The 5 People You Should Know When Buying an Architecture Firm
Kate Conley, AIA, LEED AP shares her story of acquiring an architectural practice with two partners and highlights the five key people you need to know if you’re considering firm ownership.
In February 2021, two partners and I bought an architecture firm. Our seller started his practice 40 years ago and was on the brink of retirement with no clear succession plan in place. Though my now-partner had only worked for him for a year, her skill and drive inspired him to offer the purchase of his practice to her. Not wanting to embark on firm ownership alone, she invited an architect with whom she had been collaborating on a project and me, a friend and fellow architect, to partner with her. After half a year of negotiations over video conference during a pandemic, the firm was ours. I still have never seen one of my partners in person, but we are three women in our mid-thirties running a thriving affordable housing practice.
Though our story may seem unique, the scenario is becoming increasingly common as the baby boomer generation of architects who started their firms in the late 70s and early 80s reaches retirement age. Deltek tells us that two-thirds of architecture and engineering firms have no formal plan for succession.(1) Many Millenials like my partners and me find ourselves uniquely positioned to take on not only leadership but ownership of these existing practices, particularly on the brink of a massive shift to virtual or hybrid working environments that traditional firm owners near retirement simply lack the energy or desire to undertake in their final few years of practice. These opportunities are particularly rich for women, who often start their own firms in order to gain leadership positions otherwise out of reach for them at traditional firms and now might find avenues to do so with less of the risk inherent in starting at square one.
If you don’t think this scenario applies to you, trust me, I wouldn’t have a year ago either. This opportunity found me, and will increasingly find many of you reading this. Two out of the three of my partners (myself included) would have put ourselves at a 1 out of 10 on a scale of desire to start our own firm. And that’s the key. In our minds until this year having our own practice meant STARTING our own practice. We were not willing to slow down the good work we were doing to provide much needed affordable housing in the midst of a housing crisis to build up a practice from scratch. The chance to take over an existing practice and build on a portfolio of projects and client relationships that is older than we are felt like a once in a lifetime opportunity that we could not bring ourselves to refuse.
The number one question we get is, “How did you afford this?” followed closely by, “How did you DO this?” The answer to both is, “With good help.” So without further ado, allow me to introduce you to the five people you should know when buying an architecture firm.
1. Your network
Chances are, you already know someone who has gone through a firm transition, but you may not know it. Put out feelers with members of your local AIA chapter. In our case, a friend from our local Women in Architecture (WIA) committee had recently gone through her own firm transitions and freely shared her contacts and lessons learned with us. Your network’s recommendations will be relevant and local so we encourage you to start there.
Your friends and family will also be a huge support during this time. As you negotiate, there will be emotional ups and downs that you’ll want to talk through with someone. We do encourage you to keep this circle very small. The more people you tell, the more people you have to update with every step of a long process. You also want to maintain the ability to walk away from bad negotiations or a bad deal at any time. If you’ve already told your whole network about the firm you’re going to buy, you’ll have a lot explaining to do. Keep it to a few close people: a parent and a friend, or a sibling and a mentor. Exercise caution about what information you share with these confidants as well since parts of the negotiation process will be confidential, especially when the lawyers enter the picture at the end.
And if you find yourself in the position of buying a firm, give my partners and me a shout. We received critical help and advice from our friends and networks during our negotiation, and we would love to provide the same for you.
2. Valuation Specialist or Management Consultant
The first thing you need to do is establish what you’re buying and how much it’s worth. In our case, our seller had already had his firm valued by someone who conducts firm valuations as his profession. So we sought out a second opinion to vet the valuation and advocate for our side in the negotiations. Our consultant came highly recommended by our expert #1, our friend from the WIA.
There are some professionals who are better suited to helping with internal firm transitions, where existing employees or shareholders of the firm slowly take ownership as the firm leader phases out. Others specialize in external firm sales, where buyers from outside the firm purchase the practice all at once in a single transaction. Our situation was a bit of a hybrid as one of our partners was already an employee at the firm. But because she was not an existing shareholder, the other two of us were external buyers, and the seller wanted an immediate exit, we treated our transaction largely as an external sale. There are LOTS of ways to calculate the value of a firm, so you need someone in your corner to walk you through all the options. (2)(3)
Our advocate flagged areas of the valuation calculation that emphasized the firm’s more profitable years and diminished its less profitable years. She requested all the appropriate backup information to evaluate the financial assertions being made by the seller’s team. She was fierce in meetings, encouraging us not to respond to new information right away but rather to take time to evaluate and come back to the table armed with all the right information we needed to proceed. And most importantly she provided wise counsel to the three of us, reminding us of the value we brought to the table and galvanizing us against what was, at times, a bruising negotiation process.
This is an important point. This process is emotional. On one side you have a firm owner who has spent decades building a practice that is to them, understandably, almost priceless. Then your job is to tell them, firmly and repeatedly, exactly how much you are willing to pay for that priceless legacy. It is HARD. I cannot overemphasize that. You need a neutral third party who will advocate for you through the hard. It takes a lot of hours. Do not use a lawyer who will charge you $600/hour for this service. You will go broke during the negotiations before you have paid even a penny for your firm.
By the end of the negotiation process, you will have hammered out a terms sheet that outlines the firm valuation method and all of the stipulations and conditions you have agreed to in one consolidated document. This is where the lawyers should come in. But, before you sign that terms sheet you need to talk to experts #3 and #4: your insurer and your CPA.
3. Insurance Company
It is very likely your seller is looking to have you take on ten years of liability on their past projects. As architects, we are liable for our completed works for up to ten years in California and in many other states. Most insurers will not insure a retired, non-practicing architect for this, as “tail end insurance” typically only covers up to five years. Therefore firm owners who want to retire should not simply close their doors and abandon their practice.
They must sell their liability to other architects in order to retire with peace of mind. This is a massive bargaining chip for a buyer, as a seller eager to retire likely needs you more than you need them. While you may have stars in your eyes about the amazing firm you’re going to lead, the Seller is faced with this very real necessity.
Once you’re at a point where you and your fellow buyers are fairly certain you’d like to proceed with the sale, it is important that you speak to your planned insurer about continuing liability coverage for the extant projects, or “prior acts”, you are assuming liability for. In our case, this was the current insurer of the firm we were buying. For practices that are acquiring another firm, this may mean your own current insurer.
4. Certified Public Account aka your “Tax Expert”
The best piece of advice we got from our experts #1 and #2 was to understand the tax implications of the way our deal was structured. We were fairly close to a finalized terms sheet when we reached out to a CPA with experience preparing taxes for small, service-based businesses like architecture firms. He also had personal experience acquiring an accounting firm from a fellow CPA years prior.
Our CPA pointed out a massive disparity (read: several hundred thousand dollars) in the tax implications for us depending on the way we structured the purchase. Without getting too much into the weeds, a purchase can be structured as a purchase of stock or a purchase of assets. Purchase of stock is great for the Seller but has considerable tax implications for the Buyer. We would have proceeded down this route had we not spoken to our CPA first and been very sad firm owners indeed come tax time. Purchase of assets is labour-intensive, as all aspects of the firm have to be broken down into an asset with a dollar value, but from a tax standpoint, an asset purchase is advantageous to the Buyer.
There is, however, a middle path. Stay with me now: two sections of the tax code, Sections 336(e) and 338(h)(10) allow the purchase of stock [good for Seller] to be treated as a purchase of assets [good for Buyer] from a tax standpoint. (4) Section 338(h)(10) is for a corporation buying another corporation. Section 336(e) is for individuals, like my partners and me, buying a corporation. Huzzah! Who doesn’t love a win-win option?
Another factor that may have tax implications for a deal is that different portions of a sale, such as stock purchases, contingent goodwill, and bonus or non-compete incentives to name a few, are all taxed differently. So it is important for both sides to evaluate the full terms sheet package to determine the best route. Paying more for the stock, for example, might be less expensive in the long run if it has lower tax implications. It is not important to understand all of this terminology before you embark on a deal, but it IS important that you talk to your CPA about the nuances of your situation. Don’t just agree to buy that stock without talking to a qualified accountant!
5. Attorney
Once you’ve talked to experts #1-4 and have your terms sheet ready, it’s time to talk to expert #5, an attorney. These folks are highly skilled but also highly expensive, which is why we bring them in at the end. In our case, our Seller’s attorney was the attorney for his practice, and she was already familiar with the business we were buying as well as acquisitions like ours. She and her team drafted the purchase agreement. My partners and I hired our own attorney to review the drafted agreement, provide comments, and answer any of our questions about the deal.
The goal here is to make this process as streamlined as possible. If you’ve taken the time and talked to the right people in steps 1-4 then the deal should be all but done. This step is about making sure the agreement matches the terms sheet. (It’s like checking a submittal for conformance with construction documents. You shouldn’t be reinventing the wheel at this point.)
In that spirit, we hired an attorney who was a former colleague of our Seller’s attorney. Our attorney was very familiar with her work, found the draft agreement largely complete, and had few comments, although he still advocated firmly on our behalf where we needed him to. Because of their existing rapport, once we had the draft agreement in hand our review-and-comment period only took a couple of weeks.
Then, when all the t’s were crossed and i’s were dotted, we signed the agreement to purchase our firm. Thank you gifts, gushy emails, virtual toasts, and press releases all followed. And now we are back to doing architecture, our way. Not that we had the luxury of taking a break from our full time jobs while all this negotiating was going on! We can honestly say we might not have reached this point, and certainly would not have an acquisition deal we are so happy with, without the sage advice and unflagging advocacy of our expert team.
We want to help you with your upcoming firm transition plans and questions. This article only scratches the surface of all that we learned on our journey to acquisition. Find us at https://www.firmacquisitions.com/ or email me directly at info@firmacquisitions.com