2.1.2 Succession Planning

Transcription

1 2.1 Management of the Practice Succession Planning Canadian Handbook of Practice for Architects

2 2.1.2 Introduction Options for Succession Planning Dissolution of the Practice Sale of the Practice Merger Reapportioning of Ownership New Partners or Shareholders The Strategic Human Resources Planning Process Phase 1. Strategic Planning Phase 2. Development of the Talent Pool Phase 3. Selection and Transition Phase 4. Continuous Renewal The Issues Contingency Planning Review of Shareholder and Partnership Agreements Liability for Past Work Payment Valuation of the Practice Goodwill Definition References Checklist: Items for Consideration in a Buy/Sell Agreement

3 Succession Planning Chapter Volume 2 Succession Planning Introduction Principals of architectural firms often neglect or avoid thinking about what will happen to their practice after they retire or leave for other reasons. Planning for this transition commonly called succession planning is very important. Effective succession planning will: enable architects who own a firm to extend their practice beyond the span of their own careers; allow young, emerging architects to develop the skills necessary for future leadership; permit owners (of architectural firms) to obtain a financial return on their investment of money, energy, and commitment. Although of concern to all practices, succession planning is especially important for the many architects who practise in sole proprietorships and small firms. They often have few standby resources and, therefore, face the greatest risk of succession failure. Illustration 1: Timeline for Ownership Transition According to management expert Peter Drucker, the best way to predict the future is to create the future. Effective succession planning requires careful thought and an implementation strategy that can span up to ten years. A good start is to determine one s retirement goals and work backwards to the present. This notion seems elementary, but is complicated to put into practice. A comprehensive succession plan will: set out a transition strategy; present a profile of a buyer or buyers capable of taking over the architectural practice; establish the financing; determine the practice s value; deal with tax, legal, and professional liability insurance issues. Keep in mind the success test for succession planning: Can the departing architect s clients, staff, and legacy be entrusted to the hands of others without any decrease in the firm s level of professionalism and reputation? People may miss the founding architect personally, but they will still be well served if the successors ensure that the firm s professional standards are maintained. Strategic Plan Succession Plan Pre-ownership Orientation Transfer Ownership determine long-term goals develop leaders and managers train and coach/mentor consult as required adjust partnership or shareholder agreements make financial arrangements 10 ± years (before departure) 5 ± years 2 ± years 1 ± year Canadian Handbook of Practice for Architects January 2009

4 Volume 2 Chapter Succession Planning Options for Succession Planning This chapter describes five succession planning options. Each specific practice will have unique characteristics that will result in different chances of success, selling prices or firm valuation, and planning horizons. Actual outcomes will vary according to the size of the firm, and the effectiveness of the strategy and its execution. Dissolution of the Practice A disproportionate number of small firms dissolve upon the retirement of the principal architect. Although the dissolution of the practice may seem like a failure of succession planning, this option may be necessary in some situations, for example: death; illness; disability; divorce; shareholder or partner dispute; personal choice; bankruptcy. Contingency planning may reduce the need to resort to this option. Architects who choose to retire and dissolve the practice should: comply with all provincial regulations regarding withdrawal from practice; secure a policy for professional liability insurance coverage for retirement years. Contingency planning under this option should ensure that the practice s drawings and documents are not lost or destroyed, but retained. They can be transferred to: another architect; an archiving agency such as a university or a provincial or national archive; some other acceptable organization; a storage facility. Some provincial associations have regulations requiring retention of an architect s archives. Regardless of whether regulations exist, archives must be retained because of the varying statutes of limitations on an architect s liability (refer to Chapter 2.1.9, Risk Management and Professional Liability). Sale of the Practice The firm could be sold to an architect or architects outside the practice. It is common practice for the founders to be retained by the successors as advisors or consultants for a period of time to ensure a smooth transition for both the practice and ongoing projects. Advantages: may sustain the firm s legacy; may yield some financial return for the founding architect. Disadvantages: the seller is unlikely to have much influence over the firm s future style or philosophy; outside principals will usually pay less for the practice than will inside successors, due to the valuation of goodwill. Merger Merging the practice with another architect or firm may be a very good option if the founding architect is one to three years away from retirement and if there are no internal staff available or capable of sustaining the practice. This option is similar to selling the practice in that persons previously external to the firm will have managerial influence over the practice. A significant difference is that the retiring architect may retain greater influence over the future of the composite entity. However, mergers can fail for a wide variety of reasons, including: incompatiblity of corporate culture or style of practice (refer to Chapter 2.1.1, Organization of an Architectural Practice); incompatibility of software platforms, information technology systems and internal firm structures; diversion of resources away from architectural practice as a result of focusing solely on the merger; inadequate research or concealment of liabilities by one of the partners; redundant staff who are retained resulting in inefficiencies; or conversely, reductions to operations or personnel, thereby losing expertise and employee culture. When mergers are unsuccessful, the primary reason is that the two firms do not fit well together. Consequently, the architect 2 January 2009 Canadian Handbook of Practice for Architects

5 Succession Planning Chapter Volume 2 may wish to test the fit before finalizing a formal merger by first entering into a joint venture and/or strategic alliance. Ideally, the new firm will be greater than the sum of the parts, and able to increase its competitive position and market opportunities. Reapportioning of Ownership Ownership can be distributed in different proportions to existing partners or shareholders. This option is only available if the firm has other partners and shareholders who are prepared to buy the retiring principal s shares. In these situations: if the demand for the shares is high, the seller will usually be able to obtain a higher price under this option than through a sale or merger because internal buyers typically value the acquisition more than do external buyers; if all goes well, the sustainability of the practice is high especially if the existing partners are capable leaders. New Partners or Shareholders Inviting new architects or others to become part of an existing practice as partners or shareholders is another option, if the existing partners: are close to retirement; or want to develop younger talent. If executed well, this option has a good chance of success. The selling price will also be high, especially if the new shareholders have the cash resources to fund the transfer of ownership. A longer planning horizon is generally required to properly develop people from within the internal talent pool and to give the buyer more time to provide payment for the share transfer. The following illustration summarizes some of the differences between succession planning options. Illustration 2: Succession Planning Options Options Origin of Success Selling Planning Successor Probability Price Horizon Dissolve the 0-1 year practice Sell the practice external low low 1-2 years Merge the practice external medium medium 1-3 years with another firm & internal Reapportion internal medium/high high 1-5 years ownership among existing partners or shareholders Accept new internal high high 3-10 years partners or & external shareholders External means outside the architectural practice Internal means within the architectural practice Canadian Handbook of Practice for Architects January 2009

6 Volume 2 Chapter Succession Planning The Strategic Human Resources Planning Process Succession planning is most successful when leadership can be transferred gradually within the architectural practice. This process can take up to ten years of internal staff development time and encompasses the following four stages: Phase 1. Strategic Planning know the firm s culture because leadership begins with an understanding of the firm s values; develop a strategic plan, which is essential for the firm to effectively integrate business components such as: marketing; production; information technology; finance; human resources; realize that the strategic plan will provide a framework for more detailed human resource development. Phase 2. Development of the Talent Pool identify and communicate the measures that future leadership must take to maintain staff commitment and motivate people to achieve success; assess existing staff and acquire new talent in areas of deficiency; provide opportunities for leadership and crossfunctional experience; establish a meaningful performance evaluation system to monitor and foster ongoing development through: coaching; review; feedback on performance achievements and performance gaps; keep in mind that ownership is not an end in itself, but a way to give a financial incentive to the person identified as a major contributor to the firm; implement a continuing education program to nurture the acquisition of professional knowledge. within the firm, while others may leave and become informed competitors. While it may seem counterproductive to train potential competitors, remember that: the only thing worse than training your employees and losing them, is not training them and keeping them (Zig Ziglar). Phase 3. Selection and Transition select a successor or successors and monitor their ongoing development and performance; provide prospective successors with a transition period to management and ownership which involves: management training; leadership development; orientation before taking ownership; professional development to achieve the stature of a senior partner; the introduction of successors to clients and other external business contacts. Phase 4. Continuous Renewal relentlessly continue the process; watch for opportunities to use the experience and succession plans of the other owners (if any) to regularly facilitate a staged ownership transition upon successive retirements. It is healthy to continue with professional involvement after ownership transition/retirement through such activities as mentoring, community service, and committee work. The Issues Architects must consider a variety of specific issues during the succession planning process. Contingency Planning Such planning is important because it: allows for faster succession in case of unforeseen circumstances such as illness, disability, divorce or shareholder/partnership disputes; minimizes risk of failure by making the succession plan more flexible, and by building the talent pool. A common concern regarding staff education programs is that only a limited number of staff groomed for promotion will actually advance January 2009 Canadian Handbook of Practice for Architects

7 Succession Planning Chapter Volume 2 Review of Shareholder and Partnership Agreements When reviewing agreements, sellers should: seek professional accounting advice and legal counsel when drafting or amending shareholder/partnership agreements; ensure that agreements have a termination clause which addresses misfits or poor performers or those with a mental or physical incapacity; conduct a detailed regular review of the agreements with new/prospective owners to ensure the ongoing appropriateness and relevance of the agreements. Liability for Past Work Generally, the liability for past work stays with the practice, although some insurers or provincial jurisdictions may hold the original principal responsible. Thus, it is important to: verify whether individual protection against potential long-term liability exposure after succession should be maintained; seek professional counsel for guidance within a specific context and legal jurisdiction. Payment Keep in mind that: many prospective internal buyers may have a high personal debt load; buyers may encounter difficulties providing payment for the acquisition of shares during the succession period; it is a significant advantage for the practice to be highly profitable during this period, especially if buyers expect to finance the purchase from the practice s earnings through increased salaries or bonuses; the buy-in must be feasible and attractive to new principals; a sinking fund could assist the secondgeneration owners to buy-in and pay-out the first-generation founders. Valuation of the Practice The value of the practice may be estimated through: earnings capitalization; discounted net cash flow; excess assets; goodwill; a modified book value procedure that recognizes the economic worth of the firm (the net realizable value, or NRV) as opposed to an historic assessment based upon generally accepted accounting principles. In most cases, the firm s accounting records are an objective starting point to begin the process of determining the NRV. Sellers and purchasers should seek independent professional advice when estimating the value of the practice. Goodwill Goodwill is a subjective asset. Keep in mind that: intangible assets are difficult to evaluate; goodwill is often over-valued by the seller because of emotional considerations and under-valued by the buyers due to self-interest; the valuation gap between buyers and sellers is even more pronounced when the buyer is from outside the architectural practice; the valuation of specific intangible factors should be restricted to those assets whose utility can be transferred to other parties independent of the business and therefore have some hope of a value in exchange. Even for these, hard evidence should be available to justify the basis of valuation. (Skinner) Canadian Handbook of Practice for Architects January 2009

8 Volume 2 Chapter Succession Planning Definition Goodwill: The intangible element of the value of a business (including the worth of the architect s legacy, image, and client base) calculated as the amount by which the value for sale or investment exceeds the sum of net identifiable assets. This is sometimes measured as the current value of expected future earnings in excess of the return required for sale or investment, or calculated as a multiple of earnings performance averaged over a period of five or more previous years. References Barlow, Kenneth J. Internal Transfer of Ownership: A practical guide for consulting professionals. Clarkson, Ont.: Clarkson Publishing Ltd., Kogan, Raymond F., AIA. Strategic Planning for Design Firms. United States, 2007 Royal Architectural Institute of Canada (RAIC). Firm Valuation. RAIC Practice Builder. Ottawa, Ont.: RAIC. Skinner, Ross. Accounting Standards in Evolution. Toronto, Ont.: Holt, Rinehart and Winston of Canada, Stasiowski, Frank A. The Complete Guide to Ownership Transition. Newton, MA: PSMJ Resources, Inc., Stratem Consultants, Inc. Succession Planning Within Consulting Engineering Firms. Ottawa, Ont.: Association of Consulting Engineers of Canada, January 2009 Canadian Handbook of Practice for Architects

9 Succession Planning Chapter Volume 2 Checklist: Items for Consideration in a Buy/Sell Agreement Identification of Business and Payment Assets Land and Leases Inventory, Work In Progress (WIP), Supplies & Equipment, Goodwill, Contracts & Royalties, Accounts Receivable Liabilities Purchase Price, Deposit, Payment of Balance Cash, Shares, Earn-out Security for Payment Terms of Letter of Intent Securities and Other Regulations Securities Act Compliance and Exemptions Change of Control of Ownership Investment Canada Exemption, Notification or Reviewable Transaction (for foreign purchasers) Bulk Sales Act Requirements Provincial Architects Acts Pre-Closing Matters Insurance and Good Faith Operation of Business until Closing Preview and Seek Required Consents (e.g., from landlord, etc.) Right to Conduct Due Diligence Documents to be Delivered on Closing Independent Legal Advice Other Condition Precedents to Closing Tax Issues Allocation of Purchase Price GST or HST and Tax Rollovers Tax Filing on Deemed Year End Non-Resident Vendors Tax Certificate Land Transfer Tax Loss Carry Forwards and other Tax History Retail Sales Tax Representations and Warranties of Vendor and Due Diligence of Purchaser Employment and Consultant Agreements Employment Standards Employee Benefit and Pension Plans Environmental Matters Threatened or Pending Litigation or Outstanding Judgements No Other Purchase Agreements Outstanding Contractual and Regulatory Approvals Incorporating and/or Partnership Documents and Licences Compliance with Incorporating and/or Partnership Documents Financial Statements Partnership or Shareholder Agreement Indebtedness Commitments for Capital Expenditures Tax and Source Deductions and Remittances Restrictions on Doing Business Clients and Outstanding Agreements Good Standing of Agreements Affiliations and Joint Ventures Insurance Government Assistance Liens, Charges, and Title to Assets Construction Liens affecting the Practice Real and Intellectual Property Leases of Equipment Condition of Property and Equipment Status of Vendor, i.e., Bankruptcy, Citizenship, Arms Length Post-Closing Matters Non-Competition Continuing Employment Confidentiality Employees Restructuring Employment Release by Vendor Announcements Releases from Guarantees Indemnities and Set Off of Obligations Other Obligations Continuing After Closing The foregoing is a list of common concerns and clauses in agreements for the sale of a practice. The list is not exhaustive, will vary in individual circumstances, and cannot replace legal advice. Architects should consult a lawyer before negotiating or entering into such an agreement. Canadian Handbook of Practice for Architects January 2009 CH