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Stuck in Neutral – Today’s Ownership Transition Challenges, Trends, and Takeaways

Yes I’m stuck in the middle with you,
And I’m wondering what it is I should do,
It’s so hard to keep this smile from my face,
Losing control, yeah, I’m all over the place,
Clowns to the left of me, Jokers to the right,
Here I am, stuck in the middle with you.

 

“Stuck in the Middle with You” – Stealers Wheel (1972)

This fall will mark five years since the collapse of Lehman Brothers, AIG, and global stock markets, events which unofficially kicked off the “Great Recession.” For many A/E executives, it’s been an exhausting, unrelenting stretch, and a large number of organizations have still not fully recovered from the halcyon days of the mid-2000s.

Let’s stroll down memory lane. Broadly speaking, the early years of this tumultuous period, 2009 and 2010, were generally characterized by pure survivability. Design firms shrunk dramatically as they desperately reduced staff counts, slashed salaries and benefits, and shuttered offices and divisions.  Once considered “automatic,” backlogs started to slowly evaporate and timely cash flow and collections became more elusive. Hunker down. Live to fight another day.

Years 2011 and 2012 saw incremental improvements for many as executives learned to do “more with less,” adjust expectations to a fickle client and a tougher fee climate, and get aggressive on business development in a 1% growth world. Hiring picked up for those “right people” with the golden mix of technical and sales capabilities. Organizations focused on energy, power, industrial, mining or other niche markets came away unscathed as did others not directly tied to building or land development busts. We made it but where’s the recovery?

Alas, here we are in 2013.  As the dust has settled, A/E owners have adjusted to this new, nebulous climate. Many will privately admit the last few years have made their organizations tougher and more resilient to future challenges as staffs hung together despite tough headwinds. Time for a victory lap.

Unfortunately, for many leaders who put off, but are now contemplating options to internally transferring shares, these rudderless five years have made that endeavor much more challenging.  As a result, leaders are awakening to rudely discover it’s a much different ownership transition climate than it was a mere 6 or 7 years ago. Most common lament we hear – “We’re stuck!”

Based on dozens of executive discussions and client engagements, here are a few of the internal transition challenges and trends we are observing:

More leaders are incorporating ownership transition elements in their strategic planning engagements.

This time of year typically kicks off annual strategic planning and budget/forecast activities. A/E organizations spend a significant amount of time and resources developing strategic plans to help guide them and as yardsticks for performance. These plans typically address items such as which geographic markets or service lines to penetrate, expected client needs, and competitor moves and maneuvers. Traditionally, the strategic and ownership transition planning orbits rarely intersected as leaders compartmentalized them into discrete exercises. Not today. Clients are sharing with us that with more retirements on the horizon, there is a pressing need to address the strategy execution from a leadership void perspective. That means making sure their “bench” is growing with younger, motivated talent and effectively moving blocks of stock to that next generation so they’re not a flight risk. In addition, more strategic planning exercises are also incorporating detailed financial forecasts. This is to ensure that not only do A/E firms have the cash flow and capitalization to meet their overarching strategic objectives but also are prepared for looming stock redemption obligations in a coordinated manner.

Slow growth rates and low profit margins equate to less cash flow to fund ownership transitions. Today’s owners may have to prepare for a future environment of lower value and greater liquidity risk.

For a majority of A/E firms, dampened profitability and tepid growth remain realities. Shareholder returns haven’t reached similar levels to that of the mid-2000s, and this lack of buoyancy has been a double whammy for many owners. On one hand, both dividends (distributions) and capital appreciation have been stymied, and with profit levels down, firms have less ability to pay large bonuses to fund stock transactions. And on the other, liquidity risk has increased rapidly, with younger employees either incapable, or downright skittish, to buy-in due to their own challenged personal financial picture.

Demographic trends today mean more sellers, less buyers. 

To no one’s surprise, the 65-year-old+ demographic is expected to grow by nearly 50% by 2030, with broad societal and financial ramifications for our country. For many professional service businesses there are simply fewer individuals in Generation X ready and willing to buy out the larger pool of Baby Boomer shareholders ahead of them. You just can’t make the math work. And in some cases apathetic and disinterested younger staff members are compounding the problem. Unfortunately, the lack of organizational clarity can become downright paralyzing, and “kicking the can down the road” can seem more convenient and less threatening than tackling the problem early on.

Some A/E owners are attempting to address this by inviting certain “rising stars” from younger Generation Y to increase the buyer pool. Others realize they may receive less in value/proceeds from their organization than they planned or have to extend their note payment over additional years in order to be fully redeemed. For countless owners, they are simply delaying retirement.

Many firms are already burdened with obligations to separated shareholders.

Call this the A/E “sandwich generation.” There are many multi-generational firms in between buyouts that have significant former shareholder debts on the books that ultimately have to be met.  For some of these retired owners, their timing was sublime in that they sold out right before the industry (and their firm’s stock price) took a turn for the worse. In fact, the recession caused a number of distressed firms to go back to their retirees to significantly alter their payout terms (value and/or payment duration) for pure survivability!

Unfortunately, in a plodding industry environment, burdensome debt levels result in less cash available for raises, benefits, and bonuses; equipment and software investments; hiring, training and development; and funding future shareholders and ownership programs.

Many firms that were staunchly opposed to ESOPs in the past are now giving them a second look.

The popularity of Employee Stock Ownership Plans (ESOPs) waxes and wanes with economic cycles and tax laws, and we have found that some leaders love them and others don’t. Readers of our perspectives know we have addressed the pros and cons of ESOPs in the past. Basically, the plan needs to be melded with the right leadership team, firm size, growth prospects, and open book management philosophy to gain full benefits.

However, recent interactions with A/E executives, as well as industry tax and legal advisors, have indicated a renewed interest in this tool. Primarily because ESOPs create a much larger (and easier to manage) pool of potential owners than does a traditional direct buy-sell arrangement, thus enhancing liquidity for current owners. Others have observed that mid-sized firms which have been unable to sell to strategic buyers have reconsidered the ESOP. That being said, ESOPs can be cost prohibitive, and don’t fit with every firm culture, but we’ve noticed a marked increase for ESOP-related assessments and consulting.

More A/E firms are using advisors with ownership planning skills to act as a mediator, help diffuse emotions, and provide a range of alternatives and options to various constituencies.

The hands-on, solutions-focused mentality of A/E firms leads many executives to adopt a “do it yourself” approach to activities such as strategic planning, recruiting, marketing, and, even business valuation (much to our chagrin). The internal transition process however, is often a delicate negotiation exercise, with design professionals who work cohesively together all week,  finding themselves thrust into separate, antagonistic corners over terms and conditions. And as is true in cases of buyer vs. seller, these teams have similar, but essentially incompatible goals and objectives.

As a result, increasingly, A/E firms are relying on outside, expert advisors to either represent the interests of the firm as a whole with impartiality or advocate the goals and positions of respective buyer or seller groups. Advisors can often assist with creative solutions to entrenched positions, model and run future “what if” scenarios, and simply serve as a communication conduit while reducing the stress and tension that goes along with the process.

Developing the right plan for your firm can be a daunting task. The team at ROG+ Partners has more than four decades of combined experience working with companies in the A/E and environmental consulting industry to develop comprehensive ownership plans. Our approach to transition planning takes into consideration the needs of all the key constituents – current (selling) shareholders, future (buying) shareholders, and most importantly, the company itself. We consider all available tools and options with the goal of ensuring the long-term success of your company.

ConferencelogoRegister now! Join the leading industry experts and also leverage the experience of other A/E Leaders from all over the United States and Canada – and learn how they are handling these challenges.

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