619: The Ugly Truth About Succession Planning: What No One Tells Firm Owners with Phillip Ross of Anchin | Otter.ai

619: The Ugly Truth About Succession Planning: What No One Tells Firm Owners with Phillip Ross of Anchin

Enoch Sears54min

Speaker 1

00:00

It may not necessarily always be the amount that you want that's as important, but what your terms are. Hello and welcome

Rion Willard

00:06

to the Business of Architecture. I'm your host. Ryan Willard, and today we're thrilled to welcome a true powerhouse in the world of accounting and financial strategy for the built environment. Philip Ross CPA. CGMA is a partner of Anchin and the practice leader of the firm's architecture, engineering and construction industry groups with a client base that spans from fast growing disruptors to established leaders in construction, architecture and engineering and development, Philip as at the forefront of helping firms achieve their financial and business goals. Over his illustrious career, Philip has guided many firms through the complexity of securing financing, navigating mergers and acquisitions, crafting tax strategies, planning for succession and even restructuring for greater impact, a sought after speaker for many major banks and financial institutions. Philip is also a trusted advisor to industry organizations across the tri state area, and if that wasn't enough, he's been recognized as a top industry leader by Crain's New York and New York build, among others. Philip is deeply embedded in the industry, serving on the CFO committee for the American Council of Engineering Companies, engaging with the New York Building Congress and working closely with organizations like the subcontractors Trade Association and the American Institute of Architects New York chapter. We'll dive into his insights on financial strategies in today's episode. We'll be looking at industry trends, and we'll also be looking very detailed at how companies go through planning for succession. We'll be looking at how a company, an architecture practice, gets valued, the sorts of things that companies need to be identifying with the new leadership. And we'll also be discussing the sorts of things that make an architecture firm more valuable. So for those of you who are planning your succession, this will not be an episode that you want to miss. So sit back, relax and enjoy. Philip Ross, this episode is sponsored by Smart practice, business of architecture's flagship program to help you structure your firm for freedom, fulfillment and financial profit. If you want access for our free training on how to do this, please visit smart practice method.com or if you want to speak directly to one of our advisors about how he might be able to help you, please follow the link in the information. It's time to announce this month's 203 100 club. If you missed our episode on the 200 club, listen to boa Episode 485 to learn more about this new initiative for benchmarking small firm performance. So a big congratulations to our 200 club members. Firstly, we have arini, Adams, Ramiro, Torres, Julia Aria, Philip Liang and Sean kaki. We've got Yogesh Mistry, Brad Smith Andrea nemecech, Brad Hubble and Suzanne Daly Gilbert Atik, Ryan Smith and George iguirres and our 300 club members, that means a whopping $300,000 per full time equivalent employee. We have Drew and Justin Tyndall, George catran, Christopher Rawlings and Christopher Brandon, great job to all our 203 100 club members this month. Keep it up. We are looking for architect developer stories for the Business of Architecture podcast. So are you an architect developer with valuable insights to share? We're always on the lookout for passionate voices in the industry to join us on the Business of Architecture podcast. If you're ready to share your journey, lessons, strategies with our global audience, we'd love to hear from you reach out to us to explore being a guest on our show and help inspire other architect developers on their path. We'd be interested in hearing your story, whether you're at the very beginning of your development story, or whether you have $100 million portfolio of projects already in the bag, completed. We'd like to hear from you if you're working with the developers, or that you've developed a number of small houses, or you're working at a larger scale. Philip, Welcome to the Business of Architecture. How are you I'm

Speaker 1

04:23

good. I'm good. Really happy to be here. And how are you doing? I'm

Rion Willard

04:27

very well. Thank you. So I'm very excited to be speaking with you. You're a CPA and the accounting and audit partner at Anchin, and you serve as the CO Practice Leader of the firm's architecture and engineering and construction industry groups, and you've been involved in helping companies grow. You've worked with well established companies in construction, architecture, engineering, and you also have done a lot of work helping companies with their succession planning and the kind of. Financial things that an organization needs to be considering the leadership transition, and just being able to responsibly plan for that in a fiscal manner has been one of your expertise. So welcome to the show. And perhaps we could just jump in with a little bit about your career and how you got to being the audit partner of ancient and where you're at now. And then we can talk a little bit about succession planning.

Speaker 1

05:24

Sure, sure. Well, listen, I started at ancient out of college, and probably within my first two years, I started to work on some construction, some architecture engineering clients. And just thought it was fascinating, you know, to be able to see something that isn't built yet, to start to be planned, to start, could be developed, to be worked on, to see the different levels of work going on, to me, was just much, much more interesting than any other industry. So in addition to understanding all the accounting tax and business sides of it, I also appreciated what the all the professionals were doing inside of the industries over there. And I just thought it was, you know, really great. I really enjoyed everything. And if you enjoy what you do, it really doesn't make it seem like work. And then at ancient we really look to do a lot of things for our clients. Look to be more than just their accountants. We really try to be their their advisors. And we get involved in so many things, like succession planning for them and other business matters that you really, you really feel like you're really contributing to a client's success. All of that kind of rolled in to really, you know, help me to really find my path and also to enjoy what I'm doing. And based on that, I ended up becoming a partner there, and now I'm co practice leader for the firm's architecture engineering construction group, and I would say, probably spend for out of the time I spend on clients, probably half of my time is spent on consulting and advisory work, and not just on the normal accounting and tax work. Well, that's super important, but it just gives me a great sense of satisfaction to be able to help my clients in many different ways. So you're actually

Rion Willard

06:57

kind of taking more of a strategic position, as opposed to just doing the the the kind of the grind work of the accountant, if you like, and actually helping a kind of create a vision, financial vision for an organization, whether it's through mergers or acquisitions or succession planning, is it? That's that sort of thing?

Speaker 1

07:16

Yes, and each client situation is different. You know, some some clients have bigger clients will have additional people internally that can help with that. So we're we're working one way. Smaller clients may not have as many people internally. So we might work a different way we look to work. Whichever way works is best for the client.

Rion Willard

07:34

What kind of scale organization has your career typically focused on serving?

Speaker 1

07:40

I think that's a good thing about our firm, in that we're set up to handle many different size organizations. So we have, we have clients that do five to ten million we have clients that do hundreds of millions of dollars. So we really try to tailor our services and our contribution to the client based on their size and what they need. And we listen. We have a lot of clients who started a five to 10 million and now they're doing over $100 million so we really, we really enjoy that

Rion Willard

08:06

as well. And focusing on the AEC industry. What makes the AEC industry different from other businesses? What kinds of things do you have to and particularly with architecture, what are some of the sort of challenges that you see these businesses facing that you've had to be very attentive to.

Speaker 1

08:26

So as far as my own opinion is, I think you could judge the economy by how the AEC industries are functioning. So if you have projects being built, you'll have a lot of people working, if you have a lot of people working, then all the businesses that around those, those job sites, etc, they're going to be doing well, in addition to that, you know, and if, and it also helps that if, if there's construction going on, it means architects were designing plans, engineers were designing systems. You have construction companies that are doing the work. You have, you have a lot of teamwork between those three industries as well. In addition to inside the industry, we host an A and E advisory board roundtable every quarter, and it's really great. We get about 30 to 40 C suite level people from various size and types of A and E firms, and they're very open in what they're dealing with. They're very open in with someone else has a situation that they're that they're dealing with suggestions what they've done before. So I think that's that's really good, because you could be competing with another A or E Firm today on a project, but tomorrow you could be working together with them on another project. So I think that kind of distinguishes it. But if we just take a look, whenever the economy has been been doing well, our AEC clients are doing well, and whenever the economy hasn't been then it definitely affects them. So I think they were really good barometer there. And then also handling a, e and c, we know when the A's are busy, you know it's going to get to the ease, and then to the seas as well over there, it's that definitely a good a good combination. Should have industries

Rion Willard

10:00

to work with. Yeah, and that's quite a nice overview as well. Actually being able to see the relationship between the three and particularly kind of Architects Engineers, and how that kind of relates back to the construction organizations, the architects and engineers I can conceptualize as being more similar in terms of their services and their organization as a business than construction companies, is that, right? It's a construction company kind of a lot more complex than, let's say, an architecture firm. Or

Speaker 1

10:27

I think some of it in general, that could be, I think some of it depends on the type of businesses that they're involved with. You're right, the A and E firms are not getting into as much of the direct labor and some of the actual manual labor over there, but they're still dealing with the issues they're dealing with. You know, if a project is delayed then and the award is delayed, then the architects are starting later. The engineers are starting later over there, I guess the architects and engineers are spending probably their time differently than the construction companies are. The construction companies are spending a lot of time theoretically, throughout or depending on what type of construction you're in, you might be in, doing the work on a building earlier than some others, or later than some others. With a and e, they're probably spending a larger percentage of their time on a project in the first half rather than the second half of the project. Construction companies could really vary that way. So it really depends.

Rion Willard

11:22

Do you see a lot of architecture firms or any of your clients kind of opening up and becoming design build organizations, so they're doing both, or the other way around? Construction companies opening up Engineering and Architecture departments inside

Speaker 1

11:36

some of them have have looked at it, and some of them experimented with it, it's, it's, it's, listen, you are you're really good an expert at what you're good an expert at. If you're going to do something like that, then you need to bring in other people who are good and expert at it as well. You know, one of one of my clients who did have, at one point, tried a Construction Group and everything, they were very happy that they tried it. They were also very happy when they realized it wasn't working the way that they wanted to. They were able to efficiently close it down and, you know, obviously continue and they they never lost their focus on their main business. Yeah,

Rion Willard

12:13

no, it's interesting, because I've seen a number of architects that they they have the aspiration of opening up like a construction department and, and there's a kind of, quite a range of that being done successfully, and kind of example as well people doing it one project, and they're like, You know what? I've had enough of that. That's, that's a whole another level of complexity and and trouble. It's, we will stick to our main core service. We

Speaker 1

12:41

do see, we do see some that try to align themselves with either with a construction company, and maybe they could do a potential joint venture or join bid for design build over there. But we really haven't seen that many. They're really looking to really go full force into being design build and having that all in house. Great.

Rion Willard

13:01

So let's, let's talk a little bit about succession planning in architecture firms. And we're seeing an enormous amount of this at the moment, so it's a very kind of pertinent and interesting topic in the industry, I suspect because of kind of the generational wealth transfer that we were hearing about, where lots of senior architects are deciding to step down, hand over their businesses to the next level of leadership, or even sell their firms or being be acquired by other architecture firms. From your perspective, how would you describe successful succession planning? What is it and what does it look like.

Speaker 1

13:41

Succession Planning is just like any major project that an architect firm has. It's something that you need to think about, you need to plan for. You need to have a lot of time involved and devoted to it in order to make it successful. So succession planning really is something that well before the the the the owners get to an age where they think that they may want to sell or step down, they really have to start thinking about it. We typically think, and I know it's going to sound like a very long time, but we think it's, it's probably close to a five year process, right? It's close to a five year process between starting to think about it, doing some investigation, consulting with advisors, looking at different options all while you're running your business at the same time, and then, and then, there's a lot of different intermediate milestones that go along with it, as to you judge something and maybe it works, maybe it doesn't work, and you have the ability to change your mind. So really successful succession planning is something you have to make sure you leave and you give enough time to you think about it early enough, because if you don't think about early enough, then you may not have all the options if you're thinking about it when you're too close to having to make that decision over there.

Rion Willard

14:54

So what's the what's the goal of succession planning for a practice owner? Let's say. Okay, what are they looking to do? What do they want from it?

Speaker 1

15:03

Yeah, listen, every owner can be different. You know what? What are the goals you want? You want to make sure that financially, that it's rewarding for you. You want to make sure some may want to make sure their employees are taken care of. Some may want to show there's a legacy for themselves that that's carrying on. Some may want to make sure there's still a role for them in the business going forward. Some may be, I've, you know, I've worked 4050, years already, 60 years. And, you know, I'm, I'm done, and they want to accomplish, you know, some of those and not necessarily be involved in the companies. It's really different. The key, the key for us is, is to get our clients to understand what they really want to accomplish, what what do they want out of it, and once they understand what they want out of it. And it's tough, because this is, this is one of the biggest decisions that they'll ever make, and it's not something that comes naturally to any business owner. Doesn't matter which industry you're in, to deal with this is not always the easiest thing. So it's going to, it takes more time, so there's a lot of conversations so that the owner can understand what the options could be. And if you choose Option A, does that cut off option B? Or can you explore all them together? So it, it's, it's definitely different. But this is a huge, huge decision, and something that they need to make sure they take the right amount of time for

Rion Willard

16:22

Yeah, and obviously emotionally as well. In many cases, it's like, this is my baby. And absolutely, the future of it here is that is at stake. Do you ever see people just wanting to close the business up? Wrap Up? Is that?

Speaker 1

16:38

You know, that's a very good question. During COVID, there were some people that didn't have didn't have a choice necessarily. Now, maybe business wasn't doing well, maybe people were not necessarily happy. Maybe they didn't have the next future leadership succession there, and when business really wasn't doing well, not saying they necessarily closed up shop, but maybe they had to just try to find someone who is interested in the business, and they probably receive a fraction of what the business could have been worth just because they were in that situation now. So I think COVID was a good lesson so that no firm wants to be in that position.

Rion Willard

17:14

So when should a business owner start thinking about succession? What are some of the milestones that are kind of indicators for them to start putting a succession plan in place.

Speaker 1

17:26

So in order, in order to do that, some of it depends on the size of the company. You know, our experience has been the large firms, they already have succession planning in place. If you get tweaked, it might get modified. There might be other suggestions, but they'll have it in place more often than not, the mid sized firms will also have it in place. And each one can be different. There can be different ways of buyouts and buy ins. It could be based on different formulas, etc, so and, and as I said, you could always tweak it. You could always look to make it better, etc. You could always change your mind, you know, depending you might decide, hey, we always wanted to have the next level of leadership buy in and continue in everything, and we'll and we'll mentor them some some people may decide, with all the money that might be out there, why don't we explore to see what we could get for selling the company? You know? So that's always, that's always on people's minds, to consider the options. Usually, the smaller firms are the ones that may not have thought it through, may not have come up with a plan that they think is right for them, or May, just emotionally, as you said, may not have wanted to deal with it. So for the ones who haven't dealt with it yet, I mean, you know, if your business is doing well, I would say you have to just think of how much longer you really would want to work. And you have to think of if, if, God forbid, something happened to you, who's there that could continue the firm, continue the work and preserve it, and that could factor in. I would say that if you and there's no there's no bright line, but if you have good people that are there, so that it's not as if, if something happened to you, the company is done, I'd say you really should, should, should think about it before you're 50 over there, because the other consideration is, if you do have good people, how do you incentivize them to stay they may you know when they're when they're in the younger in their careers, giving them compensation, extra compensation bonuses and different, different vehicles like that can keep them incentivized as they get to be more senior and as they get to be real, real good future leaders or current leaders. Being a part owner might be something that's going to incentivize them and keep them so you really want, you really want to see how you can use it for yourself, and how you could also use it for your really good people, to retain them, and also to make sure that they help to keep the business going, and they help the business to survive and hopefully to do even better

Rion Willard

19:50

so. So one of the things of why it's important to kind of take your time here is the identification of the right caliber of person to be taking over. For the business. And it's not uncommon that I speak to business owners, and they've been going, they've been in business for 30 plus years or so, and they're starting to think about succession planning, and then they're like, there's nobody, there's nobody in the office. There's nobody who who's got any interest in taking over the business. And what does that mean? Quite an interesting position to be in, because now it's like, okay, do they what are their options? Are they going to be looking to be acquired by another firm, or do they look to start hiring in that kind of leadership level with the with the intention of somebody taking it over? What sorts of strategies have you seen or advice would you give to business owners who feel like they haven't got a keen leadership internally? That's another

Speaker 1

20:40

really good question, and if you think about it, no matter, no matter what choice you make. So what are some of the choices that that a business owner, owners could have. They could sell to the outside. They could do an internal transition. They could merge with another company. They could do an ESOP. Or you now have PE firms that are coming in and they're looking to buy all or parts of of A and E firms over there. In any of those situations, the company is more valuable if you have good internal people, if you have good leadership, or future leadership coming up. So if you want to do an internal transition, you need to have those good people who will be able to keep the business thriving and keep the business profitable enough so that you will now be able to get paid if you do an ESOP. It's a similar type of an internal type transition over there. If you look to sell to to the outside, whether it's you're selling out to a another A E firm, or you're selling to PE the better your internal structure is, the better your future leadership, and the better the more confidence they have that the company's going to make money going forward. Then hopefully the higher price you can get, because the price is going to be based on what the company's made and is projected to make. And then even if you merge with someone, there's still some split above what piece of that merged company the owners get. So the more valuable your company is, then the bigger piece that you're going to get. So it's really important companies that are faced with the fact that they take a look and they say, I don't think I have the future leaders here. I think they have to consider at least a couple of options. Number one, maybe don't look to say, Okay, I don't have anybody here who's going to be me? Mm, hmm, maybe look to say, okay, person Person A has these characteristics, it would be great. Person B has these other characteristics, it would be great. And maybe you divide that up. Maybe you don't find that one person who's like you or like you and your and your fellow owners, but you find more people that have some of those characteristics. So you have to make sure that the team could be in place if you don't even see that, then one of the one of the options is then to either maybe find a smaller firm that maybe has some of those future leaders there, and you do a a merger in the meantime to help the succession planning right, or you can go out and try to find some laterals that you feel could be good future leaders, and you try to hire them from other firms over there. So either way, I think you want to, you want to understand that situation well before you need to make your decision. Yeah, what?

Rion Willard

23:15

What other sorts of attributes and qualities that a business owner should be looking for in the kind of next generation of leaders for their firm, I

Speaker 1

23:28

think they need to identify, you know, what's important to their business. So you have, you have business development and winning work, right? You have client relationships, you have getting the work done efficient, efficiently in technical expertise. We have the financial side of it, understanding of the business and everything over there. And then you also have people getting their place in the industry, becoming recognized, etc. Because becoming recognized that can help you to win work, or that can help you to get at least more bids and invitations to bid for work, versus if you're really not, if you're the best kept secret of a great architect, but nobody knows about you, it's going to be a little more difficult to win as much work.

Rion Willard

24:08

Yeah, it starts to paint a very interesting picture here that like actually the time it takes to find the right people and have them ready. The next part of the conversation is, how does the valuation? How do we start talking about a kind of financial payout for for the owner? How does it, how does a company get valued? And you kind of started to touch upon the things that make a company more valuable. But how does that process work? And how does a business owner start to engage with it?

Speaker 1

24:38

Sure, so, whether it's a business owner or whoever is going to be buying in typically you're you want to buy something that's going to make you money. You want to buy something in the long run that you feel you could get to make even more money, because then you just don't want to recover your money. You want to recover your money plus profits over there. So typically, they're going to use. Historical performance. And then they're going to use a look forward or projection of what the company is looking to do, or could be able to do over the next 123, to five years and that. And then they'll come up and base it with a value based on that companies can typically be valued, depending on their situation, between five to 10 times what you call EBITDA, that's earnings before interest, taxes, depreciation, amortization. So kind of like, really the normal operating elements of a business, a company that has maybe intangibles, maybe they're in a really hot market, maybe they're diversified enough that they have a number of different areas that could be very good. Maybe they'll get a higher multiple company that has really good internal people to carry on and to make the business even thrive even more, might get a little better multiple, a company that is very, very dependent on the one or two owners of the company who will not be there for a long, long time, they may get a little Lower multiple. So all of that goes into into the evaluation over there. The other item is, when you take a look at a company, there are, I'll call discretionary spending, there might be fringe benefits, there might be some extra, extra bonuses that are paid, or some other things that you might look to carve out to say, hey, we made X but realistically, if, if we were going to hire someone for this position, we would only pay half, you know, we don't paying them. You try to work that into a into a form, into a calculation, and kind of, maybe, maybe detail it as to how it would look with the new setup, whether it's the new owners, the new buyers, or or in an M and A transaction and model out what the future expenses and future operations would be to show what that would be normalized over there, there's definitely a lot of moving parts to it, and it is hard to predict which multiple you would get. I always suggest being conservative, because if you're really like the number at the conservative level, then if you can work to get a higher number, then you won't have any surprises that are going to disappoint you. If you look at us, let's look at the highest if you look at us, let's look at the highest number. Then if you and that's the number you need, then if you end up with a lower number, then it's you're not going to be satisfied.

Rion Willard

27:17

Is there more valuable ways of selling the company. So, for example, I could imagine a scenario with a business owner, and if they're looking to sell the company internally, and it's a group of kind of architects, and the architects, well, they might not be earning a huge amount of money anyway, and so their funds might be limited, and there might be some sort of deferred compensation buyout plan that the owner might end up lowering valuation, or there might be a lower price compared to what they might get from a completely external entity. And also, the other question would be say, like for an internal transition, are there two different parties doing valuations, one for the the owner, and one for the incoming leadership, or does it typically tend to be the same valuation process for the company, and they agree upon it.

Speaker 1

28:02

Those are a lot of good considerations that they have to think about. So as far as the internal transition, either you're going to do the internal transition because that's what's been agreed upon and everyone's signed on for it already, and that's sitting in either your stockholders agreement or your partnership agreement, or you feel it's more important to you for the company to continue, versus to be potentially absorbed into another company and not have that identity and not have your legacy, right? Typically, if you're doing an internal transition, there's usually the opportunity for the selling owners to stay on longer at the company, so they could have the possibility to get additional compensation, or salary or bonuses as staying on and maybe continuing to fulfill some of the functions they're already doing. And this way, it gives them that, that sense of accomplishment, because they're still there, they're still involved in the industry, and maybe they can recover some of the additional money, not all, but some additional money and having more years of compensation, or wages and bonuses, and maybe, and maybe they're only selling part of the company as well some internal transitions. It's not usually all or nothing, you know. It could be this, the owner is starting to sell over five years, you know. So they're selling over five years. They're still involved there, instead of selling all at once. But typically you would get a higher number from the outside. As far as the valuation, you know, it's important. Even though it's one company, there are different parties over there. So if there is a if there is a formula that's already laid out as to how it gets valued, then someone should be following that formula. If it's just you're engaging someone to do a valuation, then it doesn't always make sense to have two or three different valuations done. But if the selling owners aren't getting the valuation done, the buyers should have someone review that valuation, should ask questions, etc. And usually these are really just. Arm's length transactions. They're very open book. It's it's not where, at least from what I've seen, my clients are not trying to do anything and keep anything away from the new potential owners. So usually all very open, you know, but for two to get two different valuations done, think it's better to get the one valuation and then have the other, other team engage someone to review it, raise questions, etc, and then if there really are some differences and some things that may not make sense, you talk it through and everything, and you find a way to resolve it.

Rion Willard

30:32

And I suppose then there's so much kind of flexibility or adaptability to these sorts of plans. So like an owner can sell a company and be out within a couple of years. Or they can sell the company like you're talking about in they don't have to sell all of it. They can remain being an owner for much longer. They can be involved for a 10 year period. The PI out can be stretched over a longer period of time. I guess they just got to they've got to be clear on what their sort of plan is for their golden years. Let's call it of how they want to be doing them, how they're how they're kind of how they see the future of their work, career wrapping up, if you like, or take into the next phase, which are whatever the polite term Enoch is we use people's retirement nowadays. Yes,

Speaker 1

31:16

is that who's ever selling really needs to look at, depending on what that what that agreement is, you know what your cash flow is going to be, personally, and make sure that they comfortable they'll have enough cash flow. So when you do an internal transition, you're you're right. Usually the up and coming architects and the future leaders haven't accumulated wealth yet because they only have a lot of outside money to be able to pay towards this. So a lot of the funds for this will come from the fact that they become part owners, and now they're sharing in profits, and they're going to use the profits of the company to pay the selling owners. So sometimes that, if so, depending the amount that the selling owners feel that they that they can get, what evaluation merits, etc, it may not necessarily always be the amount that you want, that's as important, but what your terms are? How long? How long will you have to wait to get that paid? Is there any interest that's being paid on it, etc. So there's a, I'm sure you've heard it. There's a lot of things that are the arc to the deal. It's not necessarily always the number. Sometimes the terms are obviously just important as well.

Rion Willard

32:20

Yeah, and yeah. So it all kind of goes into a larger, kind of longer term plan for what the owner is is wanting, and also that it's interesting from the incoming internal leadership. Let's say that if it's a kind of deferred compensation, type of buyout, it's it's nice having the owner around, because they've got to have, they've got, they've got more, they've got a lot of skin in the game to keep to be selling a business that's maintains its profitability, and that the leaders, you know, make sure that they can maintain the profitability and just grow it so that actually the buyout becomes easier and easier with the growth of the firm.

Speaker 1

32:54

Yes, if you're doing an internal transition, there's all different ways to try to do it. You could just do it and say, Okay, at this point in time, I'm selling and I want you one to 10 people to be buying in. You could do that. That's fairly drastic. You could designate who your future leaders are, and you could do some type of deferred compensation plan with them, and maybe they're accumulating amounts in a deferred comp plan that they can then use towards buying ownership. The nice thing about that is they do have some money set aside, and sometimes you try to get them to have some skin in the game, so maybe there's a little extra deferred comp in there to help them with this. But maybe part of that deferred comp is also their normal bonus. It's this way, maybe they feel more involved, and they feel like they have to really work a little harder because they have some of the, some of their money in the game. And then what that also does is you don't always pick out everybody that's going to work out to be the future leader. So what if you do this over the course of 2345, years, you might see at the end of whatever period of time. You know, we picked out these four people. These three are doing fantastic. This one, this one doesn't seem to be someone who's really set to be a future owner. So that gives you also a little bit of a of an audition period for the future owners to see how they're how they're acting over there,

Rion Willard

34:18

right, right? I've seen, or I've come across a lot of family businesses in in the over the years, and I'm always intrigued with the with the succession plans, with family businesses, because there can unintentionally become another level of complexity and and sometimes there's the question of whether the business is inherited, let's say, or bought out. And sometimes there's a bit of a kind of a friction point there, and I've seen it on a number of occasions, where the the founders of the business kind of effectively retire, but then continue taking out a large salary from the firm, but they're not doing anything anymore. And then the the new owner, who is the the children who. Feel very well. They're in a they're in a different, bit of a difficult spot here, because they've they might not own their business totally themselves. They want to make sure that their families looked after, but it's also causing the business some some trouble, and there's often a reluctance to get outside consultants in to help. What's your advice with some of the complexities, and that's a very broad question, but the successfully transitioning like a family business, where the the children might be taking over the company, and from the parents perspective, they're they're often the argument might be something along the lines of, well, you know, when we die, you're going to inherit the business anyway, and but, but that has its own problems to it,

Speaker 1

35:43

family dynamics and and families, emotions and everything, are something that are have to be dealt with. They're not, obviously, always the easiest to deal with. We find them a little less in architecture firms, and the reason we find them a little less with architecture firms is because of the licensing requirements. So yes, if you're if you have one or two people, if you have two brothers owning an architecture firm, and obviously they're both licensed, and they have family who becomes licensed architects, then you can definitely have that issue. If your rest of the family, if the next generation, doesn't want to become architects, and they're limited that they really can't become owners, you know? So in that situation, you really, you really do need to consult with with consultants, because you really need someone. There's gotta be a reason why, whether the parents or the children are feeling or thinking the way that they do. Sometimes it comes it's just emotion. Sometimes it comes down to cash flow and money. Sometimes it comes down to maybe not having either faith in in in the parents not meddling in the business, or not having faith in the next generation being able to run the business. So one, if you get into what the real reasons are and everything, I'm not going to say it's going to be easy to resolve it, but you can definitely find ways to resolve it that interesting. Interesting. The parents also don't want to be short sighted, that if they're retaining ownership in a really successful business. Well, there's also the estate planning aspect as well, and I won't get into it, but the way the estate tax laws are now, they're more favorable today than they will be a year from now. You know today, today is part of the tax cuts and Jobs Act, going back to 2017 2018 they increase the estate exemption, the lifetime exemption to be approximately 14 to $15 million per person. So married couple, that could be 28, to $30 million right now, if nothing changes, that goes down to get cut in half. So depending on the parents, personal wealth situation, the value of the company, and everything you'd want to take advantage of something when you can, to minimize what that could be. And hopefully that estate issue isn't until far, far, far in the future. But just looking at just a another consideration, and hopefully those is those estate laws will change before we hit 2010 the higher exemption sunsets. But just another, another thing to take into account. Could you talk a little

Rion Willard

38:03

bit about ESOPs? Because this is, again, this is a becoming increasingly popular with forms of succession planner. What is an ESOP, and how does it work? And what are some of the advantages and what are some of the constraints

Speaker 1

38:18

ESOPs? It's just like another type of pension plan, it's an employee stock option plan, and it's become much more popular now because of the change in the for New York, at least the change in the New York state licensing requirements, which now allows ESOPs to become owners in an architecture engineering firm. So they're allowing it. You still have certain criteria to meet, but it's much easier to meet. So the ESOP is a type of an internal transition where you're basically now going out and based on employees achieving certain levels of longevity, etc, that you could have the firm owned by substantially all the employees. It gets a little more complicated, because you need financing to be able to buy the firm from the current owners. You could have a partial ESOP or full ESOPs. You could still have the current owners owning part of the company, not owning part of the company. An ESOP does come with the loan. Does come with extra interest costs, etc. But there are tax advantages that any money that's put into the ESOP by the company to make payments back to the owners or to pay the bank loan becomes a tax deduction, a pension deduction. So there are good tax attributes to it over there. There are some tax attributes that are beneficial for the sellers, that if they if they sell based on the company being a certain type of corporation, and that they don't access the money and they leave the money invested in certain types of investments that they can defer the gain and not recognize the gain, or pay tax on the proceeds, or control how much that they do pay that way. But an ESOP does come with a lot of you know it comes with the same issues you have for internal transition. You still need the good people internally. You need a great business. You do need. The future leaders. Lots of times the the selling owners will stay involved, and they could participate in the ESOP as well. So that's a little a little bit of a difference over there. And then you still need to incentivize people, you know, once you push a bunch of shares in and it gets allocated, you need to have people wanting to get more shares. You know, having mechanisms. How do they acquire more shares? How do they get incentive stock options and incentive warrants and things like that? But it's becoming much, much more popular. Typically, the ESOP will probably pay a higher amount for for a business than a regular internal transition, not a size if you sell to another 80 firm, and not as high as private equity, but would, would definitely be higher than the regular internal transition.

Rion Willard

40:49

When, when the stop has been completed, is there scope then for further buyouts, like, who? Who as that's what I don't fully understand, is that you've got, I understand that you've got a owner or a couple of owners, and then they sell the business effectively, to the entire company, to all the employees. But then what happens, does anybody has, any individual have the ability to have to be able to make that kind of wealth that the original owner made? Now that it's kind of more distributed,

Speaker 1

41:18

it becomes tougher to do that right? So what ends up happening is the owners sell into the ESOP, and then listen, there's more administrative burden with an ESOP. With an ESOP, typically you're going to need a financial statement audit. You may not have needed an audit before, maybe you did a review financial statement, but typically, because of it, you're going to need that. You need a trustee. A trustee has to be involved in protecting the interests of the ESOP, etc, over there. So there's more, more administrative burden there. The ESOP itself needs its own audit. You need a valuation every single year to value what the shares are, etc. But when the shares all get purchased, they don't all necessarily get allocated out to the participants, because if you, if you did that, and you get new people coming into the company, or new people being there long enough to now be eligible for the to participate in ESOP, you won't have any shares there. So you're going to, you're going to allocate shares to to to the employees based on some formula. A lot of the form is based on earnings. So typically, the higher earners, higher comp compensated people will get a bigger share. Um, you're going to also reserve some for future owners. You're going to reserve some for incentivizing people for accomplishing certain things, maybe with a bonus, and move a bonus over there. So the ESOP really is. It's its own entity. And then you have, then you have people who are members of the ESOP, kind of like when you participate in a pension plan over there. The only difference is, usually, in a pension plan, everything that goes in gets allocated to the people. Here, you're getting a value that goes in, but not all of it is necessarily allocated on day one to every one of the employees that are involved in the ESOP, I see.

Rion Willard

43:00

And so when people, let's say people, are part owners, and when they leave the company, do they get to sell their share back to the to the organization, or is there a kind of mechanism in place that means that? That means that you can't leave the company and retain ownership, your piece of retainership, ownership of the organization. That's correct.

Speaker 1

43:20

If you leave the company, then you can't keep ownership. Typically, that's usually the way that they're that they're drafted. And the ESOP itself is the one that would have to then pay you out. So the ESOP needs to have enough money in there. And sometimes ESOP gives a rollover feature. You could roll it over into another pension plan, potentially, or roll it over into an IRA. If you don't, then technically, it could be taxable to you at that point, and it would be taxable to you as ordinary income versus if you were an owner in a company, let's say a corporation, and you sold your stock, if you're selling it for more than you paid for it, then that would be more capital gain rates and ordinary income rates. So the ESOP does need to have ways, not only, of of getting getting funds to be able to pay the the selling owners, or to and or to pay the bank who financed it, but then to have funds in in the ESOP, to be able to pay out the owners, the people that are leaving, and lots of times, that's through a pension contribution that the company makes into the ESOP. And there's all types of calculations to do to see what a pension contribution could be, should be, and based on different options. So

Rion Willard

44:25

it's very interesting. So the the other two options that you mentioned here as well, one has obviously been being bought by a larger firm or another another company. What are some of the major considerations to make that work that you that an owner would be needing to look at.

Speaker 1

44:43

So you have to be attractive enough. And let's, let's deal with a small, a smaller firm now, versus a two big firms getting together is but you have to be make sure you you have something special enough that another larger firm would want. So whether it's the fact that you have just such a great reputation and one. Are two niches, whether it's the fact that you're in a geography that's seen as a hot area, and there's another large firm that isn't in there, you know, maybe there's a West Coast firm that doesn't have a presence on the East Coast, etc, you know. So you need something like that. And you also want to be able to show them that when you're not there, the firm's going to run very well. So that's another consideration there. Typically when those happen, you really have to valuations become very important, not that they're not important in other situations. But in some of those situations, there could be a combination of selling for for cash and also, and also selling for stock, you know, so sometimes that larger company wants to see you keep and some of the other shareholders keep skin in the game, and whether they, and if you would sell for $2 million maybe they want a piece of that $2 million to to not be paid to you, but you get an equivalent share of that in the equity of the new company over there, right? So there's a lot of considerations that way. So you have to see, well, what's the terms if I do that for me to then eventually sell in the future? Is it a one year or two year wait? Or am I handcuffed for five to 10 years? That depends, and some of that depends on if you're doing that, the age of your owners. Now, you might have five owners, and maybe two in your retirement age with the other three or not. So might be even more attractive to them to be part of a larger organization there, and if they feel that combined organization is going to be even more successful in the future, well, they not only are getting some cash, but then they have an investment that hopefully will grow as well going into the future. So all types of different considerations, if you are getting stock in or rollover equity in that in that future company. I think you also want to make sure how that stock is getting valued. Hopefully the valuation formulas are similar as to how they're valuing your company, as to how their stock is valued. So you and usually that's the case. You just want to make sure it's all black holes to apples and everything and but that's, that's a few extra considerations if you're merging slash selling to a larger company,

Rion Willard

47:08

right? Because, because they because that you could have your valuation of your organization that say, you know, $2 million or whatever, and then they say, Well, we're going to give you a million dollars worth of our stock. And you don't know what. You don't know what a million dollars of their stock is, is actually so you need to have someone sort of understanding that the the mechanism is equivalent. Yeah,

Speaker 1

47:29

you want to make sure this is, this is how you value my stock, and these are, these are multiples you used, and this is what you discount that we gave a premium to. So you will just want to make sure, okay, you're doing the same thing with your valuation, your team should be looking at that valuation also and giving you, giving you some giving you some recommendations, you know, because all you want to do is just be treated fairly. And typically, that's what we've seen

Rion Willard

47:55

so and then the final thing you mentioned was, was actually private equity firms now buying architecture, engineering and construction firms. And I find this quite interesting. And I mean, I've seen I had a couple of guys recently called Blue Water who were a a kind of Holdings Company that was specializing in just buying architecture firms and kind of taking private equity and purchasing firms in specialist sectors, and that had kind of high long term growth plans. And it actually really encourages me that private equity is available and is there, and is interested in architecture firms, because we've for so long been, you know, the industry hasn't really thought of itself as being, you know, a kind of a good business asset, but it's, but it is, what? What are the sorts of things to consider with a private equity acquisition, like, what? What does it mean to be acquired by private equity?

Speaker 1

48:50

So private equity, again, they've been getting involved in professional services firms more, and there's a, there's a business structure that they utilize, that that passes the test now. So that's why, because of that and being able to deal with ownership requirements, you're seeing private equity in there more and private equity looks for successful businesses that they can take and make even more successful, or that they could take and they could add on another 123, or however, many other businesses, and together they become more successful. Maybe they achieve synergies, etc. They reduce relative overhead. That's what they're looking for. So private equity, theoretically, is not necessarily looking to buy one, two, or however many firms and then just establish a legacy and be be in the A and E industry for 20, 3040, years. They're typically looking to do that, and they'll have a time frame as to, you know when they think they want to have their their exit strategy over there. In the meantime, they feel that they could take those firms and make them much more successful, so that if they paid $1 today in five or 10 years, hopefully they get $5 back at that point in time. So. So private equity is definitely an interesting option. Private Equity typically would pay close to the highest valuation for firm. Lots of times. If you are the the initial acquisition, you may potentially get a little higher valuation just because that's their foot in the door. Or again, if you have something special about your extra special about yourself. Every firm is special, but extra special that appeals to them. Then you might get a little higher multiple there. Private equity will be involved in running the business, but lots of times, they'll leave a lot, lot of the operational management to the current owners. So they're not necessarily looking to get to buy and have everybody out, they may decide that, you know what? We see, that these owners are really important. We see that these other one or two or three owners maybe are not as important, and we reduce overhead. So it may not be that everybody stays or everybody goes out, and private equity also, let's ask the question about you doing some rollover equity? About, we'll, we'll, we'll value the company at x. But out of that, we're only going to pay 50% 75% whatever that percentage is. And we want you to keep some skin in the game to help us build this to make this more successful. So it's a, it's it's a, definitely another option. And again, as we said, with the licensing requirements getting a little relaxed and clarified, it's definitely been an opening for PE to come into the to the AME space. Brilliant,

Rion Willard

51:31

amazing. I think that's perfect place for us to conclude the conversation, and that's been a brilliant dive into the world of succession planning for architecture firms. If a firm owner is listening to this and they want to get in contact with you, what would be the best way?

Speaker 1

51:48

Best way is they could contact you. Best way would be, they could reach out. They could take a look at ansion block and engine, go to www.anchon.com and just go to the A and E section. They'll see me there. If they want to reach out to me directly on my email address is Philip with two L's, P, H, I, L, L, i, p, dot Ross, R, o, s, s@ancient.com, and anyone that has any questions, etc, whether you're involved in succession planning now, whether you haven't considered yet you want to, or anything else involved in your In your architecture firm. Be happy to speak with you and be happy to help

Rion Willard

52:24

amazing, brilliant. Thank you so much, Philip. We put all those details into the information of the podcast. That was a real delight. Having your expertise shared like that so generously. So thank you so much, and thank

Speaker 1

52:35

you very much. I really appreciate the invitation. It's great to speak with you and to see you again and everything. I applaud you for what you do here and trying to help the industry. Thank

Unknown Speaker

52:46

you so much. Hey,

Enoch Sears

52:48

Enoch Sears here and I have a request, since you are a listener here of the Business of Architecture podcast, Ryan and I, we love putting this podcast together. We love sharing information as much as we can glean from all the other industries that we're a part of to bring it back, to empower you as an architect and a designer. One thing that helps us in our mission is the growth of this podcast, simply because it helps other architects stand for more of their value spreads the business information that we're sharing to empower architects together, so architects, designers, engineers, can really step into their greatness, whatever that looks like for each individual. And so here my my simple ask is for you to join us and be part of our community by doing the following, heading over to iTunes and leaving a review of the podcast. And as an expression of our sincere thanks, we would like to give you a free CEU course that can get you one professional development unit, but more importantly, we'll give you a very solid and firm foundation on your journey to becoming a profitable and thriving architect. So here's the process for that, after you leave us a review, send an email to support at businessof architecture.com let us know the username that you use to leave the review, and we will send you that free training. On the training, you'll discover what 99% of architecture firm owners wish they would have known 20 years ago.

Rion Willard

54:21

Hello, listeners. We hope you're enjoying our show. We love bringing you these insightful conversations, but we couldn't do it about the support of our amazing sponsors. If you're a business owner or know someone who would be an excellent fit for our audience, we'd love to hear from you. Partnering with us means your brand will reach over 40,000 engaged listeners each month. Interested in becoming a sponsor, please send us an email at support at businessof architecture.com the views expressed on this show by my guest do not represent those of the host and I make no representation. Promise, guarantee, pledge, warranty, contract, bond or commitment, except to help you be unstoppable. You.

00:0000:00