Is ownership worth it for the next generation?

December 2010 » Features » BUSINESS STRATEGIES
How transitioning firms can entice new internal buyers
Kathryn Sprankle

When strategic discussions turn to the issue of ownership transition, many clients are simply baffled by the general lack of interest among the second and third tiers in their organizations. “Don’t these people understand the value of ownership?” they ask.

No, they often don’t. And it’s not all their fault.

As an industry, we do a pathetic job of informing ownership transition candidates of what it means to be an owner. Once upon a time, the ultimate prize for civil engineers working in a private consulting firm was an invitation to be a shareholder. Ownership usually meant greater status, money, and job security. That was the deal — and everyone knew it.

Ownership in an engineering firm isn’t what it used to be; it is now a much more nuanced proposition. Yet, the current generation of firm owners operates as if nothing has changed. They assume that anyone graced with an offer of ownership would be crazy to pass it up.

By taking a step back and considering the state of the industry as it relates to today’s culture, these engineering firm leaders would realize that the value of ownership no longer is assured. Potential shareholders need compelling reasons to invest their money — and themselves — into firm ownership.

Don’t get me wrong; firm ownership can be an excellent career decision for many engineers rising through the ranks. However, senior industry leaders need to understand and account for the dynamics in play, while better defining and clarifying what ownership means in their particular firm.

Understanding the dynamics
Wish as we baby boomers might, Generation X (born from 1965-1976) and Generation Y (born from 1977-2000) see life differently. As a group, they marry and have children later in life. They’re not as willing to sacrifice personal and family time for their jobs. They tend to celebrate diversity, reject the notion of a strict company hierarchy, and remain much more open to the idea of changing careers.

These are generalizations, of course, but they are also generally on target. While there are statistics galore to support these statements, you only need to spend a few days in a typical engineering firm to witness them in action.

These tendencies are inconsistent with the concept of ownership transition as is currently practiced in engineering firms. How often do we hear ownership referred to as a vehicle to “These are not attractive options for people tie down” or “pay dues?” How many existing owners work too hard, sacrifice too much, and make too little?

who expect to change careers multiple times, who are intent on achieving a favorable life-to-work balance, and who have multiple options for their time and money.

Chris Ernst, P.E., a structural engineer for Merrick & Co. in Denver, attended one of the Association of A/E Business Leaders (AEBL) Step Up to Leadership programs recently. An eager and active participant in Merrick’s ESOP, as well as a direct shareholder, 30-year-old Ernst nonetheless recognizes and understands his peers’ reluctance to jump into the ownership pool.

“Younger generations tend to want flexibility in employment opportunities,” Ernst said, who joined the firm at 25 and became a direct owner a year later. “Participating in employee ownership programs can limit that flexibility.”

Ernst explained that one of his colleagues will only commit to buying smaller numbers of shares in multiple contracts with shorter duration, rather than buying the same number of shares in a single longer contract. This is because, at Merrick, the more shares employees buy, the longer they are expected to continue buying and the larger the penalty if they stop.

“He fully recognizes that the other way is a better investment,” Ernst added. “But if he leaves Merrick, his penalties for leaving will be less. To him, the flexibility means more.”

Ernst said this same employee is interested in other investments such as real estate. “At the end of the day, it’s his perception on other opportunities, both investment and workplace related, that prevent him from having higher amounts of commitment and buy-in to employee ownership,” he said.

It should come as no surprise that “Next-Gen” employees have this outlook. Remember, during this group’s lifetime, the Dow Jones industrial average went from around 1,100 in the mid-1970s to more than 14,000 in 2007. Real estate values skyrocketed. Expectations of wealth changed, with bigger and better homes, cars, and “stuff” becoming the norm.

“Younger generations seem to believe they are destined to be wealthy,” Ernst said. “So if you present them with a great investment opportunity that they actually have to put up money for, it is likely going to make them choke.”

David Cohen is a principal with Matheson Financial Advisors, an industry consulting firm specializing in ownership transition planning. “The generation coming up has no interest in working for 10 or 15 years in the same company and taking diminutive bonuses in exchange for stock,” he said. “These are potentially their prime earning years, and they are very concerned about reducing their annual total direct compensation in exchange for ownership.”

Cohen said many of these folks have other things on their financial minds, such as college loans, a mortgage, retirement savings, their kids’ 529 plans, home expansion, or even new “toys.” “Whatever it is, they are often living paycheck to paycheck and are comparing the offer of ownership to other investments and other things they could do with that money,” he said.

Ownership parameters and benefits
While it may be true that there are better places to invest, it is also true that owning a piece of the firm that employs you can be rewarding from a professional, personal, and financial standpoint. The key is that potential owners need to understand what it actually means to be a shareholder and how it will affect them in all three of these areas.

Professionally, will ownership equate to leadership? This is often the perception among buyers, but it is not always reality. In firms with two or three owners, every shareholder is likely to be a firm leader. But in firms undergoing a transition, where multiple owners are being brought in to buy out the stock of the previous shareholders, this is less likely the case.

At a recent AEBL CEO roundtable, participants acknowledged that existing owners often fail to clarify the relationship between ownership and leadership in a transitional situation. For a transition to work best, every new employee owner must know how ownership will (or won’t) change their job responsibilities and position in the firm.

Another common misconception among new owners is that their newfound shareholder status means they don’t have to work as hard, when in fact, the exact opposite is true. We often fail to make this point clearly or strongly enough, until it’s too late and the new owner becomes disillusioned and regretful. Sometimes they also discover that another common belief about ownership is a myth — that it means lifetime employment.

Recipe for success
There are three imperatives for transitioning firms trying to entice new internal buyers: 1) create a fair plan, 2) place a reasonable value on the stock, and 3) run a solid company.

The selling owners can’t be so intent on getting their money out that it leaves the firm hamstrung and on the road to financial ruin. “The next generation isn’t interested in the legacy costs associated with buying out retired owners by carrying the burden of deferred compensation plans or shareholder/ESOP debt, especially if these costs are unreasonable based on what the company’s cash flow can support,” Cohen said. “They don’t want to work for an extended period of time to buy back the stock from someone who is no longer participating in or driving the company with the hopes that the generation behind them is willing to do the same.”

Devaluing the stock too much is also a problem. If it is too easy to buy in, potential buyers may believe they won’t get a reasonable return on their investment when it’s their turn to sell. This also can create inherent pressure from the primary shareholders to look at an external sale to realize a significant increase in stock price.

Even with all these challenges, smart people given the opportunity to buy into a firm will jump at the chance — if the price is reasonable, the plan is fair, and the firm’s stock is worth buying. Transitioning owners simply have to make the offer attractive without damaging the health of the “product” (i.e., the firm).

Cohen said: “It’s simple. If the firm is going to use all their cash to pay for the buyout so they’ll no longer have the ability to pay bonuses, hire or retain the best people, open new offices or make acquisitions, upgrade technology, and generally reinvest in the firm, then the price of the ownership transition plan is too high.”

Kathryn Sprankle is principal consultant with management consulting firm Sprankle Leadership of San Francisco and executive director of the Association of A/E Business Leaders (AEBL). She can be contacted at kathryn@sprankleleadership.com.


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