Exit Planning for Architectural Firms
Most principals of architectural firms don’t think about their exit until it’s far too late.
You likely started your firm with a clear vision of the types of clients you hoped to work with and the type of work you wanted to do. You got into this because you love the process of bringing your creative visions to life, not so you could plod along a slow, methodical journey to build a business fit to sell and retire. Many architects who own their own firms postpone the issue of a succession plan for the far future. For young business owners, exit planning offers the opportunity to take a big step forward in building up their own independence.
Every business owner eventually leaves his or her business one way or another, so building a plan to exit the business long before you hope to do so is critical both to your firm and your personal goals. You’ll probably only do this once, so let’s do it right.
With a business sale, the buyer can benefit from an existing customer network and established work processes. Deciding to whom you should hand over your life’s work is not easy. You will naturally have many questions and doubts, which an exit plan can address. Give yourself plenty of time when looking for a successor, because a change of ownership is a lengthy process. Architects and engineers should think about this several years before the planned exit:
- What solution do you want for the succession plan?
- Is it possible to clarify the company succession within the workforce?
- Do you want to keep company shares (initially)?
What Is Exit Planning?
Exit planning is the development of a strategy by which a principal transfers ownership of his or her business to a new owner. Exit planning takes into account the entrepreneur’s objectives in terms of valuing the company, its employees, and its position in the market. It also considers personal aspects, such as the family context and the surrounding community. These factors are then put together to set up an action plan allowing the entrepreneur to achieve his or her professional and personal goals when he or she withdraws from the company.
This structured, detailed process helps you define when you plan to exit your business, how you’ll exit your business, the proceeds you’ll need to do so, and the steps required to get there. An experienced exit planning advisor usually leads this effort which ideally starts at least four to five years prior to an owner’s desire to transition.
Planning well in advance of an exit is especially critical for most architectural firms, as many are partnerships, and the external market for firms tends to be constrained and quite limited.
Reasons for an Exit Plan
Exit planning isn’t just for retiring entrepreneurs. We recommend that you implement an exit strategy several years ahead of schedule to maximize your chances of achieving all of your goals.
Significant reasons for entrepreneurs to implement an exit strategy include:
- Most businesses are built to maximize an owner’s profit today, but exit planning helps you understand how a potential buyer sees your company. Done correctly, an exit plan will help you build and run a better architectural practice with less dependence on you, less risk, more repeatability, and more operational rigor.
- It helps you understand what you’ll need financially to transition out of your business and helps you develop a plan to get there.
- It helps you plan for what comes next for you and for your employees after you leave the business.
Most Common Exit Practice in Architectural Firms
The most common method of selling architectural firms is a sale to a group of architects or an internal salaried architect. To hand over their business to their salaried architects, principals can execute a leveraged buy-out (LBO). This common and useful method for transferring ownership of a business consists of financing the transaction for the acquisition of the business via a bank loan. It is also defined as the takeover of an architectural firm using legal and financial leverage.
The different stages are as follows:
- The salaried architect(s) will create an architectural company (known as a ‘holding’ or ‘holding company’) by ensuring that they have a majority stake in the capital. (The rest of the capital can be provided by a bank, for example.)
- This holding will be responsible for acquiring the architectural firm to be purchased (known as the ‘target company’) by acquiring the majority or all of its capital. It pays using as little of its own funds as possible, mainly using the money from a bank loan.
- The financial charges of the debts contracted by the holding company will be paid via the inflow of dividends from the target company. The buyers are then able to acquire the target “thanks to its own resources.”
Key Steps to Exit Planning in an Architectural Firm
Identify when you want to exit. Perhaps your business was born out of a lifestyle choice, but your goals in 10 or 20 years may change. You may want to lead the company to future growth or you would like to hand it over to the next generation. This dynamic and its associated changes determine how you reduce business risks. Depending on your goal, you may want to take money out of the company first and step back from day-to-day operations before retiring for good. This is one way to secure your future family assets to a certain extent.
Succession decisions should ultimately be structured in such a way that they are compatible with your personal goals.
Establish baseline value. Evaluating a business is a complex exercise that requires technical support from professionals who know your industry. Evaluating an architectural firm means understanding its past, studying its present, and deducing its future developments. This assessment determines the value of the professional activity with regard to objective elements. These elements have to be determined from historical and forecasted financial data.
The price of an architectural firm, insofar as there is no organized market that defines a reference price, is essentially a function of the interest of the parties in the outcome of the operation. It is important to know the market value of your architecture business because if it’s lower than the market standard, steps must be taken to increase it in time to sell. Even if selling your business isn’t your preferred method of exit, it’s important to consider the value of the business when making your decision.
Execute the transition. The handover process is emotionally significant for both parties: one is letting go of a life’s professional work, and the other is starting a new professional life. When designing such a sensitive process, it makes sense to consult a management consultant to smooth the transition.
Critical Factors for Succession or Sale
The critical factors affecting business succession or selling a business are:
- Different asking prices. Just as the seller should not overvalue the business, the buyer should not undervalue it. Negotiations fail most often when both parties harbor significant differences regarding the company’s price. To prevent this, engage expert assistance in valuing the company.
- Emotion. The entrepreneur may find it too emotionally difficult to separate from the business.
- Lack of transparency and meaningful documents. Without comprehensible annual financial statements and current business accounts as well as important business documents (rental agreement, employment contracts), no serious sales negotiations can be conducted.
The transition to new management can only succeed if the seller and buyer agree. No matter how difficult this step may be for one side or the other, a positive climate for negotiation makes it easier to find a solution both sides can accept. A mutually agreed negotiation may result in the departing entrepreneur working for a limited time to introduce the customer to the successor. A slow exit from professional life may be a pleasant idea for some handlers.
Who Can Help Me?
Most principals work with a value creation consultant or exit planning advisor that specializes in working with architecture, engineering, or A/E firms to develop their value creation strategies and plan for their eventual exit. Some principals prefer to work with a local advisor.
Our advisors and accountants want to help you succeed in your profession as an architect. Therefore, we offer practical and concrete information directly applicable to maximizing the value of your firm with an eventual goal of selling it, whatever its size. Get in touch now to make the most out of your business before and when it’s sold!