Demystifying succession in a consulting engineering firm Make transitioning your equity a smooth and painless process
CONTENTS Succession is a complex process... 4 Traditional succession plans they may not be a viable option... 4 Management buyout versus external sale which works best for you?... 5 Management buyout (MBO)... 6 Steps to succession success... 7 Think opportunities, not limitations... 8 Contact information... 8
There s a real change in appetite among younger professionals. They want to do great things and seize the kinds of opportunities that go beyond salary, but they re not sure if they re ready for what that means they may not really know what that means. Clearly, part of addressing succession will be finding ways to better engage this group in the firm and its future. Brian Pearse, President, Opus Stewart Weir Engineering firms know that strong technical, operational and project risk management are critical to business success. Softer risks, however, such as those related to succession and exit planning, are rarely as well understood or effectively managed. The fact is, current consulting engineering demographics have made succession risk something firms should be looking at more closely. As economic conditions have changed over the past several decades, the number of engineers entering the profession and therefore of potential successors in Canadian firms has fluctuated significantly. There s a very real demographic distortion in the industry, notes Association of Consulting Engineering Companies Canada (ACEC) President and CEO John Gamble. As a result, there are many consulting engineers over 50 and many under 40, but comparatively few in the 40-50 age range. That gap may seem small, but it s a problem when you re looking for a successor. It makes the exit strategies of an entire generation more complicated than they probably anticipated. On top of this, continues Gamble, The generation of candidates who are available is more concerned than their predecessors with the time and financial commitment that ownership/leadership require. In other words, some are less interested in assuming full executive responsibility by purchasing the requisite, and often times expensive, shares. This generation also tends to be less loyal to one firm, often anticipating changing jobs and even career paths several times as they advance their careers while satisfying a growing range of personal aspirations not necessarily related to work. According to Gamble, The implications for succession are clear: when senior industry practitioners want to retire and take their equity with them, the traditional process of having a professional or professionals within the firm buy them out is becoming a challenge. Succession or implementing your exit strategy is difficult at the best of times, with a range of emotional and often family issues compounding the process. The added hurdle of extracting your equity in a straightforward manner can be an unnecessary source of stress in an already challenging time. To help you get a better handle on the options available, this paper looks at some of the challenges all professional services firms face; examines the pros and cons of management buyout versus external sale/ merger; and charts the key factors your firm should consider to improve your attractiveness for purchase (whether by an internal or an external buyer). Fortunately, engineering professionals on the cusp of retirement have options. As globalization has opened up increasingly large infrastructure projects that require correspondingly large engineering firms to handle them, merger & acquisition (M&A) activity among engineering firms is on the rise. This trend comes at an opportune time for exiting professionals, as selling to, or merging with, a larger firm becomes a viable alternative. On the other hand, if your firm currently has strong ownership, and succession is a few years away, it s important to develop an environment and culture where internal succession or a management buy-out remain viable options as well. This means having a succession plan and a strategy for engaging employees and building a sustainable succession pipeline. SUCCESSION PLANNING FOR ENGINEERING FIRMS 3
Succession is a complex process Traditional succession plans they may not be a viable option Generally speaking, succession planning is about the effective and smooth transition of your business and wealth, one you ve spent building the other accumulating your whole life. The trends we re seeing, suggests Kelly Kolke, National Leader, Professional Services, Grant Thornton LLP, consistently indicate that Canadian business owners are not preparing for the future as effectively as they could be, lacking both general long-term (five-years plus) business planning and strategy, as well as specific formal processes to support succession planning. Many owners prefer the traditional succession path, where shares are bought out by employees and junior partners who have risen through the ranks. Indeed, the simple prospect of selling the business to an outside concern can be so distressing for some owners that they will not even consider that option. With so many factors involved in determining a business successor, you simply can t put off the process or take it for granted. Even if your requirements are straightforward, planning and execution must be considered and those plans should be in place long before they come into play. Ideally, most firms prefer to nurture succession from within to best maintain firm values, culture and vision. A strong succession plan not only enables this strategy, it also provides an incentive for potential and eventual successors to perform at their best. Wilfrid Morin, former Vice President, exp 4 SUCCESSION PLANNING FOR ENGINEERING FIRMS Despite the consequences, owners too often wait for a triggering event, such as illness, divorce or death, to really begin succession planning. Instead, you should: create a succession plan early on and revisit it often, begin looking at internal succession candidates years before you anticipate succession, ensure a transparent communication process, especially when family is involved, assist internal candidates with preparing for the financial and other key considerations of being an owner, and prepare for post-succession issues by broadly training key staff in all aspects of the business. Another important factor to bear in mind is that there are two distinct components to business succession: succession of ownership (control) and succession of management (day-to-day business operations). Consider which one you re really looking to accomplish, or if it s both. You may want to sell the business but maintain a strong voice in management decisions. Conversely, you may want to maintain ownership but step back from the daily grind of management. Of course, many succession plans simply involve selling either shares or the whole business and applying your extracted capital to your retirement plans. Companies should share ownership with management and employees early on. The sense of ownership really encourages people to turn out the lights and align employee behaviour with firm success. It s a great way to begin building loyalty without fully ceding control. Wilfrid Morin, former Vice President, exp
Management buyout versus external sale which works best for you? Typically, a consulting engineering firm will have an internal succession plan in place outlining a mechanism for retiring partners to leave the practice and extract their capital. This has the advantage of continuity of vision and culture, offering the retiring partner a sense of confidence that the business will run with the same values and goals as in the past. However, when this is not possible, two other options are available: either the owners begin looking for a desirable company to merge with or to purchase the firm, or sometimes the current management team initiates a management buyout. Regardless of which of these takes place, the task of preparing the business to sell for the best value should begin long before succession becomes a reality. Owners looking at either of these options should carefully consider the advantages and disadvantages of each: External sale/merger (M&A) Merger and acquisition can be a very successful exit strategy, but it requires careful planning. For example, depending on the size and type of the business, it might be more beneficial to the seller to seek out a strategic buyer, which could include competitors in local or international markets, or larger companies looking to add a particular service/product offering or expand into particular geographic areas. In some cases, the purchase price can be more aggressive as strategic partners may be willing to pay more for the company as there may be value to them in taking out a competitor, adding synergies by streamlining staff or processes, and/or adding new products and services. Share numbers and expertise with management as soon as possible; it s important to have more transparency with potential successors regarding the business side of the business. Include visibility into marketing, HR, cash flow and the firm s financial strategy. Andrew Steeves, Senior Strategic Advisor, exp; Engineer in Residence at University of New Brunswick Some other factors to consider: Pro An external buyer may help the owner exit the business faster, as their management team is already in place and ready to take over, Pro The deal is often clean and simple, that is sometimes, does not involve a vendor take back, third-party financing, etc.; and Con The potential loss of a long-held, valued corporate culture (and possibly even the corporate name) may impact the owner s sense of legacy and may make some clients/suppliers uneasy. SUCCESSION PLANNING FOR ENGINEERING FIRMS 5
Management buyout (MBO) In this type of transaction, current management of the company offer to buy the controlling shares of their employer. Similar to traditional share sale, this may be more comfortable for the existing owner(s) as it supplies the sense that their company, legacy and vision will continue. There is also more opportunity for owners to stay on in a different role or phase out at their own pace. Moreover, the transitional security of the management buyout makes it easier to find equity sponsors to help with the purchase. It s important, however, to still conduct due diligence and get external input with respect to fair market value to ensure everyone involved gets their fair share. In some cases, the management buyout option may be limited by the demographic challenges noted earlier. However, as Opus Stewart Weir President Brian Pearse notes, Overcoming conflicting generational perceptions to develop and execute a successful succession is really nothing that communication can t solve. You need to emphasize the value and opportunity firm ownership carries with it. It s important for the older generation to share lessons learned, express their 6 SUCCESSION PLANNING FOR ENGINEERING FIRMS concerns and suggest solutions. At the same time, they need to foster loyalty and leadership by engaging the younger generation, asking them their ideas and genuinely considering their issues. Some other factors to consider: Pro Client and supplier familiarity with management potentially reduces risk for the buyer as well as providing comfort to current employees, suppliers and customers alike, Pro A wide variety of financing options are available (debt, subordinated debt, vendor take back (VTB), private equity, etc.); and Con The seller may not realize the best price under this scenario as managers have their own sense of fair market value and usually don t have as deep pockets as other potential purchasers. While both are important, management succession and ownership succession are two very different things. Management is, in fact, the bigger issue, as faith in management is what drives investment, maintains the confidence of existing clients and preserves business continuity during and following the transition. Andrew Steeves, Senior Strategic Advisor, exp; Engineer in Residence at University of New Brunswick
Steps to succession success What should consulting engineering firms do now to improve their attractiveness for sale/takeover whether by management or an external buyer? Try asking the following sets of key questions: 1 Financial considerations getting your house in order What is my business worth? Obtain a valuation that shows what your business is worth and whether it s enough for your retirement plans Has the company done everything it can to maximize value by: -- Enhancing reputation business value must go beyond the owner s name -- Minimizing personal goodwill the business can t depend solely on owner involvement to be successful -- Limiting dependency on key clients, employees and suppliers -- Eliminating discretionary expenses -- Streamlining operations to minimize costs and increase profitability, and -- Minimizing risk by: Increasing your asset base, Establishing long-term, contractual client relationships throughout the company, and Investing in robust IT systems and automated processes 2 Tax considerations protecting yourself What are the tax advantages/disadvantages of selling assets vs. shares? Am I far enough along in my succession planning given that the sale may significantly impact tax outcomes? 3 Succession planning considerations protecting your investment Do I have strong middle management that can take over? As owner, what is a reasonable transition time to offer the buyer? What should my role be during transition? What do I want it to be? Am I ready emotionally to sell my business, be an employee, accept a reduced role in decision making, etc.? 4 Financing considerations extracting your capital If I have difficulty finding a buyer, should I consider refinancing and using the capital in other ways? -- What does my balance sheet look like? -- Can my cash flows sustain taking on debt? -- How do I raise this debt? If I sell my business, how does a VTB deal work? More and more deals today have a VTB component is it right for me? What am I willing to pledge as security? SUCCESSION PLANNING FOR ENGINEERING FIRMS 7
Think opportunities, not limitations Owners and leadership teams at consulting engineering firms in Canada face a unique situation. A combination of demographic and generational change has made the succession process they traditionally embrace more difficult to execute. As a result, more firms are exploring management buyouts or selling to/merging with larger companies. The point is, despite the challenges, opportunities and options remain for senior partners and owners looking to retire. 8 SUCCESSION PLANNING FOR ENGINEERING FIRMS Whether retirement is imminent or whether succession is a long-term prospect that you know you want to start planning for, you want to extract your capital in the way that best serves you, your family and the business. The right third-party advice can help you streamline the process and ensure you consider the full range of issues and options available. Contact information Kelly Kolke Partner, National Profesional Services Leader Grant Thornton LLP T +1 902 896 2535 E Kelly.Kolke@ca.gt.com John Gamble, CET, P.Eng. President & CEO, Association of Consulting Engineering Companies-Canada T +1 613 236 0569 ext. 201 E jgamble@acec.ca
About Association Of Consulting Engineering Companies Canada (ACEC) The Association of Consulting Engineering Companies Canada (ACEC) represents 450 companies in Canada that provide professional engineering services to both public and private-sector clients. These services include the planning, design and execution of all types of engineering projects as well as providing independent advice and expertise in a wide range of engineering and engineering-related fields. ACEC member companies have a direct influence on virtually every aspect of the economic, social and environmental quality of life in Canada. ACEC is the national voice of the consulting engineering sector on business, public policy and regulatory issues. Visit www.acec.ca Audit Tax Advisory www.grantthornton.ca Grant Thornton LLP. A Canadian Member of Grant Thornton International Ltd About Grant Thornton LLP in Canada Grant Thornton LLP is a leading Canadian accounting and advisory firm providing audit, tax and advisory services to private and public organizations. We help dynamic organizations unlock their potential for growth by providing meaningful, actionable advice through a broad range of services. Together with the Quebec firm Raymond Chabot Grant Thornton LLP, Grant Thornton in Canada has approximately 4,000 people in offices across Canada. Grant Thornton LLP is a Canadian member of Grant Thornton International Ltd, whose member firms operate in over 100 countries worldwide. Except for information that is in or enters the public domain, Grant Thornton LLP will not provide any third party with information related to the client without their permission, unless required to do so by law or professional standards.