Lior Schnabel is a Co-Managing Partner at Precise, a company that provides financial management and control services for architectural and engineering firms across the USA and Europe.
If you were to ask an undergrad in Architecture or Civil Engineering, “Where do you see yourself in 15-20 years?”, the most ambitious students would say, “Owning my own practice.”
If you were to ask the owner of an architecture or engineering firm, “What do you wish will happen when you retire?”, the usual answer would be, “For someone to take over the firm and pay for my retirement.”
In both cases, a transition plan is the answer for these two wishes. The trick is to do it right, since transitioning in the architecture and engineering industry doesn’t always work out as planned – primarily due to misconceptions.
What is the purpose of a transition plan?
The four main reasons for a transition plan are:
- Retention of talent
- Increasing the motivation of the senior staff
- Retirement plan for the founding partners
- Continuity of the firm, after the retirement of the founding partners
The Poor Buyer Dilemma
One of the problems with formulating a transition plan for architecture and engineering firms is that often the buyer is an employee who does not have the available funds to buy shares directly. In that case, a more creative plan is necessary, for a “win-win” for all parties.
What is a “win-win” transition plan?
A “win-win” transition plan improves the profit and cash flow for both sides. How is that possible? Let’s have a look at the alternatives.
What would happen to the income of the owner without a transition plan, and what would happen to the firm without the owner? In the architecture or engineering industry, acquisitions are not commonplace. There are a few exceptions of course (the ones we hear about in the media) but, statistically, acquisitions of small/medium architecture or engineering firms are quite rare.
Therefore, a firm that does not have a transition plan in place will most likely see a decrease in income, and eventually compile losses until it shuts down or is given away for free. We need to remember that architecture or engineering firms are working on long-term projects, so the clients will love to see that the firm is not dependent on any one person and has continuity. Most clients would think twice before awarding a major project to a firm without continuity.
The transition plan we are suggesting looks more like a retirement plan than a “buyout” (although the numbers are similar), where the revenues and profits of the firm are used to pay for the retirement plan of the founding partners. We need to create a formula that ensures that the new partners are paying back the founders for the firm while, at the same time, sustaining (at least) the income level they had before becoming an owner.
When should you start thinking about a transition plan?
The sooner the better. A transition plan can take a few years to plan and execute, so it is better to get started as soon as possible. Once you identify a talent in the firm, and make sure they possess the right characteristics of becoming a partner you can start to prepare a path. Obviously, this is dependent on the performance and goal achievement of that person, but to plan the path in advance is highly recommended. A transition plan would make the employee more connected to the firm and more motivated.
Why not wait until just before retirement? It would be difficult to retain talented employees until then, and the reputation of the company might suffer (in terms of continuity) in the eyes of existing and future clients. Moreover, a good transition plan acts as an insurance policy in case something happens to the owner at any time.
What is a “phased” transition plan approach?
The right transition plan for architecture or engineering firms develops in stages. The best practice is to have a plan in place that continues to develop year over year.
The plan usually starts with a bonus connected to performance, followed by a profit-sharing scheme. For example, the plan can start with only those projects managed by the future partner, and then later develop into a firm-wide profit-sharing scheme.
The next phase would be minority shares in the firm, followed by the last phase — the buyout. The length of the plan is dependent on the specific situation. A common mistake is that the founding partners would like to sell their shares while they are still working. Bear in mind that to “sell” shares while still bringing in new business and managing the firm, is like giving the company away — while paying lots of taxes. It is crucial to consider every detail to ensure that the transition plan is really a win-win situation for all.
What are the tax implications?
Taxation is a big issue in a transition plan! The structure of the plan needs to be based on smart tax planning, or else the bulk of the payments will be going to the government. Another important point is that not all CPAs specialize in tax planning for a transition plan, so choose a CPA/tax attorney/consultant for the transition plan, that has experience and knowledge in this area.
A good transition plan benefits the founding partner, the future partner, and the firm. The trick is to do it right, by making sure it is a win-win plan.