Part of the American dream is the pride of ownership. Even if it's personal property on the smallest scale, most of us strive to own things. And that desire extends to owning a business. Not just shares in distant publicly traded companies that make up personal portfolios, but a company at which one can work and shape over time.
Every day in every industry, new companies are formed while others cease to exist. It's no different in the AEC business where an entrepreneurial individual or group of individuals crystallize a vision to create their own company. As time goes on, these leaders often extend that dream of ownership to others to share the wealth, tie them to the company, incentivize and excite them, and create a mechanism to transfer ownership.
These founders may have a personal end game in mind from the beginning or it may evolve over time. At some point, however, they must take their "chips off the table" so they can retire. Founders or subsequent leaders may desire to continue this company for generations to come, while some cash-in from their hard work through a more immediate transaction. In the former example, they may choose to transfer ownership to family members, a select group of key leaders, or more broadly to all employees – perhaps through an ESOP. In the latter case, they may simply sell or merge the company or go public to provide the liquidity needed to get out.
Any of these approaches can be used successfully to transition ownership. There is no right or wrong answer and often this is a personal decision for those who lead companies. Leaders who choose an end-game strategy from the outset to sell the business or go public can be applauded for having a strategy and staying with it. But unfortunately, the vast majority of leaders of companies that are sold admit after the fact that they never initially intended to sell externally. Some couldn't resist "cashing out" for a premium, but most say they sold to another company because they did not prepare the company for internal ownership transition.
Much already has been written about internal ownership transition and yet far too many companies still struggle. The remainder of this article focuses on a few steps needed to better prepare a company for internal transition in the hope that there is a "nugget" of new information or that it at least will inspire those leaders that prefer an internal transition.
What are the steps needed to either start or get back on track?
First and foremost, you need time to execute a successful internal transition. More times than not, this is the primary reason why companies fail to pull it off. The amount of time needed depends on the concentration of ownership. If a founder has 90 percent of the company, one better plan on a long time. Generally, a dozen years or more are needed if very little ownership has transferred from one group to another. And this transfer process is not one that can be turned on and off during this dozen or more years – it's a continuous effort.
Given that time is available, the next ingredient is a strong vision for the future to attract and retain individuals who ultimately will drive the business. Although this sounds somewhat emotional, having a vision with values that are shared by leaders is important for generational transfer. Establishing the vision and values in conjunction with a "high-performance culture" – one that is client centered, stresses financial performance, and establishes personal accountability – only improves the chance for transition success.
Time, a shared vision, and a performance culture are just the start. One must be able to use these to attract and then offer the opportunity to the right people to extend ownership to those current and future leaders – extending it based on performance, not tenure or position. If you're a founder, it begins with the decision to let go of complete control and share that dream of ownership more broadly. This is the first sticking point for transitions – never getting started. We are in a people business and it's crucial to recognize that company success is tied directly to people success.
Some believe that the broader the ownership is distributed, the better. Most believe it should be neither overly concentrated nor too distributed. Most companies with successful transition programs seem to limit ownership to 10 percent to 20 percent of employees. Broader ownership distribution can work if you create levels that stratify the ownership in such a way that gets more ownership into the hands of a smaller group of leaders who are ultimately driving the business. If one chooses the partial or full ESOP approach, ensuring that same top 10- to 20-percent group of leaders who drive the company are incentivized with additional real or synthetic ownership equity is important. And one should avoid "giving away" ownership. It's much better to have individuals invest in ownership because it will then likely mean more to them and increase individual performance. You can certainly bonus them more in stock once they've committed to that initial purchase.
One of the most crucial elements for transition success is operating the business in a financially sound manner. Sounds pretty basic, but many fall short on this. After looking at hundreds of financial transition models over the years, it's pretty clear that a company must generate consistent profits to transition ownership. This requires a disciplined and consistent management approach to make the right decisions for financial success in all categories. The minimum profitability needed varies between companies, but there does seem to be a strong correlation for success when pre-distribution double-digit profits on net revenues are achieved consistently.
At the same time, debt should be managed carefully. Some contend a reasonable level of debt is acceptable and is an effective use of capital for investment. Others operate with the philosophy of never taking on debt. The key is to never get overextended out of the comfort zone should profitability drop or certainly anywhere near bank covenants.
Profitable companies are then faced with satisfying the needs of investors today while making the right decisions to invest for tomorrow. Investing in new markets, services, equipment/tools, training, and leadership development while keeping some capital in the company are key to that future. All are important and, in particular, it's imperative to vigilantly retain some of that precious profit in the company to build a strong balance sheet for a financially sound company. One of the largest pitfalls in those companies that do not transition internally, let alone survive, is that they give most of the profit away to the shareholders and employees in cash instead of investing in those areas that will shape the future. Consistently giving away more than half of the pre-distribution profit is a dangerous place to be.
The preceding discussion regarding the level of profitability required and a framework for investing year-end profits for ownership transition should be evaluated and modeled well into the future. This exercise can help guide the annual decision process for leaders of where the profits should go. And it is not a one-time event – it should be performed annually.
This all sounds like it takes time and requires work. It does. Interesting enough, leaders should be doing most of this to operate a good business – setting a vision, hiring and retaining good people, producing good profits, and making good decisions on investments – because you also will create an "internal market" for the stock and greater shareholder value along that transition road. This will cause employees to "want" to own a piece of the business – pride in ownership that will endure for generations.
Gerry Salontai leads the Salontai Consulting Group (www.salontai.com), a management advisory company focused on helping companies achieve success in the areas of strategy, business management, and leadership. He can be reached at 858-756-5169 or email@example.com.