Merger and Acquisition Considerations for Design Professionals
by Jane M. Myers, Esq.
Architects, engineers and other design professionals sell or merge their design firms for many reasons. Sometimes it can be an exit strategy for the firm’s retiring principals. Other times it’s a means to enhance the scope and level of services for clients.
The merger or acquisition of any kind of company will create many issues that must be considered before signing a deal. These include: compatibility of corporate cultures, management and control of the combined entity, calculation of the purchase price, how and when the purchase price will be paid, and the roles of the principals and key employees after the merger or acquisition.
When the transaction involves design professionals, a number of special additional considerations arise.
Need for Professional Board Approval
In New York, the merger of one professional corporation (“PC”) into another, or the combination of two PCs to form a new PC (known as a “consolidation”), requires prior approval by the New York State Department of Education. However, the approval process may be avoided depending on how the transaction is structured. For example, rather than formally “merging” with another firm, a PC might sell its assets (including equipment and contracts) to the acquiring firm. Principals and/or key employees typically enter into employment agreements with the acquiring firm and thereafter, the selling PC is dissolved. The structure of the transaction will almost always trigger tax consequences and other financial repercussions. The parties would be well-served to consult with their accountants before committing to the transaction structure.
Penalties can be great for doing business in a jurisdiction where a design firm does not have proper authority. In some states it may be a criminal offense (ranging from a misdemeanor to a felony). In many states, if a client doesn’t pay the design firm’s fees, and the firm is not authorized to do business in that jurisdiction, the state will not allow the design firm to use its courts to collect those fees.
Every state has its own criteria that design firms must meet in order to legally practice there. Qualifying in another state can be difficult, and for that reason design firms often look to merge with or acquire a firm already practicing in that other state.
While some large national design firms may appear to be a single, seamless entity operating in multiple jurisdictions, in fact (if they are complying with the local laws), they are really many separate companies with identical or overlapping ownership, each tailored to meet the requirements of a particular state or group of states.
Completion of Projects
Most contracts require client consent before the contract can be assigned to a new firm. Sometimes there may be instances where consent simply can’t be obtained. The principals should consider keeping the firm “alive” temporarily if ongoing contracts cover projects in states where the new firm isn’t authorized to practice, or where the projects involve a profession that won’t be practiced by the new entity.
Collection of Fees
With respect to ongoing projects, the agreement between the design firms should cover how fees will be allocated between the firms. An important consideration for the principals of a firm that is being acquired or merged into another, and will keep ownership of its receivables, is how will those receivables actually be collected? Does the new firm have collection personnel who will undertake the process? Will there be a percentage or other charge for their services? If the principals and/or employees of the merged or acquired firm must spend time to collect existing receivables, will they be given enough time away from the new firm for this purpose?
Professional Liability Insurance
Going forward following a merger or acquisition, malpractice coverage will generally be provided by the surviving or acquiring company. Typically there is a great degree of discussion and negotiation regarding “tail coverage” – that is, coverage for the members of the merged or acquired firm for claims made against them for work they did prior to the closing and made after that firm’s insurance policies have been terminated. Tail coverage premiums can be expensive and responsibility for payment should be carefully spelled out in the contract. To avoid any gaps in coverage, both parties should contact their respective professional liability insurance brokers early in the process.
While professional licensing and practice issues add a layer of complexity to mergers and acquisitions involving design firms, the issues can usually be resolved. Addressing the issues at the outset, with advice from the firm’s accountant, attorney, insurance agent and other advisors, will help to ensure a smooth and successful transaction.
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Please note that this article is intended only as a general discussion of issues pertaining to the sale or merger of a practice and that it should not be taken as creating an attorney-client relationship or as legal advice with respect to any particular person, business or situation. Circumstances and the applicable legal principles vary and you should consult with an attorney and/or other professionals regarding the facts of your particular situation.