Growth and Succession

TEXT Elaine Pantel 

In early 2010, our firm, which has had a specialized practice area for many years devoted to the specific needs of architecture, engineering and design clients, was invited by the Ontario Association of Architects (OAA) to consult on proposed changes to the Architects Act in Ontario that would offer much greater flexibility in how the ownership of firms governed by the Act could be structured and organized.

Of particular interest to the OAA was finding out what the impact of the proposed changes would be on its members and in defining the new opportunities they would present to the owners of architectural firms throughout their active practice years and into retirement.

Among the many benefits to the firms impacted by these changes–which were implemented in 2011–is that they now have more options than ever to develop a long-term vision and strategy for growth, including internal employee succession plans, growth through a merger and/or acquisition, and the sale of the firm to an outside third party.

This first instalment of a two-part series outlines the key legislative changes in the Act relating to the ownership of architectural firms in Ontario. The next instalment will expand on how these changes can help firms in moving forward with the implementation of their long-term strategic growth plans by exploring a variety of new options. Many of these planning issues will impact any firm contemplating future growth strategies.

Arguably, the biggest change presented by the amendments to this area of the Act is that an ownership stake can now be taken on by a wide range of parties who had previously been prohibited from doing so. As before, the Act requires that at least 51% of the votes and value of the firm is held by members of the OAA and/or the Professional Engineers of Ontario. However, until the changes to the Act were introduced, the remaining interest could only be held by full-time employees of the firm.

Provided the 51% test is met by the firm, ownership shares can now be held by such parties as:

• Employees who are not OAA members (e.g., technical professional staff, senior finance and administrative personnel). Already, we’re seeing that internal succession plans in which ownership is offered to a broad base of employees over a period of years is becoming an increasingly popular organic growth strategy.

• Family members. This creates opportunities for income splitting and overall tax savings for the family, as income may be allocated to a spouse and adult children who are in a lower tax bracket, commonly through the use of a family trust.

• Retired owners who may wish to continue to hold an ownership interest. This provides a continued source of capital for the firm and a potential tax-effective income stream for the individual through the use of a holding company.

• Outside investors. This provides new opportunities for funding working capital, financing the expansion of the firm and providing funds to buy out existing owners. Investors may participate by way of loans and/or equity.

An additional significant change in the Act is that the legal manner in which ownership interests may be held has broadened, permitting a greater range of creative planning strategies using personal holding companies and trusts, and multiple classes of shares. The firm may be organized as a corporation or a partnership, and the overall legal structure may now involve the use of multiple operating and holding companies. Using personal holding companies creates many tax planning and investing opportunities. In certain scenarios, for instance, cash can be paid by the firm to a holding company as a tax-free dividend, allowing the shareholder to accumulate surplus funds in a tax-efficient manner.

The new ownership rules provide added flexibility in structuring the ownership of an architectural firm in Ontario by making it easier to bring in new owners to the firm, creating the ability to form new business arrangements and attract outside investment for the growth of the firm.

At any time when ownership changes are contemplated, it is important to step back and review the existing structure to determine whether it still meets the needs of the current owners and what may need to be changed to make it more appealing to future owners. Encompassed within this is the need to ensure the ownership structure properly addresses all related business and income tax issues.

A key point worth mentioning is that it is vitally important when considering the structure that fits with the owners’ strategic plan for the firm that long-term risk management issues are being adequately addressed. These key risk areas need to be considered during the due diligence process and before a corporate restructuring is undertaken, as this will most definitely impact on the specific ownership structures and related tax planning that will be implemented.

A Few Specific Points

Financial risk needs to be considered at several levels, starting internally with cash flow and profits from business operations, terms and conditions of financing by third-party lenders and investors, and how the owners’ retained profits may be protected from creditors. Some strategies include the use of holding companies and securing shareholder advances to the company.

Liability risk is a complex area that differs for each firm. Professional liability risk, which flows to the individual licensees, is covered by professional liability insurance. Commercial risk which relates to other business activities is covered by business insurance. The strategy is to isolate the risks for different business segments in the corporate structure through the use of separate legal entities, particularly where there is a multidisciplinary firm which includes an architecture practice.

Business risk is addressed through properly considered and drafted ownership and participation agreements. The key sections of these agreements deal with management and decision-making, buy-sell clauses for future changes in ownership interests, and dispute resolution.

Changes Impact All Firms in Ontario

Regardless of whether an architecture firm is contemplating an ownership change, the revision of the Act essentially provides an opportunity for all such firms in Ontario to undergo a review of their ownership structure to ensure everything is optimized for business and tax planning purposes.

However, whenever the number of owners is set to change, there are more factors to consider, and each owner will have a unique personal situation that may require a specific tax planning approach. The key is that the structure needs to be considered as early as possible in the planning process, because changing the ownership structure can be a complicated and time-consuming process.

The ultimate goal is to have everything in place or at least mapped out before you proceed with the strategic plan. CA

Elaine Pantel, CGA, is Principal, Assurance and Business Advisory at Toronto-based Shimmerman Penn LLP. Elaine is co-lead of the firm’s industry specialist group for architecture, engineering and design firms.