WHAT EVERY A/E FIRM LEADER NEEDS

TO KNOW ABOUT TRANSITION PLANNING

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Ownership transition activity in the architecture and engineering (A/E) space is certainly on the upswing with the Baby Boomer generation looking to retire in increasing numbers. But, how ready are you for taking on the task of transitioning ownership of your firm? Have you primed the pump with a list of possible successors?

Those who are looking to retire in the next decade need to start planning today to guarantee a smooth transition, and one that is beneficial to all parties.

Yet, if you are a firm owner looking to transition ownership within your organization, you probably already know that generational forces operating in today’s A/E firms present some major challenges.

Only a few years ago, when a young professional joined a design firm, he or she expected to serve a long time in that firm, working for the owners while becoming more and more knowledgeable and capable, and hoping, after years of loyal commitment, to someday acquire equity in the company.

Today, however, things are much different. Your incoming professionals probably seem more loyal to their own careers and their profession than to their companies. And who can blame them? In their experience, they see companies that come and go, they see companies merging or getting acquired, they see constant change. The only way they can have some control over their own destiny is to be independent: either move among companies to find what they want, or become owners fairly early.

The most talented young professionals are educated about the world, independent thinkers, and somewhat impatient for more responsibility and financial reward. They aspire to early ownership. If you want to keep them in your firm, you must make it clear that the ownership path is open to them.

In What Every A/E Firm Leader Needs to Know about Transition Planning, we help you navigate through some of the thornier parts of planning for your firm’s ownership transition, as well as present some expert advice on how firms can address the generational challenges they face today when considering selling their firm internally.

Though we only cover a small corner of the vast world of ownership transition in this e-book, we do hope you find it helpful. For more information and additional resources, please contact us at 617-965-0055 or www.psmj.com.

INTRODUCTION

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PART ONE: COVERING THE BASICSAn Overview of the Ownership Transition ProcessWhy You Should Have an Ownership Transition Plan…Now!Design Firm Transitions Differ From Other Business Transitions

PART TWO: MAKING IT HAPPENThe Four Different Generations in Today’s A/E FirmFirst, There is the Financial Side of Ownership Transition……And Then the People-Based Side of the Equation

PART THREE: NEXT STEPS TO OWNERSHIP TRANSITION SUCCESSOwnership Transition Problems to AvoidHow to Prepare For the Transition Financial Issues to ConsiderCopyright ©2016

by PSMJ Resources, Inc.®

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PSMJ Resources, Inc.®P.O. Box 95190Nonantum, MA 02495Phone: 617-965-0055Fax: 617-965-5152Email: customerservice@psmj.comwww.psmj.com

TABLE OF CONTENTS

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PART ONE: COVERING THE BASICSAN OVERVIEW OF THE OWNERSHIP TRANSITION PROCESS The goal of an ownership transition plan is usually to keep the firm intact and operating smoothly according to its original vision, whether the occasion for change is planned, such as an owner’s retirement, or an unexpected event like the sudden death or disability of a partner. Ideally, the day to start planning your transition is the day you start your firm. Don’t put it off. It affects your on-going management decisions and the year-to-year financial management of your firm. And a transition could happen sooner than you expect.

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The following are the general steps you need to take to complete a successful transition.

• Understandyourfirm’sculture.Areyou tryingtocreateanempoweredcompany whereallemployeeshavean entrepreneurialspirit?Orareyoumore concernedwithcontrol?

• Understandyourowngoalsandobjectives. Attheendofthetransition,wheredo youhopetobe,financially,personallyand professionally?

• Setyourcriteriaforleadership.Whatdoes ittaketobecomeapartnerinyourfirm?

• Decidehowyouwillfinancethetransition.

• Writeaschedule.Whetheryourplanwill takefiveyearsorfifteen,decidewhatyou needtodoandwhen.

• Knowhowtoplaceavaluationonyour firm.

• Putinplaceabuy/sellagreementandplan toreviewiteverytwoorthreeyears.

Ideally,thedaytostartplanningyourtransitionisthedayyoustartyourfirm.

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WHY YOU SHOULD HAVE AN OWNERSHIP TRANSITION PLAN…NOW! It is a common myth that ownership transition planning is only for those firm leaders who are ready to exit. This couldn’t be further from the truth! Even if an exit isn’t in your near-term plans, here are six reasons why you need to start building a plan right now:

1.Toallowolderownerstoliquidatetheir investmentinanorderlyfashion.

2.Togiveyoungerprofessionalsthe opportunitytoacquireownershipover areasonableperiodoftime.

3.Toallowasmoothtransitionfromone managementandownershipteamto anotherwithoutdisruptingserviceto clients,whetherthetransitionresults fromaplannedorunexpectedevent.

4.Toallowolderownerstophaseouttheir day-to-dayinvolvement,butcontinueto contributewheredesired.

5.Tohelprecruittalentedpeoplewhowant tobeonanownershiptrack.

6.Toalloweachcurrentandfutureowner tomaximizethereturnonhisorher investmentinthefirm.

DESIGN FIRM TRANSITIONS DIFFER FROM OTHER BUSINESS TRANSITIONS Some traits of architecture, engineering, planning and interior design firms differentiate their transfer of ownership from transfers in traditional businesses.

Emotionaltiestotheprofession.Most design firm professionals want immediate ownership, not for economic reasons, but to control their own destiny and build security. They want ownership, but might not understand what ownership means.

Financialsecrecy. Because owners tend to keep finances a secret, potential successors don’t understand the business side or the financial status of the firm.

Secondarynatureofprofit.Profit and profitability can often take a back seat to design and client relationship management.

Egoandentrepreneurialdrive. The entrepreneurial drive of the founders is often not found in the second generation.

The results: Entrepreneurs are replaced with groups who don’t like to take risks and who spend their time vying with each other for position.

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PART TWO: MAKING IT HAPPENTHE FOUR DIFFERENT GENERATIONS IN TODAY’S A/E FIRM For the first time in our history, companies are struggling to deal with four generations in the workplace at one time. The resulting culture clash is causing some serious issues that you, as both emerging and established leaders, need to understand.

A generation occurs roughly every 20 years. Social scientists clump a generation together according to events and external influences that the group shared. This is not a fixed science, so you will see different ranges of years for different generations. The characteristics of the generations don’t change though.

THE TRADITIONALISTS, born between 1900 and 1945, are mostly retired but some are still working, carrying on the beliefs, practices, and loyalty of the Greatest Generation, as they have been called. They experienced world wars, the Depression, and the industrialization of our country. While they technically are two generations, this group is viewed as one generation because their values and life experiences werethe same.Thekeyinventionintheirgeneration:radio.

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THE BABY BOOMERS, born between 1945 and 1962, are in management and leadership positions today. This generation identifies with JFK, Martin Luther King Jr., the Beatles, and the Beave. They fought for civil rights and women’s rights and in Vietnam and against the draft. They rolled in the mud at Woodstock and launched Saturday Night Live. Thegreatestinventionoftheirgeneration:television.

GENERATION X, born between 1963 and 1982, is comprised of so many different groups that researchers couldn’t find one label that fits all of them, thus the term Generation X. Gen Xers identify with Bill Clinton, Bill Gates, Michael Jordan, and Dilbert. They experienced the highest divorce rate in U.S. history and were the first latch-key kids. They saw their parents’ loyalty to corporate America rewarded by widespread layoffs. Thegreatestinventionforthem:thepersonalcomputer.

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And there are the MILLENNIALS, born between 1981 and 1999. Influencers for them include Prince William, TinkyWinky, Kurt Cobain, and Britney Spears. These people have lived with Colombine, the 9-11 bombing of the Twin Towers, and the bombing at the Olympics. The Millennials have grown up with cell phones and instant messaging. Whereas other generations have had to work on diversity, the Millennials have grown up expecting diversity. Some researchers believe this group will be known as the Next Greatest Generation. Thegreatestinventionforthisgroup:theInternet.Population:76million.

What is critical to recognize here is that the challenge of managing four generations is marked by having to manage four different sets of values:

Traditionalistsvalue stability, responsibility, frugality, and loyalty to the company.

Boomersvalue optimism, competitiveness, idealism, and rising through the ranks.

GenXersvalue skepticism, independence, resourcefulness, and work/life balance.

Millennials value loyalty, optimism, diversity, and teamwork.

Use your understanding of these distinctions to approach members of different generations accordingly.

Thechallengeofmanagingfourgenerationsismarkedbyhavingtomanagefourdifferentsetsofvalues.

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FIRST, THERE IS THE FINANCIAL SIDE OF OWNERSHIPTRANSITION…Looking at internal sales of stock ownership, processes, and partnership agreements, much has changed since the 2008 downturn. Generational forces at work in today’s architecture or engineering firm present a major challenge to effective ownership transition. Thus, as a firm leader, you must do more than consider new or revised terms in your buy-sell agreements.

Today’sPerfectStormInternal ownership transition has gotten to be one of the most difficult challenges facing A/E firm leaders today. In fact, we have just run into what could be called the “perfect storm.” The number of Baby Boomers who own equity in the A/E industry and want to get out is at an all-time high. It is going to get higher yet, but it is peaking with the current demographic of firm owners.

While current Boomers are looking to retire, however, few Generation Xers are ready to take over the reins, and the following generation (i.e. Millennials) have different expectations. And, many of these younger folks coming up the line are still shell-shocked from the recession. They saw themselves and all their friends get laid off. They expect to be given the ownership, that, in effect, they have already earned it by being a good employee.

Because of a reduced demand for shares inside the firm, there are not a lot of buyers out there for internal ownership. And, of course, this doesn’t fit with the retirement plans of the Baby Boomers, many of whom are behind schedule because of the losses they incurred during the recession. And so, when you combine a pressure for value with the fact that the younger folks don’t want to pay, the result is nothing less than a logjam.

Becauseofareduceddemandforsharesinsidethefirm,therearenotalotofbuyersoutthereforinternalownership.

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DeepDiscountvs.ExternalSaleOur experts at PSMJ are seeing a big separation in valuation between what a seller (who owns shares and wants to sell) can get from an outside firm versus what they could possibly get at a discount sell to an internal shareholder. Also, the difference between internal and external sales has become much starker. We used to see a 25-30 percent discount from an external to an internal sale. Now we are seeing double that, at least a 50-60 percent difference between what firms could sell themselves for externally versus internally.

Firm leaders, however, should not assume that an external sale is always a good “fallback” position. There’s a good chance that the younger folks would not come along in a sale.For sellers to be able to deliver firm value, they have to be able to bring their key staff with them. And so, the process is circular: It runs right back into itself.

To say it another way, retiring Baby Boomers must consider how an external sell would impact firm culture. Moving from an internal to external sale greatly increases the influence of money on your decision. If you have operated a practice-centered business for a generation, and then all of a sudden you need to get the place ready for an outside sale, you are now money-motivated.

Thus, when you change to a business-centered practice to make more profit, the firm falls apart. The middle management does not get it: They joined and stayed at the firm because of the way it operates. You might be able to turn a screw here or tighten up a bolt there, but the culture turns very slowly even in a small firm. Making the switch from an internal to an external focus requires whipping your firm into the opposite direction, and it’s likely that your employees will not come along.

ESOPsFindNewPopularityEmployee Stock Ownership Plans (ESOPs) have become more popular. They’re less overhead burdensome then they used to be and less expensive to set up. Some firms put an ESOP in place as a last resort for ownership transition. They think: “We don’t want to sell to a big firm and we can’t sell internally, so let’s do an ESOP as a fallback position.”

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The problem is that an ESOP comes with a cultural change. And firms often don’t understand how an ESOP shifts the culture of the firm into one where everybody is – in some respects –taking an ownership mindset.

Sometimes firms prep for that and do some lead-up. If firm leaders talk it up and become more open book, than the firm may not change in bad ways.

But generally, our view has always been that you can’t make people act like owners just by giving them equity-based benefits. People need to act like owners first, and then an ESOP might be a good solution. You can’t do it in reverse.

FinancialPlanningforOwnershipTransitionMany firms want to stay independent. Their owners say: “I don’t want to or I don’t think I could sell to an outside firm, and I don’t want to stick around here very much longer. I have to do whatever it takes to make this go.” And so, in order to induce the younger folks to buy, buy/sell agreements are becoming much more negotiated in the favor of the buyer. This includes much more financial assistance to the buyers, reductions in valuations for the firm for internal transition, and less-restrictive non-compete clauses.

The other thing firms are doing in the good economy right now is finding ways to maximize profits, and then increase the distribution to the owners as much as possible. If you can absorb the discount to keep the firm independent and give it to the next generation—and you can sell it at a value they are willing to accept—that’s great.

Prior to that, however, the firm would have had to set up an “earnings club”(i.e. where as much profit as possible is distributed each year to the shareholders). You have to maximize that for a few years, and then hand it off to the next group of leaders. Maybe they are prepared to handle it or maybe it’s the death of your firm. You never know, but as the Baby Boomer, you have your money at that point. Firms interested in staying independent in this way need to begin planning at least 10 years in advance.

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Peopleneedtoactlikeownersfirst,andthenanESOPmightbeagoodsolution.Youcan’tdoitinreverse.

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…AND THEN THE PEOPLE-BASED SIDE OF THE EQUATIONWhile current Baby Boomers are looking to retire, few Gen Xers are ready to take over the reins. Because there’s not a lot of them, trying to transfer your firm to Gen Xers is going to be difficult. And if you are planning ten years down the road, you are thinking the following generation (i.e. Millennials). In fact, front-edge Millennials are now just coming into the heart of their careers where they can really push a business forward. And so the question arises, how do Millennials view A/E firm ownership? What are their reactions when approached with such offer?

There are no simple answers to these questions as Millennials come to the work place with completely different expectations than today’s retiring Baby Boomers. There are a lot of Baby Boomers who started and own A/E firms and need to transition out. Yet, they are having difficulties finding Millennials that want to step up and take over.

MillennialsValueWork-LifeBalanceOne of the biggest challenges has to do with the value Millennials consign to work-life balance. As a result, they often show a resistance to the owner/partnership track,

which has been a core part of our business forever. It took time to figure out why, but this dilemma can be attributed to nothing less than the overprotective and goal-oriented parenting received by this younger generation.

If you think about it, when they were babies, their parents were trying to get them into a great kindergarten, so they could get off to a good start. In elementary school, they were told, “If you work really hard, you’ll get into all the advanced programs in high school. And if you take all these advanced courses in high school, and do all these extracurricular activities, then you’ll get into a great college.”And when they get into a great college, they are told if they work hard, get great grades, and

TherearealotofBabyBoomerswhostartedandownA/Efirmsandneedtotransitionout.Yet,theyarehavingdifficultiesfindingMillennialsthatwanttostepupandtakeover.

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do lots of extra-curricular activities, then they will get a great job. And finally, they come into our firms, and are told, “If you work hard and sacrifice for twenty years, you can be a partner just like me, and you’ll be set.” Their response is “I think I heard this story before, and I don’t buy it anymore.”

The other problem is that Boomers do a terrible job selling firm ownership. Millennials look at the Boomers with dark circles under their eyes, stress lines everywhere, and families falling apart, because they are not spending enough time at home. And so the Millennials say, “I don’t know if I really want that life.”

MillennialsAreRiskAverseFurthermore, any idea of loyalty to an employer was broken in their parent’s generation, where there were massive layoffs in the Great Recession. So Millennials don’t buy the idea that “if I put my head down and work hard for an employer, they will take care of me for the rest of my life.” They think it’s a lie.

There are a lot of forces working against Millennial’s interest in firm ownership. In addition to distrust in the process and an aversion to sacrifice, there is also the financial element. A core of Millennials graduated from college during the Great Recession, so they are risk averse when it comes to investment.

For one, Millennials are disproportionately not in the stock market. Also, their debt load is very high due to student loans. So when you ask them to take ownership of a business, and buy in, they just don’t have the financial wherewith all. If it’s going to happen, firm leaders need to come up with a smart plan to transfer ownership over time.

MillennialsNeedLeadershipTrainingWhile financial help can make it easier for Millennials to move toward ownership, successful transition cannot happen if firms do not engage in training their future leaders. That means identifying stars early in their careers by putting them in situations where they have the opportunity to thrive. Here are some guidelines to help you maximize the generational forces in your firm as you start to move toward ownership transition:

WhilefinancialhelpcanmakeiteasierforMillennialstomovetowardownership,successfultransitioncannothappeniffirmsdonotengageintrainingtheirfutureleaders.

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1.CalluponBoomerstoresumetheiryouthfulroleaschangeleaders.Now is the time to abandon hierarchical norms, sink-or-swim management, and one-size-fits-all career paths.

2.PrepareGenXersforsupervisoryresponsibilityandleadershiproles. Gen Xers are now entering their prime working years in short supply and full of attitude. Xers want status, authority, and rewards, but often resist traditional management roles. Create new paths to leadership, redesign leadership roles, and develop the new generation of leaders for those roles.

3.AcceleratetheprofessionaldevelopmentofMillennialemployees. Recruit new employees at younger ages, get them up to speed faster, and trust them with important roles involving critical tasks and responsibilities. There’s no choice; there won’t be enough older experienced workers to get all the work done. Teach managers to coach these seemingly high-maintenance younger workers through every step.

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Also, Millennials are an impatient generation when it comes to advancement. They feel that after a few years out of school they should be the CEO of the company. So there needs be a lot of interim steps in their career advancement. It’s too long to say, “You will get there in five years.”

Emerging leaders not only need to understand technical skills, but also how the business works and the leadership skills they are going to need to be successful. It is essential to have a leadership development program that is formalized within your organization. By doing so, firms encourage their best stars to stay by investing in them. They also attract potential stars who want that type of training. Since very few firms are doing this, it is a powerful recruiting and retention tool.

Millennialsareanimpatientgenerationwhenitcomestoadvancement.TheyfeelthatafterafewyearsoutofschooltheyshouldbetheCEOofthecompany.

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MillennialsWanttoSeeaCareerPathAnd finally, firms need to develop a realistic and well-thought out ownership transition plan. It takes ten years to do an ownership transition right—with people selling out and people buying in—and everyone happy with how it works out. So it is very important that the generation that wants to sell out have realistic expectations on the age that they will exit.

Among firm owners all over North America, the consistent theme is “I am going to retire in five years.” And five years from now, they are still going to retire in five years. That drives Millennials nuts.

If you want to do an ownership transition, the right time to do it is around social security retirement age. That’s the time to step back and let other people step up. It is those folks in their 30s and 40s who are going to have the passion to really move your firm forward into the future.

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PART THREE: NEXT STEPS TO OWNERSHIP TRANSITION SUCCESSOWNERSHIP TRANSITION PROBLEMS TO AVOIDIn many cases, firm owners wait until it was too late to create a plan. Requirements for a smooth transition have not been considered as part of the firm’s on-going business planning. As a result, a number of problems arise. These generally fall into four categories:

1.Leadership.The owner has been so busy managing the firm and making all the decisions, that he hasn’t spent enough time or thought to develop the people who should be ready to take over as he prepares to retire. The most serious problems are leadership problems, not ownership problems.

2.Financing. The owner approaching retirement still owns a large percentage of the stock. There aren’t enough buyers in the firm with the resources to buy him out. The firm hasn’t been funding the transition over a period of time: Younger employees are not likely to have the independent resources to purchase the firm because the younger people have not been investing in the firm and have other financial commitments.

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3.Valuation. Without careful study and firm data, many owners vastly overestimate the market value of their firm.

4.Outdatedbuy/sellagreements.Agreements should be reviewed every two or three years, partly because circumstances change but especially because tax laws change.

SUCCESSFUL OWNERSHIP TRANSITIONS SHARE THE FOLLOWING ATTRIBUTES: 1. Futureleadershaveatleastfiveyears’management experience before they assume leadership.

2. The transition plan has been in operation for several years before the owner’s retirement (ideally, ten to fifteenyears).

3. Everyone understands what is expected of him or her before, during and after the transition.

4. An up-to-date buy/sell agreement is in place.

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HOW TO PREPARE FOR THE TRANSITION • Start early.

• Create a vision statement early, along with strategies for implementation and corporate value. Make sure the behavior of leadership conforms.

• Study the valuation process early.

• Talk with other CEOs who have done it first, and collect lots of information. Get good advice from five sources: peers, management consultants, attorneys, accountants and insurance counselors.

• Decide what your personal goals and objectives are before entering ownership transition, including what you want financially out of the firm (retirement account, supplement your estate, etc.)

• Decide what you want to do after you leave the firm.

• It’s easier to go to something than to simply leave something behind.

• Don’t engage attorneys and consultants too early in the process.

• Continue to dream and vision the future.

FINANCIAL ISSUES TO CONSIDER• Make your transition is on a solid financial footing.

• Sell in small increments over time.

• Require some payment directly from the candidate.

• Don’t give it away.

• Don’t make an offer until you get things together (buy/ sell agreement, valuation, etc.)

• In setting the stock valuation formula, look at both your leaving and other shareholders leaving.

• Keep the sale and valuation as simple as possible.

• Be careful with disability clauses and insurance clauses.

• Be sure owners clearly understand the details of the buy/sell agreement.

• Don’t trust lawyers to develop documents alone.

WHAT YOU SHOULD REALLY EXPECT FROM THIS ROUNDTABLE:PSMJ’s Ownership & Leadership Transition Roundtable takes a complex process and simplifies it into clear steps you can implement while running your business. A solid understanding of how the process works brings with it greater confidence, efficiency, and value.

Our experts walk you through the Ownership & Leadership Transition process step-by-step. We help you take action to getting your own process underway with maximum efficiency and best return on effort. Many of our attendees come away saying “We didn’t know what we didn’t know until we came to this program, but now that we know, it is clear what we need to do.”

A huge benefit from attending this Roundtable comes from the opportunity to talk candidly with your peers about how they may have approached this aspect of their business. Too often, firm owners procrastinate or fail to act quickly on the pressing issue of transition, sometimes ending in painful outcomes.

PSMJ HAS BEEN ADDRESSING OWNERSHIP & LEADERSHIP TRANSITION ISSUES FOR OVER 40 YEARSPSMJ’s Ownership & Leadership Transition Roundtable is designed for the leaders of today’s A/E/C firms who want to realize the value of their firms upon retirement. Together, we walk through a structured, logical approach to developing practical planning tools for your firm’s transition planning. This Roundtable helps you understand and design a transition process to deal with this increasingly complex challenge.

A unique opportunity for A/E/C firm leaders to dig deep into the thorny issues that get too many ownership and leadership transition plans into trouble.

OWNERSHIP & LEADERSHIP TRANSITION ROUNDTABLE

“This Roundtable really addresses the future of the firm. Attend early—not too late.” Lindsey Henry, President - Midwest Environment

“Very useful. Use of case studies really helps drive the points home.” Robert Walker, President - Walker & Associates

“Excellent program! Very comprehensive overview with lots of real world examples.” R. Von Beougher, President - G&A Consultants

“Excellent presentation, very useful.” Travis Trent, Principal - Fullerum Environment

A/E/COLT2016

CALL: (617) 965-0055

E-MAIL: education@psmj.com

VISIT: http://store.psmj.com/a-e-c-ownership-and-leader-ship-transition-roundtable/

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