pertinent to the process:
- Is the next generation interested in being on board?
- Do they have the right skills and personality traits to be good stewards of the firm?
- Are they interested in ownership for the right reasons?
- Does the next generation group have enough time left in their careers to become owners and enjoy a lengthy period of ownership?
- As the current firm owner, what do you expect out of a new owner?
- Once on the team, how will the financial benefits be divided?
There are options for how the shares are sold and we will typically model scenarios for clients to show the impact of options on the financial performance of the company and the ultimate value received by the seller(s) of the shares. In every instance, we develop scenarios that will protect the viability of the firm, assuming no circumstances arise that could not be anticipated at the time the planning is done.
Internal transition plans have many positive aspects and, in many cases, the firms will experience an improvement in financial performance with a set of new, eager owners driving business forward. Unsuccessful or problematic plans generally arise because of a few issues:
- The plan is started too late and the owner(s) need out too quickly
- There is no strategic plan in place to sustain the business going forward
- The plan fails to properly manage the redemption liabilities
- The plan takes too long for the next generation to sufficiently enjoy their ownership
- The shares are ineffectively priced
An internal transition of ownership can be a rewarding experience for everyone involved. As a firm owner, it is an opportunity to set the company on the right course, with the right leadership, for the continuance of the practice.
Tracey Eaves, MBA, CBA, CVA, BCA, CMEA is a member of the valuation consulting team at Zweig Group. She has been valuing privately held company interests for more than 18 years. Contact Tracey at email@example.com or directly at 505.258.8821.