The Principal's Dilemma (Part 2 of 2)

In Part 1, I discussed research findings by Noam Wasserman that show that most entrepreneurs must eventually chose between being “king” and being “rich.”  For founders of architectural firms, this dilemma hinges on whether to pursue firm growth or stand pat. Growing a firm can result in making more money, but requires a willingness to share control.

A transition to second-generation leadership will likely be necessary if a firm is to develop value and equity for the founder. This might include a redefinition of the founder’s role, a redesign of the firm’s organizational structure, and even a “reinvention” of the founder’s vision for the firm. The payoff to the founder for relinquishing control is the possibility of establishing market value of the firm and the potential for the firm to continue beyond the founder’s active involvement. There may also be the opportunity for larger, more diverse projects and for expansion based on capabilities beyond those of the founder. Firms that embrace second-generation leadership have the potential to create financial and social equity beyond the firm’s formerly established reputation, core competency and revenue stream. Firms such as these allow the founders to retire with the promise of financial support provided by an ongoing firm. This firm lifecycle is illustrated in Figure 2.

Figure 2: Transferring ownership to second-generation leaders has the potential to increase market value of the firm.

Nonetheless, many founding principals are more comfortable being the “king” of their own domain, no matter how small or finite. Research suggests that these founders’ personal sense of success may be dependent on always being in charge of their organization. These firm owners can also have very successful practices and may accumulate significant personal savings and investments eschewing the need to build equity in their firm. Often this is done by fostering lucrative market segments or specialized, innovative expertise. Many small firm owners also pursue other endeavors to increase their earnings, such investing in real estate, or partnering with a developer.

Anecdotally, it is known that many small firm founders have satisfying practices yet fail to earn enough for significant retirement savings. They are often successful in terms of excellent work product, but since their firms are built solely on their own talent, competence, and reputation, these firms have virtually no market value when the founder retires. These founders may face retirement with little accrued equity and few financial resources.

Approaching Retirement

Whether or not firm growth is personally appealing, it is important to think about the long-term implications of this decision. Two questions need to be considered in making choices about the future of your firm.

1. Do you see the potential of accumulating significant retirement savings or investments as you currently practice?
2. Are you ready to share leadership and power with potential successors?

The answer to each of these questions opens up and closes off certain possibilities as a founder approaches retirement. The key criteria and choices are illustrated in the Figure 3.

Figure 3: As retirement approaches, founders can evaluate their choices based on their comfort level with sharing leadership and control.

Expanded Choices

If a founder is comfortable with sharing power then it is likely that greater market value and owner’s equity can be built over time. Once the firm gains market value, three choices open to the small firm founder contemplating retirement.

1. Sell the firm to an outside buyer – this is unlikely unless the firm has an expert specialty or is in a market that can expand opportunities for another firm, without the founder’s continued involvement
2. Hire someone with partnership potential and groom him/her over time – significant time may be required to insure the fit and capabilities of the potential partner
3. Transfer ownership to trusted employee(s) over time – often the best option if available, successor(s) should be around 10 years younger than the founder, but care should also be taken not to disqualify anyone based solely on age.

Narrowing Choices

If the founders’ nature and personality is such that they prefer retaining all control and leadership, the available choices are very different. It is unlikely that these firms will develop much market value beyond the talent and reputation of the founders. When the firm is closed, the founders take its net worth with them and will be able to leverage the firm’s value only in terms of personal and professional choices.

If founders do not have significant savings, or if they are just tired of the stress of small firm ownership, there are some options.

1. Close the office and seek employment at another firm at the Principal level. Many larger firms welcome mature and knowledgeable architects on their management teams.

2. Merge with another firm headed by younger leadership. A small firm’s client base, built up over many years is an asset that can be transferred to the new firm over time and may allow for a phased retirement.

Both these options have the potential to provide some income when the founder finally retires.

If founders have significant savings, other employment possibilities, or other financial resources, they have some additional options. They can simply reduce activity and close their firm over time. Some of these founders may wish to continue working or wish to pass their client base onto a younger colleague. In that case, the option of acting as a design or technical consultant to another firm may be attractive. Neither of these choices is likely to provide additional retirement income.

Small firm founders who are in their 40s, would be wise to consider their options for ownership transition and retirement; for those in their 50s, it is a must. Self-awareness regarding one’s comfort level with sharing leadership and control is a critical part of this planning process. Review of one’s savings, employment, and financial options is another vital aspect in decision about preferred futures. To be avoided is a lack of planning and a denial that retirement will eventually come.

So, if you have owned your firm for ten to twelve years, and survived the recession, the time is now to decide if you want to grow your firm. If you do, take a look at my previous post, “Thriving in the New Norm: Strategies for Post-Recession Success” for some ideas on how to make it happen. A comfortable retirement may hang in the balance.

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Rena M. Klein, FAIA is the author of The Architect's Guide to Small Firm Management (Wiley, 2010) and principal of RM Klein Consulting, a firm that specializes in helping small firm owners run their firms better.