Transitioning from founder-led to perpetual governance models
The Professional Practices Alliance recently explored the transition from founder-led models to perpetual governance models. A short summary of the some of the key points is set out below.
How can you value blood, sweat and tears? Even if founders think it is valuable, do the next gen agree?
Some possible models for founder exits
- Return of capital and distribution of profits, but no value for goodwill. Attractive to next gen. Often (unpleasantly) described as ‘naked-in, naked-out’.
- Annuity after retirement. Now rare. Good for retirees but burdensome for continuing partners and hinders recruitment and/or mergers.
- Consultancy arrangement. Often linked to performance (billings are easy to track but tat’s not right-perhaps fee for being available and effective transition).
- Valuation based structure. Buy in at outset and sell on exit. But what is the value? May be some value in recurring work or ‘stickability ’. But is that sticking with the firm or partners?
Next gen may not wish to inherit the firm. But current leadership needs to bring the next gen into leadership ASAP if founders want them to stay. They are the ones who will keep the business valuable and therefore fund founder exit routes.
Founders often have unrealistic expectations of what the business is worth. Even if realistic, next gen leaders may not want to pay that price.
A multiplier of 4 x revenue is often cited in the context of valuation. But it is still very rare for consideration to be paid on capital events, such as mergers, so it is too simplistic to say this can be used as a rule of thumb. The focus should be on the future, not the past. Smaller businesses could perhaps only expect a 1x multiplier.
Cash is King. Cash flow forecasts are vital to understand how and when founders can and will be paid out.
In professional firms, equity partner return usually comes in the form of annual profit distributions, which leans on the efforts of less well remunerated team members. The next gen may feel that the founders have already been paid-out. Is there a risk of mutiny? High achieving professionals have a lot of options.
Capital events – such as listing or mergers – may be a possible exit route. This requires the coordination of founders and next gen, and usually ties in partners for a period of time. Some capital routes secure value for the current generation of leaders (whether founders or next gen), but reduce opportunities for future generations unless there is significant growth.
An organised transition requires detailed agreement of what the retiring founder’s contribution and compensation will be. Discuss this early (e.g. 3/4/5 years before proposed exit date). This is a highly emotive situation, but this is a challenge which professionals can set for themselves and there is no reason why they cannot rise to this.
Honesty and collaboration are vital, as is changing traditional silos to secure effective transitions. Expectations needs to be managed – all partners, not just founders. Careful planning and transparent/open conversations are vital to building consensus. This will support founders, but also protects against the risk of next gen leaders leaving.
Will founder exits lead to name changes? What impact will this have on the brand?
The legal bit
Succession plans are only effective if they are properly implemented. It needs to be embedded into the firm’s agreement, culture and/or working practices. This is often overlooked, as it is bespoke to each firm.
The agreement may address some/all of the following:
- Transition of management responsibility.
- Coaching and/or mentoring for next gen but also retiring founders.
- Correct balance of voting rights of founders and non-founders/next gen?
- Profit sharing.
- Anti-embarrassment clauses?
- Transition of client relationships.
- Admission of new partners.
- Mandatory retirement age (assuming not unlawful discrimination).
- Lock-in of next gen partners.
- Restrictive covenants post-exit.
- Dispute resolution (consider mediation and/or arbitration for confidentiality).
Many thanks to the insights from the fantastic panel of Claire Watkins, David Shufflebotham, Fernando Pelaez-Pier and Zulon Begum and brilliantly chaired by Robert Millard.
If you would like to discuss any of the issues raised in this summary please contact Head of Professional Practices, Corinne Staves or your usual MTG contact.
Related in brief posts
The Association of Partnership Practitioners webinar on 12 May 2021 explored the role of NEDs in professional practices. The following is a summary of some key themes and ideas.
The Professional Practices Alliance hosted an interactive discussion on the future of working arrangements and professional firm space chaired by Corinne Staves, with panelists Oliver Richards, Beth Hale and Rob Millard.
Maurice Turnor Gardner has been included in the Times 2021 list of the best lawyers for business, public and private-client law of the top 200 legal practices in England and Wales.