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Ownership Transition Planning

The Value of the Process

By: John Pruitt    

Management’s primary mission is to grow, develop and maintain a successful company. One of the measures of company success is long-term profitability. Management of forward looking A/E firms will create an atmosphere for success through thoughtful planning and the achievement of their plans.

This article will examine one of the most important planning functions of management, how to transition ownership. The topic of ownership transition planning is broad and complex. The overall steps to achieve a plan and the associated benefits of having a viable transition plan are the focus of this article.

OwnershipWhat is an Ownership Transition Plan?

A tactical approach for anticipating and controlling ownership changes under different situations is the essence of an ownership transition plan. A transition plan establishes a blueprint for executing the bona fide option of not having to sell the company to a third party in order for the owners to retire.

A well designed ownership transition plan is analogous to the rudder on a ship. If the plan fits, then the direction and stability of the company will be enhanced. Transition planning is a natural extension of the overall strategic plan for an A/E firm. Firms that have well defined company objectives and goals usually have an appropriately thought out ownership transition plan. They seem to go hand-in-hand.

The importance and value of an ownership transition plan are usually realized only after the plan has been developed and placed into use. Plans for transitioning firm ownership will influence hiring, promotions and employee mentoring programs. Transition plans will even influence the “go, no-go” decision process when considering new professional disciplines to be included in a product line or new geographic markets.

Objectives of an Ownership Transition Plan

Most owners of A/E firms share the following objectives for transitioning ownership:

  • Reward owners for their financial investment in the firm.
  • Provide opportunity for key employees to become owners.
  • Help attract quality new people to the firm.
  • Provide for the financial health and continuation of the business as existing owners retire.
  • Create a market for the firm’s stock that guarantees retirement funding.

In a nutshell, owners want to get their financial investment returned to them when they retire, and can better accomplish this if the firm continues successfully after they leave. Besides the financial considerations, owners often have altruistic motivations—they care about their employees and the firm.

An Overview of the Process

The steps in developing an ownership transition plan include:

  • Discussing the objectives of the plan with the owners.
  • Gathering, organizing and analyzing historical data.
  • Formulating a preliminary plan.
  • Reviewing the preliminary plan with the owners–determining… Is it doable? Does it fit?
  • Revising the preliminary plan and testing results.
  • Drafting the preliminary Buy-Sell Agreement and the related documents.
  • Final review of plan–then executing the documents.
  • Implementing the plan.

Discussing the Objectives of the Plan

Discussing the plan objectives with the end users, the owners, is the means of determining the perceived goals to be accomplished by the ownership transition plan. Overall concepts such as the criteria for company ownership, planned retirement dates of existing owners and related retirement and tax planning, company valuation ideas, identification of potential new owners, rewards distribution policies, funding stock repurchases and examining possible funding vehicles for stock purchases are all discussed.

When discussing the plan objectives with the owners, there is sometimes a large divergence of ideas and opinions. One owner may believe that “we should not give away the company,” while another owner may feel “the employees deserve to own the company when we leave”. The differences of opinions between owners can usually be resolved with reliable external information on A/E firm transitioning, combined with an honest exchange of ideas regarding transition objectives. Reasoning and, in the end, compromise are the usual elements needed for owners to reach a consensus of what should be the guiding philosophy of the transition plan.

At times, owners of A/E firms will totally avoid ownership transition planning. Their feeling is that the opinions among the owners are so diverse that to attempt to agree on an ownership transition plan would be divisive. Actually, the opposite usually occurs. Once an open dialogue is established between the owners, the result is a better understanding of what individual owners want to accomplish with the professional practice. There is almost always “common ground” shared by all owners that can form the basis of an ownership transition plan.

Gathering, Organizing and Analyzing Historical Data

One of the best indicators of future performance is historical performance. Gathering, organizing and analyzing company information are necessary when developing an ownership transition plan. A systematic and thorough approach to collecting firm data lessens the chance of missing critical information that could affect the development of the plan. Such an approach also provides a consistent format that facilitates the comparison of company information to various industry surveys.

Highlights of the type of information that is gathered for this process are as follows:

  • Company background and history (including financial statements and production reports).
  • Industry information on specialties or disciplines.
  • Corporation documents.
  • Shareholder information.
  • Agreements regarding company stock and securities.
  • Other contracts (e.g., bank line agreements, insurance, leases).
  • Products and competition.
  • Organization of the company and management.
  • Litigation.
  • Audits.
  • Additional financial information (e.g., backlog, ratio analysis).
  • Professional practices (e.g., Q.C. and TQM programs).

Once the information is gathered in a logical format, it can be used to support the financial analysis and projections necessary to develop an ownership transition plan. One of the by-products of the gathering and organizing process is that there is a thorough analysis of the firm’s historical data. A comparison of the firm’s performance with industry standards is a natural extension of the development of an ownership transition plan. Ideas and strategies gained from the comparison can translate into improved bottom line performance. As with all good ideas and strategic programs, the implementation stage is where theory is translated into action.

Formulating a Preliminary Plan

With direction and input from the owners of the firm, combined with the analysis of the firm data, preliminary assumptions can be made. These assumptions will include growth rates, future profitability, the timing and amount of stock sales and redemptions, market share, valuation issues and financial/performance ratios.

A dynamic financial model is then used to examine various combinations of variables, testing whether the preliminary assumptions and plans are valid. The output of the model must include a forecast of annual financial statements (Balance Sheet, Income Statement, Statement of Cash Flows). In addition, a detailed schedule of the predicted changes in ownership position is required. The projections should include at least a ten year outlook.

The financial model should be re-run with different combinations of variables until there are several viable alternatives for the owners to consider. Once there are several options to be considered, summaries of the results are prepared.

Reviewing the Preliminary Plan with the Owners—Is it doable? Does it fit?

The results from the preliminary plans almost always uncover additional factors that must be considered. Typically, findings from the review of the preliminary plans reveal:

  • When exiting owners would prefer to be totally “cashed out”, installing aggressive funding mechanisms will be the only means of making this option available. But an aggressive funding policy for a redemption plan will result in a reduction of current profits.
  • The ownership transfer process needed to start sooner than the owners thought.
  • The amount of capital needed for the forecasted growth rate was surprisingly large. More stock sales seem to be required.
  • Cash flow challenges tend to surface.
  • “First person out” scenario emerges (i.e., the first person to retire enjoys the least risk with the largest benefits).

At this stage of the process, the critical factor is to balance the retirement needs of the existing owners with maintaining an attractive, viable company that will “pull in” new owner/employees. The question of how to value the company for ownership redemptions and sales should clearly come into focus at this stage in the development of the transition plan.

It seems, at first, that firms transitioning ownership internally are slightly under-valued in comparison to their estimated Fair Market Value. When the costs of selling, the difficulty of finding a qualified buyer and possibly the loss of control over the transition are factored into the equation, the realized value of an internal ownership transition often exceeds the Fair Market Value.

A common method for valuing a typical A/E firm includes a cost approach analysis, supported by income, capital and market analysis approaches. The different valuation approaches usually support a similar valuation range for the firm. If this is not the case, further examination is required to identify the reasons for the discrepancies.

For purposes of establishing value in a Buy-Sell Agreement, a formula approach to approximate the firm’s value is most often used. The basis for a formula approach is usually the Book Value of the firm with optional adjustments for backlog, profitability and/or under-valuation of Fixed Assets. The formula approach should produce a valuation similar to one that would be calculated by using a formal valuation process.

By using a formula, the need for having recurring formal valuations to determine selling and redemption prices is removed. This will save time, money and will prevent controversy about who should perform the valuation for the firm. The formula should be checked from time to time to verify that it is still correctly estimating the approximate value of the firm.

Revising the Preliminary Plan and Testing

This is a continuation of the process to refine the transition plan. The question is, does the plan accomplish the goal of providing a viable option for selling the firm internally? Refinements of the timing of ownership transfers, distribution and rewards policies, and the basic provisions of the Buy-Sell Agreement are completed during this part of the process.

Drafting the formal ownership transition plan, including the Buy-Sell Agreement, can only proceed when there is consensus among the owners that the plan is well thought out, will accomplish the transition goals and is doable. Owners must support the plan. The corollary to the support by the owners is the appeal the plan must have to potential employee/owners. The plan must make economic sense to potential new owners before they will buy in. Overall, the plan should be fair to all concerned.

Drafting the Preliminary Buy-Sell Agreement and the Related Documents

The major provisions that a Buy-Sell Agreement should address are:

  • The firm’s buy-back obligation upon death, disability, termination of employment and voluntary and/or involuntary transfers.
  • The issuance of new stock or ownership interests.
  • Means of establishing the purchase price of stock or ownership interest.
  • Payment terms for purchase and redemption of company stock.
  • Non-competition agreements.

The Buy-Sell Agreement is a legal document. The document must be reviewed by an attorney qualified to render legal services in the state in which the A/E firm is registered. Factors that vary from state to state, such as community property laws, will affect how the final document is written.

Documents that relate to a Buy-Sell Agreement can range from a simple Promissory Note that is used to acknowledge the financing arrangements for stock purchases, to a Deferred Compensation Agreement that is incorporated as part of the overall ownership transition plan. All documents and plans for the transition of ownership must be considered together as to how they work in total. They should work in concert to facilitate an internal ownership transition.

Final Review of Plan–Executing the Documents

This is an opportunity to take a final look at the total plan. The transition plan should “feel” comfortable and durable. An ownership transition plan does not necessarily need to be complicated to accomplish the goal of preserving the option for an internal transition of ownership. But, the plan does need to anticipate opportunities as well as challenges so that the A/E firm has the chance to plan.

The basic plan is now complete. All owners should sign the plan documents.

Implementing the Plan

The most dynamic and interesting part of the ownership transition planning process is the implementation of the plan. By this stage of the process, the owners have a shared philosophy about the purpose of the plan and are committed to its principles. The ownership transition plan is now an integral part of the overall strategic plan for the firm. As a result, the leadership and the direction of the firm are typically better focused.

The “selling” of the ownership transition plan to employees is the most important step that is left to be accomplished. Often employees do not understand the degree of effort and risk that must be undertaken to reap the rewards of ownership. Potential employee/owners must have the opportunity to understand both the criteria for ownership and the reasoning behind the criteria. Mentoring and other management training programs can be part of the process of educating potential owners. New owners must clearly understand the benefits, obligations and costs associated with ownership.

As with all plans, provisions must be made for periodic reviews. On an annual basis, owners should review whether the ownership transition plan is accomplishing the contemplated goals. Once a thoughtful ownership transition plan is in place, usually only minor adjustments are needed to keep the plan updated and active.


A good ownership transition plan incorporates a firm’s philosophy about how to grow and maintain a successful company. The result of ownership transition planning is much more than a Buy-Sell Agreement. A transition plan is an extension of a firm’s overall strategic plan. Owners of firms who install transition plans typically gain additional control over the direction of their firm and have an improved understanding of where they want to go.

John B. Pruitt, CPA, is President of A/E Consulting Services, Inc. He has extensive experience in developing ownership transition plans and strategic plans for A/E firms. Mr. Pruitt may be contacted at A/E Consulting Services, Inc., 1623 Second St., Kirkland, WA 98033,or call (425) 827-2995.


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