BY THOMAS B. ERIKSEN
This article originally appeared in the Summer 2016 edition of the Oregon Architect
An architectural practice presents unique challenges when the owners decide it is time to engage in succession planning in order to assure the continuation of the firm and a smooth exit for the principals. Succession planning can be viewed as the art of structuring the transition of the ownership, management, and control of the architecture practice. Each of these elements requires careful planning, structuring, and implementation in order for the succession plan to be successful.
Often, the legal structure of the architecture practice limits the universe of potential buyers to other licensed professionals. In essence, this means that current key employees or a competing architecture firm are the most likely to be in a position to acquire the practice of a departing principal. Each option comes with its own challenges.
If key employees are the preferred target buyers, consideration must be given to the fact that few employees will have the financial resources to purchase the firm outright. Often the key employees will need to acquire ownership over time. That can be accomplished through a variety of tools, from stock bonus plans to buy-sell agreements funded with insurance or deferred compensation plans. The transition of the practice to key employees can be a five- to ten-year process. Not all key employees will stay with the firm for the duration of the succession plan, requiring some recalibration of the plan over time.
If the practice is to be sold to or merged with a competing architecture firm, confidentiality is a key component of the transaction. If it becomes known in the industry that the firm is for sale, competitors will use that information to attempt to pick off valuable employees and clients. During the due diligence phase of a transaction, financial information and other proprietary information is often shared with the potential buyer. If not properly protected, this information can also be used against the potential seller if the transaction is not completed.
How much is the practice worth? Typically, an architecture practice has few tangible assets. Office equipment and systems are likely fully depreciated and may be in need of replacement. Accordingly, book value as shown on the financial statements of the practice offers little help in determining the value of the practice. Absent tangible assets, intangibles are likely to comprise the bulk of the value of the practice. These intangibles will include such items as the anticipated future profits of the firm as represented by the volume of backlog of work, the skill level of the in-place work force, special areas of expertise, and market share. Determining the value of these intangibles requires an appraiser or consultant with expertise and experience in valuing architectural practices.
The target buyer (internal or external) can also impact the value of the practice. When transitioning the ownership to internal candidates, these small portions of ownership will often be subject to minority interest and lack of control discounts, resulting in a smaller payoff to the departing principal. Sale or merger of the entire firm to an external buyer often allows the departing principal to obtain the full enterprise value for the firm, without discounts for lack of marketability or minority interest.
Designing and implementing a succession plan does not necessarily mean giving up control of the firm. If an internal succession plan is preferred, the transitioning of the key employees into ownership and management of the firm will occur over time. While key employees are identified and trained, senior principals can retain control of the firm by retaining a majority of the Board of Directors positions, and by retaining the key officer positions of the company, even as their ownership interest in the firm decreases.
Securing and monetizing the value that an architecture principal has spent a career creating takes careful planning and a long-term vision. Starting the process well before the need to exit the practice will help assure the success of the firm, both in terms of the continued longevity of the firm and returning value to the departing principals.