As an architecture or engineering firm owner, you've dedicated many years of your career to building a successful business, leading your team, establishing a strong culture, and fostering great relationships with your clients and community. However, as your firm grows there will eventually be the need to elevate trusted employees to become members of the firm's leadership team. There will also come a point in time when you will want to step back from the day-to-day operations of the business. Meaning you will eventually want to sell part or all of the business to the next generation of firm owners.
This can be a stressful time in the evolution of a firm, and needs thoughtful planning to execute successfully. It is also important to strategically plan for this to maximize the value of the firm for your financial exit.
There are many reasons to start succession planning, from transitioning into retirement, opening up your time to pursue personal projects, expanding the leadership team to prepare for future growth, or perhaps you simply want to achieve a better work-life balance by sharing the responsibility of firm management. Perhaps most of all, you want to see a financial return on investment from the risk you took on building and growing a successful business, to the financial contributions you made getting it up and running.
This is a pivotal time that will drive the future direction of your firm. It will have an immense impact on yourself, you team, and of course the people who will be stepping up to take the reins. Planning for this transition is vital to ensure a smooth passing of the baton.
Succession planning is not just about your personal goals, but also about ensuring the continued success and stability of your business for years to come. You want to protect the legacy of the business you have grown, ensure you get a return on your investment in the business as an asset, and empower the next generation of leaders to carry it forward. This process will safeguard the future of the firm for the employees and the clients you serve, while giving you an opportunity to get a financial return on your investment in years and financial sacrifice getting the business to where it is today.
Why Succession Planning Is Critical for A&E Firms
A big reason is personal. Financial freedom is hard to achieve through salaries, savings, retirement accounts, or even real estate. They are tied to markets outside your control and take a long time to mature into significant asset. For example real estate is illiquid and has a high overhead and takes a whole career to pay off a standard 30 year mortgage.
On the other hand, your firm is probably your most overlooked retirement asset. You have direct control over it's management and if done well, it can quickly grow into a valuable asset that can provide you with financial freedom earlier on in your career arch.
You should think of your firm not just a platform to design projects but rather as an engine of value creation. It should be your most valuable asset, and unlike a retirement account your firm has unlimited growth potential. Meanwhile, you control your firm’s operations and growth.
A second reason, is that your firm provides for all of your employees and their families. Building an entity that can live beyond your leadership tenure ensures your team can maintain their jobs when you are ready to step away. Plus it can provide the upward trajectory many of your employees want to see in order to stay at the firm.
Designing An Architecture or Engineering Firm With Long-Term Value
In order for you to sell the firm, whether to an outside buyer or to someone from within your business, you need to have something they want to buy. You should be working towards building long-term value for your business as part of your management decision making. Here are some of the things to consider that can be of lasting value to someone acquiring your firm.
Diversifying your Client Base
Firms that depend on only a few large clients are vulnerable to economic swings which creates risk for buyer. This is especially true if those clients are because of long term relationships with you as the current owner. If you leave, will those clients stick with the firm? A diverse client base protects against downturns in any specific market sector and is more resilient if people leave or switch jobs. You should have a steady stream of work from a wide range of clients, and balance work that comes from your personal relationships with work that is generated from inbound inquiries and marketing or business development beyond your connections.
Building a strong and efficient team
All successful firms shouldn’t be reliant on one or two people to stay in business or deliver the work for your clients. The goal has to be developing an organizational structure, and systems and processes, so your team can thrive without constant oversight from the owner or key individuals. The firm should be able to continue to run itself successfully if any individual leaves.
Having the right people in place is vital. But so is having the systems and processes in place to deliver the work that your clients expect in an efficient way that is profitable. This means you have a track record of managing projects profitably.
Diversifying your services
An entrepreneurial mindset means you look at the needs of the marketplace and see where your skills and interests can deliver value to a customer base. However, the initial gap in the market that you filled by starting your business is not necessarily the same as what is needed now or in the future. Technological shifts, changes in the economy or marketplace, can all affect what clients are looking for from A&E services. The wider a range of services your firm offers, the more resilient your business becomes. Plus expanding your services can increase client satisfaction and increase your revenue and profits.
Unique selling proposition (USP)
Related to expanding your services, having a unique selling proposition can make you more resilient in the market. If all your firm does is the standard services A&E professionals provide you are probably turning your business into a commodity that can easily be relaced by another competing firm. This means you are missing out on an opportunity to differentiate yourself in the marketplace. There are countless talented professionals out there for clients to chose from. You have to be absolutely clear what separates you from the competition. When a prospect asks, why should I hire you, over your competitors, it’s already probably too late. They should always be aware of what separates you from the rest.
Continuous marketing process
Marketing has to be an integral part of your business strategy. You can't rely on your relationships, word of mouth, or pray that someone will call. A resilient firm needs to constantly be in marketing mode and have a set process and budget to conduct this effectively. Marketing should be part of your weekly and monthly agendas for the firm's leadership team, and ideally multiple people in the office are contributing. Doing good work is not a marketing strategy. If you plan on increasing the value of your business for a possible exit, then you need to invest in a marketing systems that continually drives new leads to the firm.
Manageable growth and financially healthy
A sustainable firm is one that grows steadily, without overextending itself. It's financially healthy, with controlled expenses and predictable revenue. Much like a building designed for energy efficiency, your firm should be designed for financial efficiency, where the resources you invest yield consistent returns over time.
Think long-term
With all of these points you are thinking long term and planning for the life of the business after you step away. Value comes when your firm is set up to thrive when you hand the reigns to the next generation of leaders, or it is at a place where another business can acquire it and have it continue to generate value.
3 Strategic Steps For Ownership Transition for your Architecture or Engineering firm
The process of ownership transition needs to be planned thoughtfully. First by setting what the goals are for an exit, how you want to build up value in the business, and what sort of transition you want to pursue. Let's break down these further.
Step 1: Vision and Exit Goals
Even early on in a firm, owners should be thinking about their exit goals. This could affect whether you want to grow, who you hire, what types of projects you pursue, and more.
Start by asking yourself, and your partners, what role you want to play in the firm, both now, but also in 5 or 10 years. You should have an idea of how you will contribute to the operations and management of the firm in the present, but also what your role may transform into when you are ready to step back - either contribute part time or retire completely.
Many firm owners still want to stay engaged in an advisory role, as a board member, or maybe just for helping with business development.
As you plan your organizational structure, roles and responsibilities, and systems and process, design them with an eye towards what the firm would be like without you. How will it bring in work? Will the business continue to grow? Who will make key business decisions?
These questions should be part of the business plan even if your retirement is many years off. Especially if the goal is to build value in order to sell.
Step 2: Financial Planning and Valuation
From day one of running a firm you should be familiar with how firms are valued. This on-demand webinar on Succession Planning discusses the main themes of succession planning and dives into how to calculate firm values. Steve Burns even talks through some case studies that help clarify different formulas for valuations.
A proper valuation looks at more than the firm's revenue or its book value. A comprehensive valuation looks at profitability over time, recurring revenue or clients, intellectual property, firm size, and any assets the firm may own. There are some common formulas that calculate valuation with these variables and more. An objective valuation is key to understanding what you can expect to get from a sale or transition. It’s not what you think your firm is worth—it’s about what the market says it’s worth.
Once an estimate of the firm's value is established, the next step is financial planning for the transition. This will change based on the type of transition you are anticipating. If you’re selling internally to existing employees, how will they finance the purchase? Will it be an upfront cash buyout or a phased buyout over several years? If you’re selling to an external buyer, are you financially prepared for the tax implications and legal fees that come with the sale?
Deciding to sell and the potential return is an important part of your own personal financial planning. How much do you need from the sale of your firm to retire comfortably? How will the timing of the sale impact your personal cash flow and retirement goals? Without a clear understanding of the firm’s value and careful planning for how the transaction will unfold, you could leave money on the table or run into unexpected financial hurdles.
Step 3: Ownership Transition Models
There are some common ways that A&E firms transition ownership, from internal leaders stepping up to take over the firm, to selling to an outside company. We will briefly explore a handful of these options here, but we also encourage you to think through what might make the most sense for your business either now or in the future so you can design a plan to reach your goals.
Internal Sale
The first option is an internal sale. This entails selling your firm to someone that is already working for the firm. Often the person or people are already members of a leadership team or are key employees who have significant responsibility within the operations of the business. This is a popular choice because the firm continues operating with the same culture and vision. The transition is often smoother because the new owners already know the firm’s operations, team members, and clients. If you are starting to plan for a transition, consider who at your firm might be the right people to assume ownership in the future.
One of the challenges with internal sales is they often require financing by the purshasers. This could take the structure of a business loan or more commonly takes shape through a phased buyout of the existing ownership over time. You have to be ok receiving payments over time and trust that the new leadership team can run the firm successfully to generate the revenue and profits needed for them to afford your payments.
Another potential downside is with an internal sale you are often building in some discounts to the firm's valuation and sales price to encourage the purchase. You have the make the deal enticing to the people buying you out, and with less capital involved it might mean accepting something below what you would get from an outside buyer (assuming your firm is even interesting to an outside buyer with is not always the case).
Merger or Acquisition (External Sale)
The advantage of an external sale is that it usually provides a higher upfront payout as you are probably selling to a larger firm or investment group that is well capitalized. This often means you sell for the full value of the firm and can walk away with more money. This sounds great but there are challenges and downsides.
An external sale is often a longer process. External buyers will do extensive due diligence to make sure the firm is worth their investment. And there will be a tough negotiation as both sides try to get the best deal. There is no personal relationship so this is much more of an objective business decision based on financial data.
Another consideration is that an outside acquisition probably results in larger changes changes in the direction or leadership style of the firm. The team and culture you built up over the years is now absorbed into a larger company that has their own systems, processes, culture, and values. This isn't always easy for your team to weather. It also often means that your legacy gets absorbed into the brand and portfolio of the new company. Not everyone is comfortable with that.
Employee Stock Ownership Plan (ESOP)
An alternative to selling to internal candidates directly, is to create an Employee Stock Ownership Plan, or ESOP. This is where employees buy the firm through a trust, and each employee becomes a shareholder. ESOPs are attractive because they align the interests of the employees with the success of the firm. Everyone has a stake in the firm’s performance, which can drive motivation and retention.
But there are definitely some significant downsides. Setting up an ESOP is a complex legal process and can be rather expensive. You need to work with specialized lawyers and accountants, and the costs of creating and maintaining the plan can be high. ESOPs are also subject to strict regulations, so this path requires careful consideration and planning.
Family Succession
In the Architecture and Engineering industry it isn't uncommon for owners to pass the firm on to a family member as the next generation of leadership. This probably isn't the path with the highest financial return, but can be a great option if you are more concerned about legacy or wanting to set up your children for a promising career by passing on a valuable asset.
Like with the other options, this option also brings challenges. Family succession often blurs the lines between personal and professional. Without clear expectations, it can lead to tension or conflict which can be tough to navigate with family members.
It is also important to have conversations about ownership with your successor early. You may assume someone is on the path to take over your business when you retire, but they have other plans. Plus you have to make sure they have the necessary skills and commitment to run the firm.
Close the doors
Not every firm is built in a way that makes sense to sell or transition to a new ownership team. Sole practioners, small offices with no clear successor, or even larger firms where the owners don't want someone else to take over their legacy, are all examples of firms that might not be a sellable asset. Many firm owners just work until they don't want to anymore and simple close up shop. Perhaps they slowly phase out by stopping to take on new projects and as they finish serving their existing clients they simple slow down into there is no projects to work on.
Selling isn't right for everyone. Although this option doesn't offer any financial return on all of the effort building a business over the years, it is the right path for some.
Conclusion
The biggest takeaway from this post should be that it is never too early to start thinking about succession planning. We actually think it is something you should consider and discuss with partners as you set up for your first business plan. If you wait until you are ready to retire, it is too late. Planning and executing on a ownership transition takes years to do effectively so have a strategy in place early on.
Even if you’re not ready to sell or step back now, you should be building a firm that can thrive without you by investing in your team, refining your processes, and making sure the business is healthy and profitable. Cultivate a strong leadership team as early as possible and don’t resist giving them responsibility.
Understand firm valuation long before you’re ready to sell. We actually think you should be monitoring the value of your business on an annual basis as a good best practice. This means thinking beyond just your revenue, using some standard equations and trying to be objective about what your firm is work. The goal of having this knowledge is to enable you to make business decisions on a day-to-day basis that will maximize the value of the business when you are ready to consider selling.
Succession planning is different for each firm and each owner. It is a complex process and it’s worth seeking outside advice. Whether it’s getting a comprehensive firm valuation or finding the right buyer, experts can help guide you through the transition and maximize your return.
Additional Succession Planning Resources:
