A smooth ownership transition in AEC firms requires expert guidance and advanced planning. Even if an exit from your architecture, engineering, or environmental consulting firm isn’t in your immediate plans, that doesn’t mean that you shouldn’t be taking steps now to put your company on solid footing for an ownership transition that maximizes your future payout.
Establishing a timeline, identifying future leaders, and managing risk are all crucial aspects of ownership transition planning for AE firms, and — more often than not — the sooner you start planning for these activities, the better your results will be, for both your firm and your bottom line. But making the necessary arrangements for an ownership transition years in advance is often easier said than done. Let’s explore just how far in advance you should be planning and alternative options for ownership transitions that will help your firm
Plan Your Exit at Least a Decade in Advance
Morrissey Goodale’s ownership transition experts recommend that firm leaders start thinking about the transition process at least 10 years before their planned retirements or expected departures from firm ownership. Here’s a recommended timeline to follow:
- Ten Years Prior to an Ownership Transition: The first steps in the process are to identify those employees with partnership potential. Have discussions with them about their futures at the firm and tell them about the partnership paths you see for them if they continue to develop and perform.
- Seven to Nine Years Prior to an Ownership Transition: Begin to bring those on the partner track into the ownership group by selling them small stakes in the firm.
- Five Years Prior to an Ownership Transition: Ensure that options for the future leadership team are in place and, ideally, reduce the ownership of retiring shareholders to 70% or less.
- One to Three Years Prior to an Ownership Transition: Develop a detailed share transfer plan and get commitments from the next generation of owners.
The Pitfalls of Poor Ownership Transition Planning
A lack of sufficient preparation can dampen the value of your eventual payout. Whether you’re planning for an internal or external ownership transition or establishing an Employee Stock Ownership Plan (ESOP), in all cases, you will need the next generation of leadership firmly in place. Although it will be slightly less important in the case of an external acquisition, a buyer will still want to know that the key leaders and client relationships will pass along with the firm.
An external sale can be accomplished quickly in most cases, but without investing time to groom your successors, you could find yourself in a forced sale position that will decrease your firm’s valuation. With proper forethought, however, you can put in place a highly capable leadership group that will continue to grow your firm and enhance the value of your payout.
Earn Outs Balance Sellers’ Risk, Reward
In uncertain economic and geopolitical times such as these, buyers may not want to take the risk of promising the full payouts that firm owners believe reflect the value of the firms they’ve spent years building, which can certainly be a major roadblock to a smooth ownership transition.
One solution to consider is an “earn out,” which makes the ultimate price you get contingent on the firm’s subsequent performance. If the business proceeds as expected, sellers get their expected payouts. If it deteriorates, they forego some of their payouts for the good of the firm. And if the firm’s performance takes off, sellers get to share in the wealth and receive a higher payout than they otherwise would.
To see how it works, imagine a firm with $15 million in net revenue, a 12% profit margin, and a $10 million valuation. In a simple sale, the sellers would just get $10 million in cash, paid over a period of several years. With an earn out, those guaranteed payments might be reduced to $6 million with earn-out payments ranging from $0 if the company’s profits declined to $8 million if they accelerated. The sellers take some risk, but in this scenario, they also have opportunities to increase their payouts by 40% if the company is highly successful.
When AE firm leaders plan ahead and properly mentor and prepare the next generation of firm leadership, they’re charting a course for success and helping the firm derive the most value from an earn out deal.
Earn Outs Can Benefit Buyers, Too
From a buyer’s perspective, the earn out means less risk. In the AE and environmental industry, internal buyers must usually take out loans from either banks or the company to pay for their stock.
If all goes well, the firm generates sufficient profits that allow buyers to use their distributions to repay the loans. But if the business falters, the distributions dry up, and buyers have to pay the loans out of their own pockets, which can be a substantial burden.
An earn out can ease some of the financial pressure by reducing the required payments if the firm is less profitable. On the flip side, the earn out will reduce some of the buyers’ windfalls if the firm’s profits grow rapidly.
Morrissey Goodale’s Ownership Transition Experts Can Help
Need help in structuring an ownership transition plan or earn-out agreement for your architecture, engineering, or environmental firm?
With decades of experience and an AE industry specialization, Morrissey Goodale’s seasoned financial consultants can help you make informed decisions about which internal and external ownership transition plans are right for your firm to ensure you’re fully prepared for an eventual succession or sale and maximize the return on your investment.
Contact us today to find out how Morrissey Goodale can help your firm secure a successful future.
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