There are several ideas for helping “first-time” buyers—those with outstanding loans:
• Some firms have tried extending a second loan from the firm to the new partners to help them make the payments, essentially making the payments on their behalf. Such loans can be subordinated to the original loan and be repaid when the crisis is over. This is even easier if the firm is the lender (though in many cases we have been involved with, the professionals borrowed from a bank). Unfortunately, we’re assuming that firms have the capital to lend a hand when they may not.
• Another idea is for firms to try to protect their profit margins at the expense of compensation. There were a select few very large firms that did that in 2009: The partners took a pay cut so that the profit margins could stay at a healthy level and the new owners could continue making payments. Depending on the size of the firm, the partner compensation can be between 15% of the revenue (at a very large firm) and 40% (at a small firm) and the economic impact of that can be very significant. The political process behind these decisions, however, is anything but simple. A number of partners have to voluntarily give up compensation for the benefit of a few. This can be a real test of unity.
What we have to remember is the reason equity was sold to the new partners in the first place: so they could commit their energy and careers to their firms and therefore create not just succession but also growth and stability at their firms. The decision is a symbolic one too. By making professionals “partners,” we declare our commitment to one another.
Delayed Succession Gets Delayed Again
Those that fly a lot will recognize the phenomenon that when a flight is delayed once, it is 10 times more likely to be delayed again and again until it may even be canceled. In a similar fashion, succession plans that were already behind the ideal time line will become derailed by the current crisis and may need to be canceled entirely.
In his book Success and Succession, Tim Kochis made it clear that the process works best if you start early. If you start late, valuations and cash flow work against you. If you postpone the deal some more, you may never catch up. It was not until 2011 that partners saw their income reach the levels they expected before the great recession, and three years may be a very long time to wait for many plans to have a realistic chance.
Imagine, for example, that a successor had planned to purchase 5% of the equity of a firm each year for the next five years. This would make them a 25% owner by 2025 and would allow one of the founders to retire. What happens now if we have to wait three years for a recovery to start the process again? Either the founder’s retirement has to be pushed back to 2028 or we have to somehow get the successor to buy larger “chunks” (for example, 3 x 8.33%) starting in 2023. Neither choice may be practical.
Some remarkable entrepreneurs I talked to in the last month looked at this problem and decided to forge ahead. The founders committed to continue selling equity, even at a lower valuation, and to finance the transaction so that it worked for the buyer. I truly admire such businesspeople, but unfortunately, they are likely in the minority. Even if the sellers stay committed, the buyers may not be there.
Buyers Get Scared
Internal buyers are a nervous bunch. Many of them had likely already been worried about what would happen during a recession amid a meteoric rise in advisory firm valuations, which they likely saw as unsustainable, and that likely made them wary of buying into equity that could decline. Now their fears have come true and the trauma may leave them without any further appetite for the risk of buying equity. They’re also facing a period of reduced or frozen compensation that will deplete their personal financial resources, perhaps force them to put personal projects on hold (home projects, for instance). It can be a bit like the feeling after you’ve twisted an ankle. You’re going to be afraid to jump for a while.