Archinect
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Buying in to a firm

bowling_ball

Wondering what others' experiences have been with buying in to firms - good, bad, or ugly, and the circumstances around it.

As somebody with some debt, and an aversion to taking on another $250k+ to get my foot in the door, I'm starting to debate the opportunities in front of me, even if they're still a few years away. It can't hurt to have a game plan, but there's also plenty of risk.  Experiences?

 
Aug 12, 15 8:30 am
curtkram

i have only seen this from a fairly outside perspective, but from my experience it's hard to trust people.  if someone offers you the opportunity to buy in, get someone qualified to look it over and make sure it isn't just someone looking to screw you so they can cash out.

i know a guy in MEP that bought in to his firm and it seems things went quite well for him, so to say good, bad, or ugly, it could definitely be any of those.

Aug 12, 15 9:44 am
JonathanLivingston

I think it is almost always a bad deal. Architecture firms tend to not have much equity. It is very difficult to hand off personal relationships that repeat business is built on. The overhead, is fairly low compared to other businesses. you don't usually have a dependable back stock to value, no product sitting on the shelves that could be liquidated. Ask yourself this: If you were to buy in and then years from now business slows and you want out, how much would your share of ownership be worth? Would your investment return itself? In architecture the answer is almost always NO. There is just very little market for purchasing a firm, especially in bad times. This is why most people achieve partnership by starting their own firm or merging with another. If you have your own clients then that is really the equity you bring to the table and what you should use for negotiating partnership. 

I do know of at least one horror story of a smaller boutique firm that I worked at. During the 2007-8 recession things were getting bad, people were downsized and at least two employee's associates at the time were offered partnership for a 25k buy in. The money was used to pay down debt on a small business loan. The principle owner decided to shut down the business, as there was little work at the time. the two employee's as far as I know had to stomach the 25k loss as part of the business. I heard there was litigation but it didn't go very far. 

Anyways, Yes be very careful of buy in proposals for architecture firms. do the math and know what your buying, what the return on that investment should be, and what options for exit you would have should things not work out. The math can clearly be very different for say a large international firm who's name stands above the relationships but its a hard thing to estimate. 

Aug 12, 15 12:14 pm

You'd be much better off buying a 7-11 franchise. 

Aug 12, 15 12:18 pm
Carrera

You don’t buy-in for an investment; you buy-in for control.

Aug 12, 15 12:22 pm
JonathanLivingston

Buy in for control? A Share of control maybe. But not looking at that as an investment is a poor decision. Why not invest that 250k in starting your own business with complete control then? 

Aug 12, 15 12:27 pm

I don't think that's the question.  

Buying into a partnership as a minority interest gives you control of nothing while legally obligating you with fiduciary responsibilities and liability. Buying in as a majority interest is a takeover. If you have that kind of capital, why would you give it to someone else, and what would you get in return? It is an investment no matter how you look at it. If you're going to invest in a business, invest in your own or buy one that is proven profitable over which you will have complete control. Don't buy anything you won't own. 

Aug 12, 15 12:36 pm
chigurh

I heard a very similar story to Jonathan. 

AE company that was not doing well, principal offered buy-in to a bunch of employees, shortly after during the recession, company went under, somehow the original business owner jumped ship in time, made money, screwed all the people that bought in.

Agree with Carrera, if you are vested in the firm and there is an open book policy where you can do a full analysis prior to cutting a check, probably not a bad thing, especially if it seems like there is momentum.

Could also be worth starting your own shop, but that is tough...

Aug 12, 15 1:11 pm
quizzical

For those who aspire to become a principal in a firm, this decision often presents a conundrum of sorts. Here are a few dimensions one might consider when trying to come to grips with the decision:

a. What are alternative uses for the money you would need to invest?   Could the same investment enable you to start your own firm? Would you be comfortable / qualified starting a firm from scratch and becoming responsible for supporting and managing that firm as it grows? Would you be better off in the long run taking that same sum of money and investing it in equities or real estate - while continuing to work your day job?

b. How do you feel about the people who would become your partners?  Are they trustworthy? Will they treat you as a "true partner" or simply as an employee with a financial stake in the firm? Are they sharing with you all of the information needed to make an informed decision? Are they sincerely looking to you (and perhaps others) as a future leader of the firm and are they willing to work hard to ensure that you have the experience and skills necessary to become successful in that role?

c. Are you looking for "influence" or "control"?  Becoming a principal in an existing firm does not -- as mentioned above -- provide full control over your future. At best, it only gives you some influence, which can be meaningful in a small firm, but somewhat of an illusion in a big firm with many, many shareholders. How confident are you that you can parlay that 'influence' into 'control' over time?

d. How comfortable are you with risk? Owners don't just enjoy the firm's profits - they also share in the firm's losses. Principals frequently are required to sign personal guarantees on the firm's bank loans and leases - are you prepared for that? Principals frequently are the first members of the firm to take pay cuts / defer paychecks when cash flow dries up – can your personal finances accommodate those situations? Are you prepared to deal with professional liability risk as a firm owner? What if the firm fails - can you afford to lose your investment, along with your job?

e. Are you prepared to take on responsibilities above and beyond your project role? Are you comfortable dealing with personnel issues? Are you prepared to take on a much bigger role in business development? Are you prepared to learn about income statements and balance sheets – and deal with such information in a mature fashion? Or, do you just want to do projects and not get involved in all those other aspects of firm management?

f. Do you have a "vision" of what the firm should become over time?  Or, are you just along for the ride?  And, if you do have such a vision, to what extent do the other principals understand & share that vision?

g. Have you seriously considered what it would be like to be partners with these people during hard times? Because 'hard times' are inevitable. And, personality traits one rarely sees during periods of prosperity often surface when there is a serious downturn in the business. 

Nothing I write above is meant to deter anybody from pursuing an ownership interest in an existing firm. My aim is to help those people make a well-informed and successful decision if that is a direction one chooses to pursue.

Aug 12, 15 1:37 pm
Carrera

The problem with a buy-in is value, if you are inside I would only pay your share of book value, if you are from the outside I might pay market value, the difference between the two (market value is always higher) is “good will” (reputation, future business etc.). If you are inside you are a part of the good will, no point in buying yourself. Book value is easy to determine and it reflects what the current owners “own”, and with most architectural firms it’s not much.

Market value can get complicated and should involve a business appraiser; a lot of blue sky can creep in just dealing with what the current owners think.

As for “control”, they might be able to buy-you-out, but they can’t throw-you-out, any buy-in should include an employment agreement locking down your desired role, your income etc., making sure that the only way you can be terminated is through a buy-out. In my years I’ve never had a partner that could afford to buy me out.

A buy-in is an opportunity to control your employment; it’s no longer “at-will”. At book value it's a good investment to protect your future employment, and book value is mostly the value of the stuff...if the garbage bag breaks you can always sell the stuff.

Aug 12, 15 1:40 pm
3tk

A lot depends on your relationship to the current partners.  The buy-ins I've witnessed are the ones where due diligence was done (with accountants on both sides and lawyers having checked everything).

1. Do you want to work with the current and future partners?

2. What is the value of the firm (portfolio, client list, ongoing projects, growth rate, liquid assets, cash -if any-)? - See Carrera's comment above.

3. What is the value of the liabilities (insurance, debts -if any-, completed projects with remaining liability, ongoing litigation -if any-, operating costs)?

4. What are the terms of the buy-in - in most cases where my friends bought in, it was a percentage of their income (with some consideration for years of service to offset the liability they were taking on) more or less in line with their annual contribution to a retirement plan (10~15%)

5. How good is their strategic plan? growth and profitability?

-Buying a great portfolio is undoubtedly helpful, as long as the firm is growing.  If revenue is slowing or stagnant, it may mean more liability than value.  Also, as others have noted, you want to make sure that you're not just paying off someone's debt.  Most likely, you are helping some of the current ownership group retire - if there's a long term plan and they stick around to help you transition their best clients, it may be worth buying them out.

Aug 12, 15 2:30 pm
curtkram

they might be able to buy-you-out, but they can’t throw-you-out

i know of principals who owned their company and were basically thrown out.  we could get into a balkins-esque semantic argument about what "thrown out" actually means, or make up a bunch of stuff about what the contract actually said (which none of us has access to - i don't know the specific details), but in the end, an architecture firm was split basically along the lines of project type and the principals involved with the less favored project types were shown the door.

i don't think you can buy control.  you just change the form of what your lack of control looks like.

Aug 12, 15 2:44 pm
quizzical

Every partnership agreement, or shareholder agreement, that I've ever seen contained provisions for the removal of a partner, or shareholder, either "for cause" or "not for cause".  Do not for a minute believe that an ownership position in a design firm is tantamount to 'tenure' in the academic world.

If a firm wants you gone - either for performance or economic reasons - you will be gone. Naturally, the firm must purchase your ownership interest per the terms of the agreement that you signed. However, the value of a buy-out may vary, depending on the reason the individual is moved out - meaning "for cause" removals typically will involve a lower price, or a longer payout period.

Aug 12, 15 3:21 pm

However, if you have controlling interest like in a corporation, you have legal weight to prevent what is commonly called 'hostile takeover' and this is essentially in essence what is happening when partners force out other partners when buying out and then gaining sufficient control to vote out a shareholder who was the biggest shareholder and was functioning as CEO/President and Chairman. One's own control and ability to retain control comes in controlling interest.

In partnership agreement, controlling interest and voting weight has to be outlined in the partnership agreement as statutory default rules may default that each partner to have equal voting power. Whether you can do this depends on state laws and rules.

Uniformity isn't always so uniform.

Aug 12, 15 4:19 pm
curtkram

they wouldn't call it 'hostile' if it wasn't 'hostile.'

Aug 12, 15 4:34 pm

"hostile takeover' is a business term and isn't always that 'hostile'. You aren't necessarily seeing people duking it out. 

In this case, it isn't technically called a 'hostile takeover' but essentially the same process. There isn't necessarily an external business entity agent into the equation. Aside from that, the takeover process in corporate terms is about obtaining controlling interest and usually resulting in forcing out the old.

In any case, it really doesn't matter. Bottom line: It would be a 'takeover' process of some kind.

Aug 12, 15 4:43 pm
mightyaa

Totally depends on the firm.   A couple scenarios I know of.

One is an older established firm with retiring aged principals.  So, they selectively make offers to those they believe can pick up the torch as they fade out.  That is the ideal situation.  And they aren't going to give up there stock for free; It has worth and part of their retirement is banking on it.  Lots of 'stock transfer' vehicles can be used so it isn't such a hit (salary withholding, retirement plans & continued benefits, etc.).  Basically they are offering the stock, not as a way to raise capitol, but because they want the firm to continue after they've gone.  They are going to be selective.

Another situation is the acquisition buy in.  Troubled firm financially, yet has an outstanding portfolio and network in an arena or location you want to market.  It is a ton cheaper to snatch up a firm that already owns the equipment, space, tools, and staff than it is to build it up on your own.  You just have to bet on yourself that YOU can turn that firm around and make a profit.  Just like reality tv.  My Dad's old firm did this a few times to get footholds in different regions and open branches.  Usually this would be one firm buying another.  Occasionally, you'll see a well financed rain maker individual sort do this too.

Whatever you do, be realistic.  Don't expect you buying 5% of the company stock is going to get you much of a voice.  It will however buy you job security from first round layoff's because revaluing the firm isn't easy to buy your shares back at fair market value.

Aug 12, 15 5:00 pm
Carrera

Would just agree with Mighty, you’d probably last longer than the first round, and it matters if you’re a rainmaker.

Aug 12, 15 5:29 pm
geezertect

they might be able to buy-you-out, but they can’t throw-you-out

But, that works both ways.  You also can't throw out someone with whom you have major problems.  What do you do if one of your partners is making decisions which you believe are unprofessional, unethical, or illegal, which are exposing you to unwanted liability?  You are jointly and severally liable.  A small minority partnership interest could mean major exposure.

As for "market value" of the firm, there is no market for the vast number of firms.  They are not publicly traded, and there is no liquidity to your investment.

Be very careful.  I personally can think of better ways to invest cash money.  One of your investment goals should be diversification.  Having both your income and net worth tied up in a single entity is dangerous.  Ask the former employees of Enron.

Aug 12, 15 7:44 pm
quizzical

While apparently of a similar generation, I have to disagree with geezertect's post immediately above.

Compensation in architecture is, and will continue to be, difficult. Those who are reasonably well compensated are, almost always, participants in the ownership of a firm. The main benefits of ownership -- aside from the influence and control aspects already discussed -- are associated with the annual income potential that a successful practice can provide. The value and growth potential of one's equity -- while not insignificant -- does not represent the primary economic benefit that accrues to ownership. That value comes primarily from salary, benefits, perks and year-end distributions. "Buying in" often represents the ante required to enjoy those benefits.

There are, to be sure, risks associated with design firm ownership. But, careful and smart people can manage those risks to a very reasonable degree. 

Aug 12, 15 8:48 pm
Carrera

+++quizzical

It’s not a financial investment; it’s a rung in the ladder.

Aug 12, 15 9:12 pm
bowling_ball

Thanks for the feedback and discussion.

The reality is that the owners are running a very successful, 5th generation firm, which they've managed to grow from 6 to 20+ over the last decade, despite the recession. They've offered to open the books when the time comes - and are open to being "pushed out" by the next generation of owners, because both have been very successful and want to retire while relatively young.  The question for me becomes, will I be able to keep the ship from sinking during hard times? Will I be able to call on the established relationships that already exist between arch firm and owners, or contractors? The firm is currently very profitable, but there's no reward without risk. 

Aug 13, 15 12:56 am
curtkram

What kind of relationship do you have with the people offering you their company?  Rich uncle who wants you to succeed?  Employer who has mentored you for years and wants you to keep their business running?  Random person who posted an ad on Craigslist? 

Aug 13, 15 7:44 am
geezertect

How many "successful" firms survive the death or retirement of the founding principals?  I don't know the answer (maybe someone else does) but my guess is that the number is pretty low.  That should tell you something about the odds.  Architects' time is heavily concentrated on serving a small number of customers.  It's just the nature of the profession.  Consequently, the "chemistry" and confidence that the client has in the firm is bound up in their respective personalities.  It is not very easily transferable.  

Aug 13, 15 8:42 am
mightyaa

Ummm... Geezer.  The one he's talking about is "5th Generation".  So who cares how many don't... this one does.

Aug 13, 15 10:41 am
curtkram

i bet that's what lehman brothers said.

Aug 13, 15 10:57 am
null pointer

geezer,

Noting how many clients I've taken with me from my previous jobs, I'd dare say that's bullshit.

Architects are rarer than you think, and we are a bitch to deal with (I only actively chase a few leads, most people think architects produce drawings and only drawings, and don't like to pay for information). Luckily, most people don't have the luxury of picking among more than 2 or 3 architects.

Aug 13, 15 11:02 am
Non Sequitur

We have a client in my office who juggles 2 to 3 different local architects. To save time, he'll often have everyone at the same table even-though the projects discussed are from different offices. There is at least 6 to 8 active projects in my office from this one client.

Aug 13, 15 11:13 am
Carrera

It’s not “bullshit”. Depends on the principal. Depends if you are buying a firm or buying a principal. It takes time to transition and to wean the client base from the founders, know many that didn’t survive.

Aug 13, 15 11:21 am
gwharton

On the financial side, there are good reasons to buy in: mainly to participate in profit distributions and build value for retirement (pension? LOL. What's that?). My grandfather, who was a fairly successful businessman (profiled in the WSJ and all that), was a lifelong advocate of the principle that your best investment is always in yourself. Put your money where your mouth is, and all that. It's a good mantra to live by.

The downside on the financials is that architecture firms are notoriously difficult to value, and our workflow is very unpredictable. I personally know a handful of architects who made partnership buy-ins just prior to the Downturn. Their first profit participation cycle, after having just ponied up a couple hundred thousand in equity, was a demand to pay in to cover losses. That was extremely painful for them, and in a couple of cases resulted in lawsuits. Architecture is a cyclical business. Unfortunately, that means that most buy-in offers are made near market tops when the business value and workload high and the future looks very bright. Not a lot of partnership offers get made during recessions. So be aware that your buy-in could easily go underwater for a decade before it really starts to pay off for you.

For those of you who have never looked at a firm valuation statement or firm balance sheet before, there is an accounting term you should become intimately familiar with: Goodwill. This is the accountant's way of taking something that is totally intangible and nearly impossible to quantify (reputation, relationships, quality of past work, loyalty of staff, and all that stuff) and turning it into a number so that the green eyeshade types can feel more comfortable talking about it. Incidentally, you may notice the parallels between this concept and trying to sell your clients  on the value of good design (another intangible which is unquantifiable). When you're the prospective buyer, now the shoe is on the other foot. What is the firm actually worth?

Architecture firms typically don't have much by way of real assets to use for a realistic book value. Computer equipment, furniture, and possibly their own office building if they've been extremely profitable and foresighted. That more or less exhausts the list of assets. They typically also don't have much cash either. The way tax laws apply to arch firms provides a huge incentive for owners to distribute all profits to themselves and not have any retained earnings. This is another reason why firms are typically very sensitive to market cyclicality and lots of them downsize radically at the first hint of work slowdowns: marginal cash flow problems and lack of any kind of cash balance on the books. That's what happens when your costs are fixed, your income is variable, and you have very little margin for error.

An architecture firm really only has three meaningful assets, none of which you can analyze and put a hard number valuation on:

  1. The reputation of the firm and relationships with its market
  2. The people on staff
  3. The portfolio of work

All three of those things are lumped together under "goodwill" in a valuation, disguised by a lot of hand-waving and rationalizations about three- and five-year past performance metrics. The firm doesn't even "own" the first two (as much as we'd like to actually chain interns to desks), and the third is what you might call a "wasting asset." So even though you own it, you have to constantly work to maintain its value.

That's a big problem, and there is an entire subspecialty domain of accounting devoted to dealing with it. With only limited success.

Which is all a really roundabout way of saying CAVEAT EMPTOR. The best way to know the value of a firm is to have been part of it for many years, knowing it from the inside out, doing your own due diligence as an experienced part of it. Even then, you can wind up with hidden problems (especially if the firm is highly entrepreneurial in its management style). But you've got a much better understanding of it, so at least you'll know it was a snake when you pick it up.

(more in next installment)

Aug 13, 15 11:38 am
gwharton

The second reason to become an owner in a firm is to be in control of your own professional destiny and no longer practicing at the whim of other architects. This is often the more compelling reason to do it, emotionally and psychologically. It provides the closest thing there is to stability and lets you start working for your future without the distraction of wondering whether or not some senior partner in your firm is going to throw you on an unemployment line because they screwed up a pitch meeting.

Of course, once you have control of your own destiny, you are also 100% completely responsible for it. That's the part most of us don't really think through.

As an owner in a firm, you become personally responsible for it. Let's take a moment to think that over and let it sink in. You. Personally. Responsible.

I'm not just talking about the legal liability ramifications of having your name on the masthead of a regulated professional service firm dealing with life safety compliance issues. There is that, but the kind of responsibility I'm talking about here is much more far-reaching and scary. I can, however, sum it up with one word: LEADERSHIP.

I've written on this topic extensively in other places, including for AIA whitepapers, but I'll try and summarize.

As a firm owner, you become one of its leaders. Leaders must provide direction and establish and maintain organizational culture. They must anticipate and then provide strategies for dealing with change. They need to build loyalty and common purpose. They need to be pro-active stewards of the people for whom they are responsible, building them up and empowering them to act toward common goals.

Most importantly, I'm going to say this explicitly since most architects seem to be very confused about it: LEADERSHIP IS NOT MANAGEMENT and MANAGEMENT IS NOT LEADERSHIP.

You may be a great manager, project or otherwise. That says nothing about whether or not you will be an effective leader. There are a few traits and behaviors common between managers and leaders, but the skill domains between them are more different than similar. As an owner, you will have to do both, but you'll need to be more leader than manager most of the time. Firm leadership is not just a slightly-more-complicated version of project management. It's an entirely different animal. Are you ready for that?

The good news is that leadership skills and abilities can be learned with practice. It's not magic. So you can prepare yourself for it. Doing so by trial and error on the job when you have to make payroll every two weeks, however, is not the best way to go about doing that. If you're planning to make a buy-in, prepare yourself to move into a leadership role in the company, not just with your staff, but with your clients, markets, and peers. Do that, and you'll be successful and your investment ought to pay off many times over.

Aug 13, 15 12:05 pm
Carrera

^+++ However you don't necessarily need both if you have partners.

Aug 13, 15 12:12 pm
gwharton

If you're a partner, you're a leader. That's kind of the point. Management-only partners should not be partners. They should be managers.

Aug 13, 15 12:13 pm
Carrera

Well, I just disagree; the whole idea of having partners is the mix. I do agree that all partners need some leadership qualities, but not all need it to your suggested level.

Aug 13, 15 12:22 pm
curtkram

i've mentioned before; some people get carried...

Aug 13, 15 12:26 pm
gwharton

Partners in a business definitely need to have complementary skill sets, and having a partner with strong management skills is a must as part of that. I don't dispute any of that. There are many successful practices where you've got a design-emphasis partner, biz-dev-emphasis partner, and a management-emphasis partner. That's a solid combo.

But simply by virtue of being an owner, you are a leader first. Everything else is really secondary to that, management, design, whatever. Failure to come to grips with that has resulted in a lot of firms developing serious problems.

Aug 13, 15 12:28 pm
Carrera

^ True, had a bunch of them.

Aug 13, 15 12:28 pm
Carrera

^ was referring to "some people get carried"

Aug 13, 15 1:13 pm
3tk

Common thread i see above, and one I've seen in many successful multi-generational firms is the partnerships at the top - sole proprietorships seem harder to hand down in comparison to those that stick around for ages; the team effort of multiple partners with complementary strengths can bring the best out of each.
 

Aug 13, 15 3:16 pm
shellarchitect

really interesting discussion...

My former firm was transitioning from a partnership to employee owned at the time that I left.  From what carrera's written it sounds like this is a great way for the chairman and another partner to maximize their buyout price since everything is great now w/o having to worry about finding someone w/ the cash to buy in

Aug 13, 15 3:43 pm
Carrera

Owners wishing to retire have to start the transition early, if they have no partners. The problem is too many wait too long to start, because they resist transition. With partners it's easier to step away.

Aug 13, 15 4:30 pm
quizzical

Most architects think 'ownership transition' is primarily about money.

In fact, it's much more about 'power and control' -- meaning a) who has it now; b) who's going to have it next; and c) how quickly and thoroughly will that transition take place.

In my experience, most OT processes that fail end up failing because the individuals wanting to sell their interest in the firm are unwilling, or unable, to start sharing REAL power and REAL control early enough in the process to keep the next generation from becoming extraordinarily frustrated. The roots of this reluctance usually are strongly embedded in "ego".

Aug 13, 15 7:01 pm
gwharton

...the individuals wanting to sell their interest in the firm are unwilling, or unable, to start sharing REAL power and REAL control early enough in the process to keep the next generation from becoming extraordinarily frustrated.

I personally have left two firms for exactly this reason.

Aug 14, 15 5:00 pm
shellarchitect

funny coincidence, over the past weekend I got a letter from my former firm basically saying that my share of the company was worth about $12,000 (way more than I expected) unfortunately I left too early too for any of that to vest.

Aug 25, 15 12:11 pm
geezertect

^  Why did they send a letter telling you that, if it was moot since you weren't vested.

Aug 25, 15 7:23 pm
comb

^ I suspect they must keep shuellmi's account active for a certain period of time by law -- if shuellmi were to return to the firm, he probably could pick back up where he was on the vesting schedule when he left.

Aug 25, 15 9:08 pm

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