We have been discussing the importance of succession planning for closely held businesses in our recent series of articles. But if you own a professional services firm, you might have noticed that some of the succession planning strategies discussed in these articles may not apply to your business.
This is because succession planning for professional services firms tends to be different than it is for manufacturers, wholesalers, retailers and most other types of businesses. In this article, we’ll discuss succession planning from the perspective of professional services providers like accounting, engineering, architectural and law firms.
Two Main Objectives
To state the obvious, professional services firms provide services, not tangible products, to their customers. Therefore, succession planning strategies for such firms should be geared around two main objectives:
1. Transitioning the owner’s experience, contacts and relationships to successor owners and/or managers. Your knowledge, talents, skill sets and client relationships are a key component of your firm’s value and comprise much of the firm’s intellectual property. To the greatest extent possible, all of this needs to be passed on to others in your firm.
This process is critical regardless of whether the firm will be sold internally to key employees via a management buyout (MBO), other partners will buy your shares, or the firm will be sold to external buyers. It should start well in advance of your planned departure date to allow plenty of transition time for everyone involved.
If you are your firm’s primary “rainmaker,” it’s especially critical that you make provisions for how new business will be developed and new clients recruited after you have left. Try to identify employees with potentially strong business development skills whom you can start spending time with and sharing your wealth of knowledge and contacts.
Meanwhile, if you don’t have a formal sales and business development program, now is the time to create one. You don’t want the firm’s future to be dependent on the rainmaking abilities of just one or two key individuals.
2. Creating a buyout structure that provides an income stream for the departing owner without putting excessive financial pressure on the business. If the business will be sold to external (strategic or financial) buyers, you will negotiate a purchase price based on the business’ value, which should be determined by having a formal business valuation performed by a professional business valuator. While there are a number of different financing options for the business, the buyer may request a buyout in which you are paid out of proceeds from the business over a number of years.
Maximizing your payout is obviously one of your primary goals. However, you’ll want to work closely with the buyer to structure the payout in such a way that the business’ future cash flow is sufficient to meet operating expenses. Otherwise, the ongoing viability of the business (and your payouts) could be placed in jeopardy.
If the business will be sold to internal buyers (key employees or other partners), the key is agreeing to a fair purchase price for your shares while structuring the buyout so that it results in positive cash flow for new owners or remaining partners. In the case of a partnership, this can be challenging if you have a significant book of business or a unique skill set that will be hard to replace.
A one-time goodwill payout is often used in this scenario, but it can’t be so large that it jeopardizes future cash flow. One solution is to make any payouts above the business’ book value on a contingent basis, such as a retained business clause for clients you brought into the firm.
Start Planning Early
As noted above, succession planning for your professional services firm should start long before you actually plan to leave the firm. Every firm and owner is different, but five to 10 years before your planned departure date is not too early to start planning. In particular, your succession plan should focus on:
- Retaining clients whose primary relationship is with you.
- Maintaining necessary levels of professional expertise and skills among the firm’s employees.
- Ensuring continued strong firm management and leadership.
- Continuing the firm’s successful sales and business development efforts.
- Generating a personal income stream for you after you leave to support your post-sale plans, whether this is retirement, the launch of a new business or something else.