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.
Succession planning is a strategy that successfully transfers capital – whether it be intellectual, financial or creative – to the next generation of leaders and stakeholders when a firm inevitably restructures due to key employees retiring, otherwise leaving, or passing away. See also Appendix A of this chapter, Succession Challenges in the Event of a Sudden Unplanned Closure of Firm
Succession planning in the context of architectural practice is very important, but it has a different meaning in different types of practice. Historically, succession planning has most often been the concern of sole proprietorships and partnerships. In these cases, succession plans would need to be developed to manage the transition of the ownership of practice from one person or a group of persons to other individuals or groups.
In larger, corporate firms, succession planning is still very important, but the plan is not necessarily about transferring ownership but about developing future leaders at all levels of the practice in order to advance a body of future potential owners.
In both cases, the core goal of a succession plan is to ensure the ongoing success of the practice by identifying future leaders, mentoring them, and helping them successfully transition into their new roles.
Proprietors 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 proprietors to extend their practice beyond the span of their own careers;
- allow emerging practitioners and proprietors to develop the skills necessary for future leadership (see Chapter 1.4 – Mentorship and Career Transitions);
- permit proprietors to obtain a financial return on their investment of money, energy and commitment;
- address the risk of sudden departure of a key individual.
High-potential individuals are identified and then mentored in order to prepare them for a specific role in the firm. Often this mentorship is undertaken by the person who currently holds the role and is moving on to something else. See Chapter 1.4 – Mentorship and Career Transitions.
FIGURE 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 10 years. A good start is to determine one’s retirement goals and work backward 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.
Art Gensler describes what he calls “the quiet transition,” one that personally informs clients of succession changes and is not publicized in the media, to relieve pressure on all concerned. He writes:
“By quietly making the transition, you take a more personalized approach toward making your clients aware of the changes, and give them a preview of some of the positive changes to come. Ultimately, you give the new leadership a chance to become the trusted advisor that your clients and employees have come to expect at your company.” (Gensler, p. 86)
Options for Succession Planning
This chapter describes five succession 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
Many small firms with a single architect or shareholder 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:
- shareholder or partner dispute;
- personal choice;
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 and territorial associations of architects 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; archives enable the architect and their insurer to mount a robust defence (see Chapter 3.8 – Risk Management and Professional Liability).
Sale of the Practice
The firm could be sold to an architect or architects outside the practice (such as private investors). 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.
- may sustain the firm’s legacy;
- may yield some financial return for the founding architect.
- 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 with Another Practice
Merging the practice with another architect or firm may be a very good option if the founding architect is planning retirement and if there is 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:
- incompatibility of corporate culture or style of practice (see Chapter 3.1 – Starting and Organizing 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 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.
Transfer 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.
TABLE 1 Succession Planning Options
The Strategic Human Resources Planning Process
Although there are many valid options, succession planning is most successful when leadership can be transferred gradually within the architectural practice. This process can take up to 10 years of internal staff development time and encompasses the following three stages.
FIGURE 2 Timeline for Strategic Management
Stage 1: Strategic Planning
As part of the firm’s strategic planning process, the following steps should be considered in succession planning:
- Know the firm’s culture; leadership begins with an understanding of the firm’s values.
- Develop a strategic plan; it is essential for the firm to effectively integrate business components, such as:
- information technology;
- human resources.
- Realize that the strategic plan will provide a framework for more detailed human resource development.
Stage 2: Development of the Talent Pool
As part of the firm’s development, a focus should be directed towards its people, as the talent pool is a key asset to the firm. More specifically, steps and considerations in succession planning include:
- Identify and communicate the measures that future leaders 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 cross-functional experience.
- Establish a meaningful performance evaluation system to monitor and foster ongoing development through:
- 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.
A common concern regarding staff education programs is that only a limited number of staff groomed for promotion will actually advance 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” (motivational speaker and business consultant Zig Ziglar).
Stage 3: Selection and Transition
For succession planning to be successful, some steps and considerations include:
- Select a successor or successors and manage 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.
Stage 4: Continuous Renewal
In delivering a successful succession plan, the firm’s ownership will:
- 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.
Architects must consider a variety of specific issues during the succession planning process.
Such planning is important because it:
- allows for faster succession in case of unforeseen circumstances such as illness, disability, sudden death, divorce or shareholder/partnership disputes;
- minimizes risks of failure by making the succession plan more flexible, and by building the talent pool.
Review of Shareholder and Partnership Agreements
When reviewing agreements, buyers and 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 cultural incompatibility and/or poor performance;
- 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.
Keep in mind that:
- 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 second-generation 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;
- a modified book value procedure that recognizes the economic worth of the firm (the net realizable value, or NRV) as opposed to a 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 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.” (Ross Skinner)
Gensler, Arthur, and Michael Lindenmayer. Art’s Principles: 50 years of hard-learned lessons in building a world-class professional services firm. Wilson Lafferty, 2015.
Milburn, J. Alex, and Ross Skinner. Accounting Standards in Evolution, 2nd Edition. Toronto: Holt, Reinhart and Winston Canada, 2000.