What are the key issues you should consider when selling equity in your architectural practice?
So you own equity in an architectural practice and have surprised yourself at how well you have done, considering you may not have had any formal training in running a business. After all, studying and practising as an architect does not come with a manual on how to run a business.
Nonetheless, you may now be at a stage where you are looking at the idea of selling all or part of your practice to an employee or other party. Knowing how to go about this is the difficult but crucial next step.
Some of the considerations you should be taking into account include:
- Why are you selling your business?
- What are you selling?
- How is it valued?
- What types of shareholder agreements need to be considered?
- What do you look for when choosing a Financial Advisor to assist with the process?
For many years, JVA have provided architectural practices with financial advice on many issues, including equity transfers. Recently, JVA formally interviewed over 20 architects spread across 12 different practices of varying size and complexity to identify the common issues faced.
Why am I selling my business?
Before you get into the detail of looking into your business, it is beneficial to understand why. The most important question to ask yourself is “Why are you selling your business?” You may be looking at bringing in new partners into your business so that you can plan a voluntary exit sometime in the future. You may be trying to hang on to key employees, to ensure they don’t leave and set up on their own as a competitor. You may be planning to sell your business to another firm – effectively merging your practice.
To truly understand the why you also need to look at your timing.
- How quickly do you want to sell?
- Do you want to sell quickly at a low price?
- Do you want to plan a slower sale and maximise your price?
- Are you selling the whole practice or just a part of your practice?
In asking yourself these questions, it may seem like you are stating the obvious. But our research has shown that some practice owners neglect to pay attention to this important part of the due diligence process, which can affect your outcome.
What am I selling?
Once you understand why you are selling, you are certainly in a better position to understand what is included in the sale. What makes up your practice? Our research and knowledge of the structure of architectural practices has shown there are many layers to an architectural practice. And many practice owners find it difficult to break down the components that make up your business.
People and procedures
The staff who make up your business – from professional staff to your administration team – are a crucial component of your business. The knowledge, expertise and experience of this team is a key factor that any buyer will consider carefully. Some questions a buyer may consider include:
- What is the staff culture?
- How are staff motivated?
- What are the morals and ethics of your team?
- Will the staff stay on?
Your business’s policies and procedures – everything that makes the office function administratively – are another key component of your business and can increase or decrease its value. A buyer may ask what are the procedures for:
- Employing staff and paying salaries?
- Occupational Health and safety?
- Professional registration and training?
Similarly, your processes and systems for managing projects are a crucial component of your business. Formal quality assurance may also comprise a key part of your business. Some questions a buyer may consider are:
- What drawing and document management systems do you have?
- What client project processes do you have in place?
Design and reputation
For many, many reasons, every practice has a certain reputation and an “X factor”. Some practices have a bigger X than others.
Your practice’s uniqueness, quality, look and feel, ability to influence and win repeat business, ability to influence clients to accept out of the box design, and your vision will all be a part of the sale and will also certainly affect your business’s value. Your relationship with clients and referrers as well as consultants like engineers, quantity surveyors, acoustics, hydraulics, heat and light, landscape architects as well as your ability and your systems to manage these relationships is also a part of your business.
Most importantly, your contract pipeline – the projects which you have on the drawing board and in construction – is a major part of your business which you will sell. Some questions you may need to consider in determining this important component of your business include:
- How committed is the cash flow from these projects?
- Are they notional or do they have a contractual agreement?
- What stage of the design and construction are they?
A business with a pipeline of committed contracts at initial design phase is going to be worth more than a business with a series of projects in post practical completion.
Fixtures and fittings
Finally, your business’s physical assets – your office furniture, computers, printers, software, or even office premises – all make up a part of the sale. You may also have a library of resource material which may also make up a part of the business.
Likewise, your business’s liabilities are a part of the sale. This would include any debt that comes with the business as well as employment liabilities such as unpaid superannuation, leave owing, etc.
Business valuations – How is my business valued?
When selling, you must get a basic understanding of what impacts the value of your business. Although it’s not an exact science, there are both external and internal factors that determine your business value. While you cannot control some external influences, you can control many of the internal ones.
External – Economic Cycles
It is very clear that right now, the economy is affecting architecture significantly. While schools continue to need new buildings and government infrastructure projects, continue, more speculative accommodation and housing projects have been put on the back burner until the economy picks up.
When the economy is riding a high with lots of building activity, your practice is going to be worth more than during an economic downturn. Unfortunately, it is in the leaner times when most people want to sell.
Your people – you, other principals and your staff – can affect your business value in a number of ways. First, your business’s degree of dependency on the principal/s to operate and ‘rain make’ new business will affect the value. If you are heavily involved:
- How will your knowledge and expertise be preserved and transferred?
- How is intellectual property documented and transferred?
You may like to consider a practice style manual or you may offer to stay working in a retainer capacity to transfer your knowledge to the new owner. Your reputation and governance structures within your business can influence your business value.
- Do you have a history of professional indemnity claims against your business?
- Do the principals of the practice have a solid reputation?
The loyalty of your staff will also impact. Will they stay on with the new owner?
The amount and quality of future work in your business’s pipeline will also have a huge impact on your business’s value.
- What stage of the design/construction cycle is generating the business’s cash flow?
- What costs are required to realise this cash flow?
You must also consider the business’s billing history.
- Will the client still be there at the end of the project to ensure the business is paid everything that is due?
Architects also do a lot of concept work that may or may not be paid upfront, but may produce some income in the future.
- Is the prospect of this work included in the sale?
- If so, how is it valued?
The procedures and structure of your business’s systems will also impact on the sale price. Looking at your business holistically, do you have:
- A strategic business growth plan, a business development/marketing plan for acquiring new business?
- Do you have well-established systems and steps in designing?
- Do you have well-established finance and accounting systems?
- Do you have an operations manual so that any team member will know how to do the basics around the office?
- Do you have human resources policies and procedures for absenteeism, working from home, sick leave and long-service leave?
- Do you have risk management policies and procedures?
How do I know what is a fair agreement?
After working with many architects who are buying and selling shares in a practice, we believe the key to successful share participation is the strength of the shareholder agreement.
But as a practice owner, how do you know what is a fair shareholder agreement? And what will potential buyers be looking for?
Buyers will want to clearly understand how your practice has been valued and how the share price has been determined.
If the practice is expanding, the value of the shareholding may be based on capital appreciation and income/dividend payments. If the practice has limited scope for capital growth, has the shareholding value predominantly been based on income/dividends?
Setting the share price can be a major issue for both parties. Setting it too low may make it too “easy come / easy go”. But setting it too high may scare off potential shareholders.
Both parties must also understand the assets to liabilities mix of the business. Some practices have limited assets and have large employment-based liabilities such as long-service leave and annual leave. Others may own business premises.
Buyers will want to understand the corporate structure that they are investing in. They may ask:
- Is there a single business or multiple entities with an overarching corporate service company?
- Are there multiple classes of shareholders with different voting and participant rights depending on the class of shares purchased?
- What are the voting rights of share participants versus weight of share ownership?
Buyers may also want the shareholder agreement to have some flexibility.
Architecture is very cyclical and the profitability of architectural practices fluctuates with general market and economic conditions. During the purchase period, the employee may be buying shares when the business profitability is low. Some questions they may ask include:
- Is the purchase price fixed for a reasonable period of time (up to five years) to allow the purchase to be completed?
- What are the options if the purchase is not completed in one transaction?
- Is there allowance and what are the options if the agreement expires?
- Will you as the employer keep the offer open at the same price, revalue the business or offer equity to another party?
Finally, to determine whether your shareholders agreement is fair, buyers will also want to understand the conditions at the time of sale.
When the business is performing well, most practices run smoothly. However, when economic times are tough, buyers will want to make sure the shareholder agreement is strong and fair for all. They will also need to consider how they may leave when they want to retire.
- Some questions they may ask are:
- What is the exit price strategy for voluntary and involuntary exit?
- Can the exiting shareholders manipulate the share price to their own benefit?
What do I look for to in an adviser?
Most owners in architectural practices looking at the possibility of selling shares to employees can probably relate to many of the issues we’ve highlighted. But knowing what to do, where to go, and who to trust is sometimes the most difficult step.
Following is a list of what you should consider when choosing a financial adviser who may be able to guide you:
- Does the financial adviser co-ordinate a team of professionals including your accountant, bank, investment managers, and lawyers?
- Does the financial adviser have comprehensive experience and knowledge of architectural practices, shareholder agreements and partnership structures?
- Does the financial adviser understand issues such as share and asset structuring, managing income and debt, superannuation, succession planning, and estate planning in the context of your overall financial situation?
- Does the financial adviser understand your long-term strategy, personal needs, and fundamental values?
- Does the financial adviser offer transparent annual fee for service, rather than commission-based advice?
- Do they tailor advice to suit your changing needs?
We’ve highlighted many of the practical issues – why you’re selling, what is your business’s value and what is a fair shareholder agreement – that owners of architectural practices should consider when looking to sell equity.
Financial advisers who understand these issues and have experience working with architects will advise you appropriately to ensure you obtain the best financial outcome.
JVA have a long history of providing financial advice to architectural practices of varying sizes and structures. If you’re thinking of selling your practice, get in touch and we’ll walk you through the process.