Executive Corner: What Is Your Ownership Strategy?
Does your firm have an ownership strategy that clearly defines how you will be able to exit your firm? Are you relying on selling your firm to a third party or the next generation of leaders?
According to the Census Bureau (and assuming age 67 for retirement), more than 9,000 people each day are hitting retirement age, and this is expected to increase to more than 12,000 per day by 2028. During this same period, the gap between the number of buyers and sellers will likely narrow and, in some years, will be negative. This gap will not widen to significant levels until 2035. During the next 15 years, transitioning ownership will be one of the major challenges for A/E firm leaders.
Boomers to Millennials
The chasm between buyers and sellers seems to be increasing, which is making ownership planning more challenging. Buyers—who will likely be Millennials—have a different appreciation for risk/reward trade-off, and many have higher student-debt obligations than previous generations. Compounding this chasm are the sellers—likely to be Baby Boomers—who are reluctant to give up control. Sellers also may not be satisfied with their valuation, because they’ve invested so much into their company but haven’t been taking anything out. They’re banking on the “End of the Rainbow” value.
Many firms elect an internal ownership transition plan, because sustaining their business and ensuring the welfare of their employees is most important to them. Although an internal transition plan is the path most firms choose, it doesn’t take an external ownership plan off the table. Many firms develop their internal transition plans with the desire to sell to a third party in the future. However, will the market be in their favor? If not, they still have the option of transferring internally.
The share repurchase obligation is one of the biggest risks of a closely held company. Since the redemption of shares isn’t a tax-deductible expense, for every $1.00 of stock value redeemed, a company needs to generate about $1.41 of cash flow. Managing this tax risk leads firms to seek alternative ways to improve liquidity for their shares by discounting their value, which can be done through equity-based deferred compensation plans, or sponsoring partial or 100-percent Employee Stock Ownership Plans (ESOPs).
Selling shareholders are finding it more difficult to get a fair value for their ownership interest in a closely held A/E firm. As a result, I’m seeing more firms relying on discounted stock valuation and delivering high returns in the form of dividend payments to offset low stock appreciation. Also, more firms are sponsoring ESOP ownership plans to take advantage of their tax benefits—especially 100-percent S-Corp ESOP ownership plans—as these firms become tax-exempt entities.
During the last two years, I have rendered more fairness opinions for firms converting their ownership to 100-percent S-Corp ESOPs than the previous 15 years. Will this trend continue?