Creating an ownership structure for success

June 2011 » Columns » DEAL POINTS
W. Hobson Hogan

Our economy, regardless of its trajectory, is beginning to undergo the single largest change in ownership it has ever experienced as baby boomers sell shares throughout the AEC industry. In many cases, the sellers of engineering, architecture, planning, and environmental firms have 100 percent ownership, or at least a majority of the shares of the firms they are selling. The scenario most often is a “one-to-many” relationship between the seller and the buyers — there are many more buyers than there are sellers. This relationship presents a challenge in how to distribute shares among the buyers so the firm will be successful in the future.

Firms with one owner often have streamlined decision-making processes, and their company structures have evolved around one or two decision makers. As a firm contemplates a broader ownership structure, it is important that the firm match appropriate ownership stakes with the position that a particular buyer will hold in the organization. As firms transition from the single-ownership model, a knee-jerk reaction by the buyer group often is to overcompensate for the previous concentrated ownership structure by allocating shares equally among the buyers. This may take the form of an Employee Stock Option Plan (ESOP) or equal holdings by the firm’s principals. Sellers often have difficulty choosing an allocation plan that fits the organizational reality and choose “equality” as the path of least resistance.

While broadening ownership has many advantages, there are many disadvantages to diluting ownership in key leadership positions. Prior to beginning an ownership transition, the current firm leadership should discuss the end game, not what ownership looks like in the first year of a transition. It often is easier for the firm to set ownership goals for particular positions and not particular individuals so that a consistent plan can be implemented throughout the transition.

In some cases, equal ownership may be the most appropriate ownership model. An equal-ownership model is likely to fit a firm where each of the owners are selling and executing work in an environment of peers. Firms with many capable professionals may choose an equal ownership model and construct corporate governance to assist in the collective management of the firm. This model works well where the individual owners can exercise their own judgment to build their businesses to the benefit of the firm. The equal-ownership model does not work in firms where strong executive leadership is required or strong managers are required to sell and execute the work. As you begin to layer on organizational complexity, it becomes necessary to reward skilled executives and managers with ownership stakes larger than if they were allocated on an equal basis.

If a firm is contemplating utilizing an ESOP for a transition, the ESOP should own less than 100 percent of the firm. While an ESOP can become a strong recruiting and retention tool for the firm in a broader sense, a 100-percent ESOP can become a disincentive in attracting and retaining top talent because of the rigidity in the ownership structure. The inability for individuals in a 100-percent ESOP firm to “move the needle” substantially on a personal ownership level can send top performers to firms where they can have a larger personal ownership stake. It is more difficult to foster an entrepreneurial spirit in a 100-percent ESOP firm than one that has at least 30-percent ownership outside the ESOP.

Any ownership transition should have an element of identifying and training talented individuals so they may become owners in the future. Cultivating future leaders is a never-ending task and ownership-transition plans that have the ability to award leadership and star talent with larger ownership stakes provide a firm with an advantage in the marketplace. Bonuses and salaries rise and fall with the market; however, ownership endures and provides benefits beyond what a profit-sharing plan or cash bonuses can achieve.

When talent and leadership intersect in one individual, the market is willing to pay for those skills no matter how bleak or bright the future. If future leaders in your organization view that their situation has artificial barriers to success — such as low ownership relative to the value they create — there is a strong likelihood they will find a place where their value creation will be on par with their ownership stake. The single largest risk in any ownership transition is replacing the current leadership with talented individuals who will manage the firm successfully. Picking the right ownership structure can provide a mechanism to attract and retain the leaders necessary to maintain a firm’s success for the future.

W. Hobson Hogan, a principal at ZweigWhite, assists AEC firms with strategy formulation and ownership transfer issues, including buyer and seller representations. He can be contacted at hhogan@zweigwhite.com.


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