Recently, we brought you the story of Nadel Architects ownership transition, as part of our continuing series on building and growing your business. We were intrigued by the process and wanted to get more details on the nuts and bolts of ownership transitions in general. We went right to the source: attorney Bill Mandel, who handled the ownership transition plan for Nadel Architects, and his partner Laura Terry Howard. At their San Francisco–based firm MBV Law, Mandel specializes in transition planning for architecture, engineering and design firms, including mergers and acquisitions and ownership transition programs, while Howard's practice area runs from addressing formation issues in the start-up phase to developing and implementing an exit strategy. Here, they give us more insight into a critical process in the life of a firm—when done right, it can mean thriving for decades to come.
What are some transition scenarios?
Laura Terry Howard: There are a number of choices one might have. You could sell the firm to an outside buyer or close the doors. Our experience is that selling to an outside buyer isn’t impossible, but it’s a different transaction to engineer and it’s not really common. The more viable alternative is to look around your organization and see who could be owners. Ownership transition doesn’t result in the absolute highest value to a selling owner, but over the lifetime of the program the owner will be well compensated. If you close the doors, you will get very little value. If you sell to someone outside, you’ll get a higher value but give up all control. Giving that up isn’t really appealing to a lot of people.
Bill Mandel: Of the merger-and-acquisition deals we’ve done, very few have been for architecture firms. Architecture firms aren’t as prone to being acquired, because their cultures are unique and, therefore, are hard to merge into another firm. Generally, architects are limited to doing an ownership transition program or closing the firm.
When do you start planning for an ownership transition?
Bill Mandel: Starting early is best—at least 10 years before a founder (owner) is ready to exit the firm. That gives time to identify candidates for ownership and bring them on board. There are often hits and misses. Sometimes candidates don't work out as owners, so you need time to regroup and find other people. You should start no less than five years before exiting, because you need time to craft a good transition program.
How do you identify future owners?
Bill Mandel: You look at the firm’s needs: do you need good marketers, good project managers, and/or good administrators? In all cases, candidates should have a sense of entrepreneurship and risk taking. Sometimes it’s difficult to identify the best candidates. We work with consultants who are well versed in evaluating candidates to get a good assessment. Founders are often not in a very good position to evaluate candidates, because they are too close to the candidates and aren't able to view them with objectivity.
We advise our clients to always look for new candidates. Keep your eyes open for the next generation. We had a case where a client only offered ownership to the most senior people. There were terrific people in the generation after and those folks walked out and formed their own firm, creating real competition for the firm they left.
Laura Terry Howard: It can be difficult to find people in the next generation that have all the qualifications and skills you may want. You may see a collective formed that will have the necessary skills.
Sometimes candidates won’t tell the founders what they really think about becoming an owner. The founders may believe they have three or four candidates ready to go, but the consultants might find they’re not interested in being owners.
What is involved with an ownership transition plan?
Bill Mandel: A direct ownership plan involves a sale of stock from the founders to candidates. The program establishes the value of the company, using a formula that will be applied for all future purchases and sales of the firm's stock. We tell our client founders that candidates are interested in the three "C's": Cost, Compensation and Control. How much will the ownership cost the candidate, what will their compensation be as owners and what kind of control will they have (a say in decision-making). We generally advise clients to start with a small amount of ownership and see how it works. If it works, you can sell more stock.
How do you pitch it to employees?
Bill Mandel: We develop the plan with the owners and then present it to the candidates. We find that our programs have a high degree of acceptance. You start off spending time with the founder going through the road map and putting together a term sheet. Then we sit down with the owner and candidates, discuss the term sheet with them and ask them to go off and talk to their attorneys, spouses and other advisers. And let us know if they want to proceed with the program Once the candidate has indicated a willingness to proceed, we will prepare the legal documents and meet with the candidates to review them. If a program has the right elements and is seen as affordable and beneficial, there is a high likelihood that the candidates will accept it. We also explain the obligations that candidates have to take on, so they understand the risk element in being owners. Rewards of being an owner rarely come without some risk.
Laura Terry Howard: One of the biggest challenges we often face is that we have to show founders that the price paid is going to be fair to them. It might not be as high as if the firm were sold to an outside buyer. They have to look at it objectively, look at the people buying in, recognizing they have other financial obligations—so it has to be affordable to candidates. If it’s not affordable, then no one will buy it. The other big challenge is control of the firm. When we talk to founders, they’ve been controlling their own destiny and aren’t used to giving up control. Ownership transition requires a frank discussion between founders and candidates about changes in leadership and governance after the buy-in.
What are the advantages of having a clearly delineated transition plan in place?
Bill Mandel: It provides for an orderly transition of ownership and leadership and allows the founder to have partners to share in the responsibilities of running the firm. It’s also an effective method of attracting and retaining key people. It also creates sustainability for the firm. Another benefit is that people who are being recruited for employment by more than one firm are likely to go with the one with an established ownership transition program.
Laura Terry Howard: It’s all about the talent and intellectual capital and keeping it within a firm.