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When those aging baby boomers just won’t retire

“When Alan turned 60, he announced his intent to retire at age 65.  That was ten years ago.”

Alan co-founded a successful consulting engineering firm when he was in his 30’s. Over the years the practice grew steadily, adding new staff, offices, and owners along the way. When Alan turned 60, he announced his intent to retire at age 65. That was ten years ago.  Now, at age 70, he still enjoys his work, and while he’s cut back on hours, business travel, and administrative duties, he still manages a significant portfolio of business. The last time someone asked when he planned to retire, he answered (tongue firmly planted in cheek), “the day after I die at my desk.”

Of course, Alan is a fictional character, but I would wager that many of our readers have one or more Alans in their firms, and may be wrestling with the challenge of how to accommodate such seasoned professionals who are both able and willing to continue in full-time employment while maintaining upward mobility for more junior staff.

Demographic Trends

An interesting demographic trend over the last decade is the aging of the working population, both in the U.S. and globally.  According to the Pew Research Center, the population of people age 65 and older has been increasing both in numbers, and as a percentage of the total population since 1950, and this trend is projected to continue through 2050. Furthermore, the rate of participation in the workforce of those age 65 and older has been on the rise since 2007.

U.S. Population by Age range – Historical & Projected

Source: Pew Research Center

Source: Pew Research Center

When you combine the aging workforce trend illustrated above with the emergence of the Millennial generation, which is projected to dominate the workforce for the next thirty years, you get some painful pressure points. These can include:

  1. Upward mobility traffic jams:

Boomers postponing retirements AND being unwilling to hand over the reins of management can create real tension in an organization—potentially driving off the top talent below them. The best leaders recognize when it’s time to step back from their senior management roles to create that opportunity for advancement. And the best of the best will do so early enough that their successors will have a sufficient term to achieve their own vision for the firm.

  1. The inability to accurately budget for stock redemption obligations:

If Alan can’t tell us when he plans to retire, how are we supposed to budget for his stock redemption? That kind of financial uncertainty is enough to drive a CFO crazy. The problem can be particularly acute if Alan is still a significant or even a majority shareholder.  In response, we are seeing more firms incorporate mandatory divestment clauses into their governing shareholder agreements. In this way, a valued principal like Alan can continue to be employed, even as his shares are repurchased.

  1. The inability to adequately compensate (and thereby retain) top talent:

There’s no doubt that this is the most competitive marketplace for talent that the A/E industry has witnessed since before the 2008 recession. The best employees expect to be compensated appropriately, and the younger generations have shown themselves to be less patient than earlier generations, and less inclined to “put in their time” or “pay their dues.” Ownership remains one of the most effective ways to retain key staff and provide them with the opportunity to build real wealth for themselves through stock appreciation and profit distributions. But this requires older shareholders to be willing to part with their stock, and at a fair price.

Dealing with these challenges often comes down to the question of price.  Companies that price their stock too conservatively often create a situation where shareholders nearing retirement cannot be compelled to sell because the profit distributions are simply too great, relative to the share price, to give up.  On the other hand, companies that price their stock too high will find it difficult to convince new owners to invest.

The Opportunity

Ultimately, the challenge of the aging boomers (and the up and coming millennials) may also represent an opportunity for firms to rethink roles and responsibilities, and how ownership relates to both. Stock divestment does not have to mean retirement, nor does relinquishing leadership roles, although both are necessary for ensuring the Company’s longevity. At the same time, finding new roles for those boomers that just aren’t ready to retire can be the key to preserving and transferring the wealth of technical knowledge and experience they represent.


2017 ROG Growth & Ownership Strategies Conference

If the subject of generational challenges in the A/E workplace, attracting and retaining top talent, and ownership transition planning are of interest to you, you’ll want to be sure to attend our annual Growth & Ownership Strategies Conference November 8th to 10th at the beautiful Ritz Carlton in Naples, Florida.  This conference is the only one of its kind designed for A/E and environmental consulting firm leaders interested in the creation of real and sustainable value in their organizations.  To learn more go to: conference.rog-partners.com.

Mitigating Taxes While Achieving Your Strategic Ownership Goals

In my experience, the top three reasons why A/E firms implement employee stock ownership plans (ESOPs) are taxes, taxes, and taxes. However, while mitigating taxes is an important element, a good ownership plan should be driven by a firm’s strategic plan and its long-term goals. An ownership plan that is exclusively focused on mitigating or eliminating taxes will rarely help a firm address its strategic goals. Strategic ownership goals might include aligning ownership with leadership, making the investment process affordable to new owners, and ensuring that the stock produces a healthy return on investment for all owners. The tax consequences of an ownership plan should be considered in the context of how they impact the firm’s ability to achieve its strategic ownership goals.

ESOPs have long been considered the panacea of tax efficiency when it comes to ownership transition, but not every firm is a good candidate for ESOP ownership, particularly if it does not address the firm’s strategic ownership goals. A few years ago, I stumbled upon an idea of creating an ownership model that has economic benefits similar to those of an ESOP, but is not as costly as an ESOP (implementation and operating) and does not require ownership to be shared with all employees. This ownership model uses common and synthetic securities with the former being valued at adjusted book value and latter having value that is similar to the goodwill value of the firm. On a combined basis, the value of these two securities will be similar to the fair market value of the company. The tax benefits of this plan can be significant – especially if your firm is very profitable. The key difference is that a shareholder will buy their shares and earn their synthetic equity.

The table below demonstrates four ownership transition scenarios and a comparison of the required cash flow to redeem the same volume shares under each scenario. These are actual metrics of a client. In the example, the company’s book value is $3.94 million, its fair market value is $10.00 million and the assumed tax rate is 40%. We have compared the economic benefit of redeeming $10.00 million of value using a direct ownership model, a 100% ESOP ownership model, a 30% ESOP ownership model, and a SRP (Supplemental Retirement Plan) model, which uses both common and synthetic equity.

aug17perspective-chart

The cost of redeeming $10.00 million in stock under the direct ownership model is $16.67 million, because the company has to generate enough profits to pay taxes so that it has $10 million left over to redeem the shares (net income/[1-tax rate]). Under a 100% ESOP model, the company would only have to generate $10 million in profits because at 100% ESOP ownership the company becomes a tax-free entity and is not subject to corporate taxes (the company is a subchapter S corporation). This savings significantly enhances the overall liquidity of the shares because of the tax efficiencies, which is why we have seen so many firms consider a 100% ESOP ownership model.

Under a 30% ESOP model, the company would have to generate $13.89 million in profits, paying taxes of $3.89 million in order to have $10 million remaining to redeem the shares. This explains why many firms adopt the partial ESOP ownership model. While the benefits are not as great as the 100% ESOP, is still represents significant tax savings over the direct ownership model.

Now let’s consider the SRP model. Assuming the shares are redeemed at book value and SRP units are redeemed at the difference between $10 million and $3.94 million ($6.57 million), the total cash flow required is $12.63 million. This is lower than the Direct and 30% ESOP models because the SRP units are tax deductible to the company (this security instrument takes on similar features to a deferred compensation plan). Additionally, the SRP model has some key benefits that go beyond the tax benefits described above. For example, creating an attractive return on investment is now easier because lower cash flow is required to yield greater returns. In this example, the company pays a 15% dividend on its common stock. At book value, the total dividend paid is $591,000. This makes the investment in common equity extremely attractive. Since the SRP component of this model can be a significant portion of the overall value to a shareholder, it is advisable that the SRP units vest over a long-period of time. This encourages long-term commitment on the part of the shareholders.

I will be presenting this ownership model in Los Angeles at a one-day Ownership Transition Strategies Seminar on September 19th and at our Growth & Ownership Conference in Naples this November. If you wish to understand how this SRP model can allow you to mitigate the tax consequences of ownership transition, while helping achieve your firm’s long-term goals, feel free to contact me.

2017 Mid-Year Executive Outlook

Summer is finally here and that means it’s once again time to reflect how industry conditions and firm prospects are unfolding with our Mid-Year Outlook. For this year’s piece we have focused our attention on niche and specialized firms run by first generation founders. Given that 95% of the A/E industry is comprised of firms with less than 50 employees, these owners offer unique insights for their success as well as challenges. They shared with us how their firm’s size is a competitive advantage, advice for those thinking of starting their own firm, and what their summer plans are to unwind.

Jeff Cowan, Principal, Cowan Group Engineering, LLC, Oklahoma City, OK

Tell me about Cowan Group Engineering’s capabilities and markets. How many staff members do you currently have?

Cowan Group Engineering (CGE) is a general civil engineering firm providing professional services for water resources, transportation, contract city engineering services, drainage, land planning/development and land surveying. Our market is located across Oklahoma and our client base includes local and state governments, along with private organizations. Currently, we have 22 staff members and looking to add more in the next two quarters.

How has your performance fared so far in 2017?

We’ve been on track this year, meeting our 2017 revenue goals along with net income results for the first two quarters.

What are the biggest concerns your clients face today?

Our biggest concern is the Oklahoma economy (balanced budget negotiations) which affects all businesses and citizens in Oklahoma. The state government needs to improve the revenue side of the equation while maintaining a favorable business climate for entrepreneurs and attracting new companies here.

How has your firm’s size been a competitive strength?

We are very competitive due to our firm’s size. We are able to serve the smallest to the largest cities throughout the state.

What inspired you to start Cowan Group Engineering? What advice would you offer engineering entrepreneurs today?

The desire to start a company has always been a part of my vision and recently we celebrated our 5 year anniversary. Recently, our firm was notified that we made the 2017 Inc. 5000 list for our 1000% growth over the last five years! My advice to engineers starting a company is to develop a written “business plan” and then work the plan. Next, find a local banker to partner with for the growth.

What are your plans this summer for rest and relaxation?

My wife and I just celebrated our 25th wedding anniversary and enjoyed that time in Cancun!

Michael Kukuk, P.G., President, Blackstone Environmental, Inc., Overland Park, KS

Tell me about Blackstone Environmental’s capabilities and markets. How many staff members do you currently have?

Blackstone employs engineers, geologists and scientists to serve our clients. Our staff size at the current time is 15 and we are very diverse in our capabilities to deliver. Our main market areas are: solid waste engineering and consulting; water resource engineering; general environmental consulting; construction management and oversight; groundwater monitoring and reporting; and air permitting services. We mainly operate in the Central United States.

How has your performance fared so far in 2017?

2017 is turning out to be a very good year for Blackstone. The 1st quarter was fairly flat, which is not atypical for us and we are now into our busy season from an engineering design and construction oversight standpoint. Our utilization remains high and our profits are at or above plan. After a disappointing 2015 due to client budgetary restrictions and market forces, we had an outstanding 2016, and 2017 has followed suit. In 2016 we added 3 engineers, significantly increasing our capabilities. One of these strategic hires was an air permitting and compliance engineer, which added a new service line for our clients. We have added 2 geologists so far in 2017 with more growth planned. All of our growth has been organic.

What are the biggest concerns your clients face today?

Our client’s biggest concerns are associated with the continued uncertainty with the economy, political direction/leadership, and environmental regulations. All of these factors add uncertainty which affects the budgeting process as well as the ability to confidently plan growth for the future. Budgetary demands on our clients tend to dictate the overall feasibility of a project even if the solution will be long term improvement. Some needed projects or improvements don’t get completed due to short term budget restrictions, even if it costs the client more money in the long run. Our clients want to know that our approaches to their issues are sustainable now and into the future, and won’t be significantly altered by political or regulatory forces.

How has your firm’s size been a competitive strength?

The size of our firm, which is relatively small at this time, has generally been an advantage for us. We work for many large corporations. We have had long relationships with many of our clients, even though Blackstone has been in business less than seven years. Many clients transferred their work over to Blackstone when we incorporated in 2010. Our smaller size is not a negative factor with our clients. They hire us because we are very nimble and they know our people and the quality of the product and customer service that we will deliver. Our size also gives us a competitive advantage with our lower overhead multiplier (fees). Being a low-cost provider is not our goal but it does give us the ability to be very competitive when we need to be.

What inspired you to start Blackstone? What advice would you offer environmental and engineering entrepreneurs today?

In 2002 I was one of three co-founders of another environmental, engineering and hydrogeological firm in Kansas City which was very successful at the time. I left that firm in 2010 and founded Blackstone with the desire to surround myself with like-minded people and to create a company where professionals can practice their craft in a collaborative environment. I enjoyed starting and growing (with others) an employee-owned firm the first time and desired to do it again as opposed to taking a leadership position in a larger firm.

My advice to others would be if you fear failure, uncertainty, or a non-guaranteed paycheck, starting a company may not be for you. If you have the confidence (and clients!) that it will work and it can be very rewarding. There will be significant bumps in the road that you did not anticipate and you need to have the personality and fortitude to persevere through the tough times.

What are your plans this summer for rest and relaxation?

For the first time in many years, I don’t have a summer vacation planned with my kids. We did go to Phoenix over spring break to visit Grandpa. I also took a week and vacationed in the Cayman Islands for the first time this May. It was quiet and wonderful!

Karen Jehanian, P.E., President, KMJ Consulting, Inc., Ardmore, PA

Tell me about KMJ Consulting’s capabilities and markets. How many staff members do you currently have?

KMJ Consulting is a 100% Woman-owned business. We are a niche firm whose market is public sector traffic engineering design, planning, and stakeholder involvement. We have clients at the federal, state and local level and are known in the market sector to provide strategic, creative and responsive service for nearly 20 years. KMJ’s team is comprised of 15 members with a variety of skill sets, including traffic engineering, IT, stakeholder involvement and social media.

How has your performance fared so far in 2017?

So far, we have had a very productive year. I project our gross revenue at about $1.5M, an increase of about 10% over 2016. Our comparative utilization is also higher and our backlog is running at about 12-18 months. Managing the backlog, more specifically the peaks and valleys can be challenging. We project workload at the macro and micro level. At the macro level to 12-18 months and at the micro level based upon actual project work anticipated for eight to ten weeks.

What are the biggest concerns your clients face today?

One of our major clients has expressed a series of human resource concerns ranging from their staff able to communicate and run meetings effectively to having enough experienced project managers to handle the volume of capital projects they have funded. As consulting engineers, we need to remember that the public economy affects our business in these ways. From our experience, we have found the most successful projects have had active project management teams on both the consultant and owner sides. In this case, as public-sector folks retire there are two ways that consultants can be effective: 1) by having excellent project managers who work proactively to anticipate and solve problems or 2) hire the public-sector retirees.

How has your firm’s size been a competitive strength?

KMJ currently has about 15 people on staff. This works for us. More important than our size, is the attitude and character of our people. They are great! And, our size offers us the opportunity to interact at a deeper level. We believe in training our staff to understand how to engage the client in a personal way allowing for a more targeted, focused and streamlined approach to their needs. Everything we do is customized. We are not a one-size-fits-all group behind a big company name. I know that our clients (both the owners and the consultants) value the quality of service they receive from KMJ. We communicate clearly, anticipate their needs and act appropriately.

From the position of our staff there are three opportunities: 1) they have direct access to the owner of the firm and share in an active and open dialogue throughout the course of a project and their tenure with KMJ; 2) they have direct access and receive feedback from our clients, and; 3) there is a synergy among our staff and we have the ability to learn from each other. This is something I really appreciate and that I think is very special about KMJ. We have a group of really smart, down to earth people who come to work each day excited to meet the day’s challenges.

What does being a civil engineer mean to you?

In our field, we are given the choice to perform our civic and civil duty. Associating our work to real-life situations makes for a meaningful and fulfilling life. For instance, designing ADA curb ramps – you may not think much of it when you are talking a walk around town, but for those in a wheelchair, this is a vital resource. When you get to the heart of it and understand the ‘Why’ behind these plans and studies, we understand the real benefit to our society. This is very powerful and I keep it at the forefront of our work. It is not just the plans and studies, it is about the impact on humanity and civil society.

What inspired you to start KMJ? What advice would you offer engineering entrepreneurs today?

I truly believe that entrepreneurship is in my DNA! I come from a family that had both engineers and entrepreneurs and I had the spirit from a young age. I started out selling apples before I was allowed to turn the street corner alone (so, I found an older friend to escort me). As a teenager, I joined Junior Achievement and learned how to read financial statements and run a business. When I graduated from Drexel University with my BSCE, I was very intentional about learning how to run an A/E firm and when the opportunity arose to start my firm I seized it. As with most start-ups, it was not easy, but it was exhilarating to start from scratch and nearly 20 years later we are an ever-evolving, but always going concern. I started the firm to offer a unique work and cultural experience for our staff, and specifically to create a friendly and creative environment. By all accounts, this has been accomplished.

My advice to anyone interested in starting a firm or any business is that you really have to want it! If you go it alone, you need to be able to wear three hats: technical, marketing and accounting. Of course, once you get going you can hire these folks, but as a small business, it is always beneficial and useful to have this background.

What’s on your summer reading list?

My summer reading list is either aggressive or aspirational depending upon how you look at it. I always have two or three books that I am reading. This summer’s list includes both fiction and non-fiction, including: A Dog’s Journey by W. Bruce Cameron, Stories of Your Life by Ted Chiang and The Law of Attraction: The Basics of the Teachings of Abraham by Esther and Jerry Hicks. So, my list is eclectic and varied. No engineering or business books per se, but I’m always reading and learning.

Vincent Pedraza, Principal and Executive Vice President, JVP Engineers, P.C., Washington, D.C.

pedrazaTell me about JVP’s capabilities and markets. How many staff members do you currently have?

Established in 1992, JVP Engineers is an award-winning, nationally recognized mechanical, electrical, and plumbing engineering design firm. The firm began as an independent, small, professional corporation located in Washington, D.C., and has grown into a competitive enterprise with a reputation within the engineering community for engineering professionalism.

We specialize in engineering designs ranging from office buildings, airports, embassies, chanceries, and computer facilities to hotels, hospitals, laboratory and research facilities, museums, educational facilities, and military command centers. The firm has designed systems for buildings within the Washington Metropolitan area, across the United States, and internationally, including some of the country’s most beloved historical structures.

How has your performance fared so far in 2017?

Over the years, we have predominantly done a lot of federal work. Given the condition of our federal government and the lack of an approved federal budget, we are seeing a reduction in workload. In contract, we are seeing more higher education and elementary school solicitations coming out. Notwithstanding the above, we have fared well in the performance of our current projects and are optimistic about the future work that will be coming out of the various federal agencies.

What are the biggest concerns your clients face today?

Although each client seems to be facing different issues, the more common ones appear to be: the collection of fees, managing the BIM process with multiple consultants, and the urgency of project schedules which do not appear to be afforded enough time to perform the required coordination and quality control.

How has your firm’s size been a competitive strength?

As a small firm (25-50 people), we feel the competitive advantage we have is providing personalized service by high-level principals and senior engineers. The principals of larger firms tend not to be involved in the day-to-day design activities and we have learned that this is often what our clients are seeking. By offering the involvement of our senior personnel and owners, our clients have a strong sense of trust with respect to the designs we are proposing. Similarly, we are able to offer new interns and younger engineers an in-depth and hands-on experience working alongside veteran senior staff and principals.

You and your father established JVP and have worked together successfully for 25 years. How has that special relationship worked for you and the firm?

My father has been a mentor, business partner, friend, colleague, and confidant throughout these past 25 years. I could not have asked for a better scenario to start a business when I came out of college. The experience has been extremely positive, and we have enjoyed a great deal of success as result of our ability to complement each other’s strengths and weaknesses. I could not have asked for a better partner type relationship. I have benefitted tremendously from his wisdom and guidance and I am thankful to have had the opportunity to work alongside him. His mentorship and tutelage have prepared me for the next 25 years and the future successes that JVP will achieve.

What are your plans this summer for rest and relaxation?

My family enjoys the water so I envision multiple trips to our house in Ocean City, Maryland.

Brandon G. Sprague, Principal, Brightworks Sustainability, San Jose, CA

spragueTell me about Brightworks Sustainability’s capabilities and markets. How many staff members do you currently have?

We are a multi-disciplinary team of 22 consultants serving clients in over 25 industries from offices in Los Angeles, New York, Oakland, and Portland. Founded in 2001, Brightworks’ early consulting practice in corporate sustainability helped organizations audit, assess, and quantify the environmental footprints of their operations and then establish systematic programs for managing, mitigating, and reversing those impacts. During this period, Brightworks facilitated UC Santa Barbara’s first-ever campus sustainability plan, for example.

We are still active in developing and implementing corporate sustainability programs. But the same year that Brightworks was founded, the USGBC launched the LEED program. To meet the resulting interest in green buildings, Brightworks added engineers, architects, and energy experts to its initial team of consultants focused on business operations.

Today, we are active in the following practice areas: Energy, Carbon, Waste, & Water Consulting; Green Building Certification & Consulting; Design Simulation & Modeling; Healthy & Sustainable Materials; Planning & Infrastructure; Corporate Sustainability Programs; and Reporting & Regulatory Compliance.

How has your performance fared so far this year?

We have experienced very strong growth for at least two years. Most interesting to us are the reasons we see for this.

Our clients tend to be in growth industries and have resources to invest. Not only do the jurisdictions where they are based have impressive sustainability regulations; our clients’ appetite to take on voluntary sustainability measures has also increased. The baseline for sustainability performance among these clients has rapidly shifted upward. At the same time, the sustainability laggards have increased their commitments. So we are seeing clients increase their efforts in multiple dimensions – more clients are taking action, and those who have already begun are taking more action.

What are the biggest concerns your clients face today?

Half of our clients are owners, and half are prime contractors, to whom we are sub-contractors (these include program managers, architects, engineers, construction managers, or general contractors). Among the owners, the leaders in sustainability are moving full-steam-ahead and setting ever-more ambitious environmental stewardship targets, especially clients in tech, financial services, and higher education. The sustainability teams within these organizations are managing far more complex sustainability programs, with far greater scrutiny from a wider range of stakeholders than ever before, and value our help. This creates the desire for seamless communication between client and consultant since we are ultimately one team.

By contrast, the prime contractors we work with are primarily concerned with the immediate need to win new business. Directly related to this, they seem most concerned with establishing, defending, and presenting the right mix of differentiating factors for each specific opportunity. This is very hard to do when practice is largely standardized between firms, as it is in architecture and engineering. Points of differentiation become points of parity when competitors generally meet the same standards of practice.

Our A/E clients are increasingly asking us – and presumably other specialty consultants – to help them win new business by involving us heavily in new business pursuits. We recently wrote the sustainability approach for an architect client’s proposal for an LBC project. We learned that the owner selected their team because they were, in their words, “overwhelmed by the thoughtfulness of the sustainable approach.” That’s a true win-win-win — we exceeded the owner’s expectations, we helped a long-time A/E client win an extremely competitive pursuit, and we get to work with an enlightened owner and great design firm on an inspiring project!

How has your firm’s size been a competitive strength?

Brightworks Sustainability can be considered a small firm and a large firm. We are a fairly large firm among sustainability-focused consulting firms. This is a function of our age (over 15 years of business), stage of maturity, client base, and business strategy. Our scale lets us serve large clients with complex needs. It also lets us develop areas of focused expertise in specialty areas of sustainability practice that make us useful resources to both large and small clients.

In addition to size, I would add that independence has been a competitive strength for us. Our clients have told us that they view sustainability practitioners within larger enterprises with skepticism, fearing reduced transparency and accountability and a focus on selling over innovation and project delivery. Being independent, fairly large among sustainability-focused consulting firms, small enough to be nimble, and expert in multiple complementary areas of expertise have helped our competitiveness.

What have been the drivers in your sales and business development philosophy? Is one marketing method more effective than others?

Related to the need for seamless communication with clients described above, we are very focused on maintaining close relationships with our owner clients and keeping them up to date on the many changes that are regularly occurring in sustainability practice. The high level of ferment recently in sustainability has made them eager to learn about new offerings and lessons learned from other projects we are working on. So we schedule regular calls, lunches, presentations, coffees, and happy hours to stay in communication with them. For our A/E and prime contractor clients, we are focused on showing them with our actions that we are doing all we can to help them win new business.

What are your plans this summer for rest and relaxation?

In early August, I will spend a week-and-a-half working out of our New York office before my partner and I fly to Paris for a baptism. We will stay in France for a week and a half, then stop in Amsterdam for four days on our way back to the U.S. West Coast.

Scott Thomas, P.E., PTOE, Principal, Apex Design, PC, Denver, CO

thomasTell me about Apex Design’s capabilities and markets. How many staff members do you currently have?

Apex Design is based in Denver with a staff of 32 really great people. We were founded in 2006 as an Intelligent Transportation Systems consulting firm and expanded into the traditional traffic engineering and transportation planning services. The majority of our work is in Colorado, with some clients in neighboring states. The clients we serve are typically public agencies.

How has your performance fared so far in 2017?

Things are going well. Backlog is healthy and we have some larger “anchor” projects that provide base revenue and allow us to pursue other contracts with more freedom. We are on pace to grow revenue by 15% this year. Like others we’ve talked with, we are seeing a shortage of talented engineers. Luckily, Colorado is a desirable place to live and that helps with recruiting.

What are the biggest concerns your clients face today?

Our clients are inundated with their day-to-day responsibilities and aren’t able to get everything done they wish to achieve. We are seeing more on-call contracts and outsourcing of both technical and management roles.

There are some local infrastructure bond initiatives going to vote this November in Colorado and the State legislature passed a toned down version of the proposed transportation budget last session. Everyone would like to see infrastructure funding increased, and more sustainable.

How has your firm’s size been a competitive strength?

We are a small firm and that allows us to be nimble. This provides us the flexibility to adapt to changing markets and pursue projects of all shapes and sizes; our staff appreciates this. We also focus on our niche and are able to remain specialized and do what we do well.

What inspired you to start Apex Design? What advice would you offer engineering entrepreneurs today?

At the time we founded Apex Design, we were some of the only folks doing Intelligent Transportation Systems consulting work in Colorado and didn’t really see a “home” for us at other firms. First and foremost we were engineers. Being ignorant about running a business really helped us! Had we known what we know now, we may have thought twice about launching. We purchased used computers and furniture, subleased modest office space, and incorporated and insured ourselves. Then we kindly asked clients to give us a try and figured out the rest as we went along. I’ve been constantly amazed by how helpful and eager most people are in our industry to share knowledge and provide advice and mentorship.

The advice I’d offer entrepreneurs extends to everyone: treat people well, do good work, and follow through on your commitments. Your personal reputation is what is important, and that follows you throughout your business endeavors. It really is hard to give advice on starting an engineering business because personal and professional goals vary so much.

What’s on your summer reading list?

I am a voracious reader and always reading something. I am currently reading Memoirs of a Geisha by Arthur Golden. The next three books I have are The Mothers by Brit Bennett, Today Will be Different by Maria Semple and The Underground Railroad by Colson Whitehead.


Coming!
Ownership Transition Strategies for A/E Firm Leaders: A One-Day Seminar
Tuesday, September 19, 2017
Newport Beach Marriott Hotel & Spa
Newport Beach, California
Click here for more details and to register.

Growth & Ownership Strategies Conference
November 8 – 10, 2017
Ritz-Carlton Golf Resort
Naples, Florida
Click here for more details and to register.

What Really Drives A/E Performance – Culture or Governance?

Among the many complexities of running professional service firms, certain core foundations need to be in place to achieve operational and financial success. When we undertake engagements involving either measuring, enhancing or extracting firm value, we attempt to also look beyond the numbers to understand why an organization performs the way it does. And while the balance sheet and income statement are merely the “report cards” for keeping score, we critically assess both a firm’s daily norms and behaviors as well as recent strategic decisions that serve as indicators to influencing its objectives.

And while no two firms are the same, we’ve found the most important drivers of sustainable A/E performance are: 1) having a positive and productive culture, and 2) a leadership team that consistently makes sound decisions that lead to profitable outcomes. In other words, how a business is governed.

So what exactly is “culture” and “governance”? While both terms are tossed around frequently in understanding the context of A/E organizational and interpersonal dynamics, it may help to revisit both.

We admit that culture can be nebulous, fluid and also shaped by many factors – a firm’s size, ownership, client base, disciplines, and founder’s persona. Many A/E leaders and employees will often describe their culture to us. We hear adjectives that run the gamut from “collegial,” “family,” “controlling,” “independent,” “collaborative” to “work hard, play hard.” All are helpful to appreciate patterns, traditions and policies at a macro-level, but understanding what comprises culture requires something much more elemental.

For help, I turned to our friend Chris McGoff, founder of the strategic and management consulting firm The Clearing in Washington, D.C. Over the course of his career, Chris has worked with countless organizations, including a large number of A/E and professional service firms.

From his upcoming book, Match in the Root Cellar, Chris offers that every firm culture is real, and it’s tangible. It’s a part of the human experience, and there will always be culture around us, in every form. Cultures can be generated that inhibit performance, and cultures can be generated that propel people to perform at their absolute peak.

Chris says that those that live in this kind of culture, a Peak Performance Culture, just “click.” Everything they do, they do as one, seamlessly, so that things go fast, but they go smoothly. Big, complex architecture or engineering projects suddenly seem easy because an entire culture is geared toward the same goal, the same cause, following the same processes, and relying on each other because they know that every other person on their team has the same goal, the same thought and the same mind. That is culture. It is the best kind of culture, and it is the simplest thing in the world to define.

However, his key takeaway is culture is the line that separates the behaviors you will tolerate from those you won’t. Every time you’re with a group of colleagues, this line exists. It’s invisible, but it’s real, and if you step across it, you know it immediately. His chart below captures that essence perfectly.

(c) 2013 The Primes, Inc. All Rights Reserved.

(c) 2013 The Primes, Inc. All Rights Reserved.

And what do we mean by governance? Quite simply, it’s how leaders run the business. CEOs, presidents, principals, boards and other key individuals enact broad policies and specific decisions that they believe will best serve the interests of the firm, their employees and clients. In most cases, these are choices that leaders feel will put their company’s resources to their best use and allocation, maximize profits, minimize risks, while also adhering to specific morals, values and the mission of the organization overall.

Examples of this are: Who makes principal this year? Should we acquire other firms? How do we allocate bonuses in a down year? Is it worth cold starting an office in Florida? Could we raise our billing rates? Should we refresh our website and corporate logo? Is it better to extend our lease or look for new office space? Which clients and projects need more of our attention? Is an ESOP the best option for us?

Now, of course, every organization would love to have the best of both worlds – a strong and cohesive leadership team and a Peak Performance Culture. Unfortunately, in our experience, that dynamic can be somewhat elusive. Let me illustrate with two scenarios:

Excelsior Architects has what many feel is an enviable culture. The 180-person firm recently celebrated 75 years in business and proudly maintains a list of cutting-edge and award-winning projects across a variety of market sectors. Best practices of technical innovation, design acumen, and cultivating younger architects are traced to its origins. There is an unspoken “Excelsior Way” to business development, project delivery and ownership transition, which has led to many satisfied and repeat clients. Excelsior is highly respected by its competitors.

Recently, however, the staff feels that leadership has veered off track. Never fully recovering from the recession, there are whispers the firm’s best days are behind them. Seeking new avenues, the principals made two small acquisitions in the last seven years, neither one of which integrated well, leading to “us vs. them” turf battles. Staff openly feels management has kept on several prominent, yet unproductive principals who barely carry their billing and client weight. Excelsior’s key K-12 market experienced a downturn which caught the leadership team by surprise and led to blaming and further inaction. Two rising stars passed over for promotion left to start a competing interiors firm and management failed to appreciate the impacts on three key clients. Most of the principals are over 55 and aren’t responsive to new tactics for marketing, social media and interacting with a fresh staff of status-hungry millennials.

Or how about the opposite case? Paramount Consulting Engineers is a first generation, 65-person civil engineering firm. The founder and CEO is a charismatic individual who has assembled a hard-working and accountable management team that directly oversees its various offices and divisions. The Paramount leaders promise to “walk the talk” and openly communicate the company values of “Service, Communication, Passion, Courage and Pride.” The firm has increasingly taken market share in its core land development sector and makes strong profit margins year in and year out. Two new branch offices have been successfully started within the last 5 years.

Yet, for all its good fortune something never connects culturally. Paramount has a reputation as a “sweat shop” and turnover rates are abnormally high. Emphasis on profit and office silos has led to an attitude of sharp elbows and lack of trust in sharing resources and opportunities. Staff openly gossip while others make ego-centric promises or detrimental threats in a “sink or swim” environment. Paramount seems to be successful in spite of itself.

***

The ramifications of understanding culture vs. governance as distinct performance drivers are evident in many situations. With regards to succession planning and ownership transition, should the priority of new leaders and owners be as change agents or stewards of the current culture? With M&A transactions, finding compatible cultures that align is key, but equally important are the seller’s leaders who must work and remain with the combined entity. How does an A/E firm that markets itself with recognizable thought leaders and design personalities help find meaning and purpose for others to achieve self-satisfaction?

Thoughts? Opinions? What are your culture and governance like? Are both driving your firm to sustained and peak performance?

Is the Future of Your Firm in the Hands of Millennials?

One of the largest ownership transition issues A/E firm owners currently face is the same one they faced years ago: finding a way to influence younger employees and warm them to the idea of equity ownership. Luckily, now there is much more robust qualitative (and quantitative) data available from which we can draw stronger inferences as to what many Millennials’ thoughts are on long-term employment with a single employer. And we increasingly see that this piece of the equation, once understood, leads to a much simpler path to effecting a successful internal ownership.

According to the Pew Research Center, the number of employed Millennials exceeded that of employed Generation Xers for the first time in 2015 – only one year after surpassing the number of Baby Boomers in the labor force. This rapid emergence as the dominant demographic of the employed U.S. population continues to force A/E firm leaders, owners, and managers to learn and adapt to previously unfamiliar needs, preferences, and styles when it comes to working. Because this fully-burgeoned generation of employee now comprises the majority of the workforce, their voices shouldn’t be disregarded or even taken lightly.

Millennial-related key takeaways of what I’ve learned from the past five years’ worth of due diligence, analyses, and plan implementation surrounding internal ownership transfers are these: Millennials value personal growth; interactive relationships with their superiors and coworkers alike; and democratic systems that allow them a voice. Some owners, unfortunately, struggle to understand work preferences and philosophies of their youngest employees, which leads to communication issues between the two groups, which in turn can create rifts that ultimately foster and promote the idea that changing jobs is the solution for Millennials. As a result, some not-too-positive stereotypes of these younger employees persist, especially in firms where there’s a noticeable belief that they and their peers are entitled.

How can this cycle be broken? By addressing what it is that these valuable employees are seeking. Many of the comments I hear from young non-owners include wanting to: grow and nurture the specific skills they desire (be they technical or not); fashion the customary boss/owner-employee relationship into more of a coach/mentor-student dynamic; and gain a larger voice to make their participation in the firm more meaningful than just what they’re able to produce as technical employees. Of course, these goals are usually mentioned in the same breath as “producing good work” and “keeping clients happy,” but fewer young employees view these goals as peripheral.

The A/E firm owners who do make the effort to learn what Millennials want, including what skills they want to improve on as well as the kind of work they want to be doing, have stronger relationships with their younger employees. A stronger relationship leads to a more motivated, incentivized employee who is inclined to stick around longer and work with owners in pursuing their vision of growth. Many young engineers and architects regularly express that being a part of their firms’ wider visions and growth plans would help eliminate their leeriness in terms of ownership.

Millennials seek meaning in what they do, perhaps more so than generations past, and there is a strong correlation between devoting efforts to keep them happily engaged and their longevity within a company. The old narrative relegated most young workers to positions of little input and choice, while the owners’ expectation was that remaining loyal to one firm and rising through the ranks was a given. While this isn’t quite the case anymore, there is certainly no dearth of young employees who desire to become invested, financially and emotionally in their companies. However, for Millennials to evolve and meet their growth goals, firms must provide them with opportunities to work in close collaboration with their managers. Including them in the vision of the company will reap benefits for both current and future owners.


Related news topic:
ROG+ Growth & Ownership Strategies Conference
Ritz Carlton – Naples, Florida
Keynote Session: Thursday morning, November 9th, 2017

When Generations Connect – Communication across Generational Divides
Hannah Ubl, Research Director, Bridgeworks

Four distinct generations are working together shoulder to shoulder, each with a unique set of attitudes, values and work styles. It used to be that older workers were bosses and younger ones took orders. Now, roles are all over the board and rules are being rewritten. Organizations are feeling the pain of generations as they struggle to manage productivity and morale while maintaining high standards of quality and service in a competitive economy. Hannah’s keynote demonstrates not only why it’s important to understand what shaped the generations, but why they behave the way they do. Find out how generation gaps hit the bottom line. Learn what to do about the approaching talent gap; grasp the keys to retaining the generations you need most and discover how to convert this form of diversity from an obstacle into an opportunity.

Learn more and register to attend at www.conference.rog-partners.com.

Wall Street Sentiments Suggest Strong A/E Industry Outlook

Sometimes the movement of money in capital markets can tell us a lot about investors’ expectations for a particular stock or a particular industry. In the case of the A/E industry, there are a number of factors that are likely impacting investors’ sentiments. Will increasing rates from the Federal Reserve offset any decrease in tax rates? Will reducing regulations have a positive impact on corporate growth? Will Trump’s trade policies help or hurt U.S. based companies? Based on market’s performance so far, it seems that investors’ sentiments are favorable.

The chart below shows the trend in stock prices in the A/E industry compared to the S&P 500. From September 30, 2016 into the first week in February. The A/E Index (“A/E” – in red) and the S&P 500 Index (“S&P” – in blue), both saw declines of nearly 5% through Election Day. But on November 9th, the day after Trump was elected, the S&P increased 1% and the A/E increased 9%. The increase in the A/E sector stock index shortly after the election implies that investors felt that a Trump victory and Republican control of both houses of Congress would be good for the industry.

Through February 6th, the S&P 500 increased 6% and the A/E Index increase reached as high as 20%. The A/E index has since decreased to about 16% (as of February 6, 2017), but has still out-paced the overall broad market.

A/E Index consists of the following tickers: ACM, CBI, EME, EXPO, FLR, HIL, JEC, NVEE, STN, TRR, TTEK, & WLDN

Chart 1: A/E Index consists of the following tickers: ACM, CBI, EME, EXPO, FLR, HIL, JEC, NVEE, STN, TRR, TTEK, & WLDN

What does this mean to firms operating in the A/E industry? See Chart 2. Stock prices don’t always tell the whole story, but since the election, the S&P 500’s P/E (price/earnings) multiple increased from 16.6x on November 8th to 17.7x on February 6th – an increase of 6.6%.  In contrast, the A/E firms’ P/E multiples increased from 24.1x to 29.4x over that same period – an increase of 21.9%. Again, this suggests that the markets are reacting very favorably to the new administration’s proposed agenda.

Chart 2

Chart 2

There are three critical elements of a P/E Multiple: (i) Earnings Per Share (EPS), (ii) projected EPS growth rates, (iii) and the risk of future EPS (the discount rate or required rate of return). Understanding the risks of your investment requires an understanding of the risk to your current earnings stream and its future growth expectations.

Chart 3

Chart 3

When we analyze investors’ growth expectations for the broad stock market and the A/E industry specifically, the S&P 500 enjoyed the biggest percentage increase in earnings growth potential of 21% (an increase from 3.3% to 3.7%), while the A/E industry growth expectation only changed 8.8% (an increase from 9.1% to 9.9%). This is a very important factor in your risk to future earnings. Had the A/E industry change been much faster than the overall broad market, the perceived risk associated with A/E industry returns would be much greater. Instead, we are seeing a slight decrease in the A/E industry’s perceived risk, and this decrease is the first we have observed since before the recession.

Why does this matter?

When we first started following firms in the A/E industry, the risk profile of A/E firms was generally lower than the risk profile of the overall broad market. Around the time of the last recession, this risk shifted to be much greater than the broad market. Today, while A/E firms perceived risk is still higher than the broad market, it is decreasing. If the A/E industry risk continues to decrease, the impact on values will be positive, and the investment opportunity in this sector could benefit enormously.

Of course, when it comes to the overall outlook for the U.S. economy, there are still many uncertainties, and public markets have been known for their “irrational exuberance.” Only time will tell if the trends highlighted above will continue, but so far, the outlook for the A/E industry in the U.S. seems positive.

How Tax Law Changes Could Impact the Value of Your A/E Firm

Like it or not, with an incoming Trump administration, and Republican control of the House and Senate, we’re likely to see some significant changes in the Federal tax code in 2017. In addition to cutting and simplifying the personal income tax brackets, the incoming administration has signaled that it will propose a dramatic reduction of the Federal income tax on corporations from 35% to 15%. It has also suggested that the same cut will apply to pass-through corporate entities, such as S-corporations, LLCs and partnerships.

So what will this mean for the typical A/E firm? Notwithstanding other changes that might eliminate or limit various deductions, such cuts will mean significant cash savings for companies and their owners. It would also mean a substantial increase in company stock values.

Let’s take the example of a company generating $30 million in net service revenue and $5 million in taxable income. Under the current corporate income tax environment, such a company might be paying as much as 35% in federal income taxes, perhaps as much as 40% in combined federal and state taxes, which would equate to $2 million annually. Under the proposed corporate income tax cut, the same company would have a blended federal and state rate of 21.5%, or $1,075,000 annually (assuming state taxes are deductible).

Assuming this company’s stock is valued at 5x earnings (on a non-marketable, minority interest basis), its total equity value would increase from $15,000,000 to 19,625,000, an instant jump of $4,625,000 (5x the annual tax savings of $925,000), or a whopping 31%. I personally suspect this sort of calculus was at least part of the reason for the post-election rally in U.S. stock markets.

But before you get too excited (or concerned), keep in mind that the proposed tax cuts are just that… proposed. Concern over the impact of such cuts on the budget deficit and national debt may result in these ambitious proposals being scaled back. Furthermore, other forces may have a downward impact on values. The Federal Reserve is expected to hike interest rates in 2017, and part of the proposed tax overhaul includes the elimination or limitation of the interest expense deduction for businesses. These changes would have the combined effect of increasing a company’s cost of capital, thereby reducing its value.

Using our prior example of a firm generating $5 million in earnings with an equity value of $15 million, and assuming the company has $2 million in debt bearing interest at a rate of 4.5%, and an estimated cost of equity of 18%, its weighted average cost of capital would be calculated as follows:

Original Cost of Capital Interest Rate Weighting Weighted Rate
Pre-tax cost of debt 4.5%
After-tax cost of debt 2.7% 11.8% 0.3%
Cost of equity 18.0% 88.2% 15.9%
Weighted Average Cost of Capital 16.2%

Assuming a 50 basis point interest rate hike over the course of 2017, and the elimination of the deductibility of interest expense, the company’s cost of capital would increase by 0.6 percentage points, as illustrated below.

Adjusted Cost of Capital Interest Rate Weighting Weighted Rate
Pre-tax cost of debt 5.0%
After-tax cost of debt (no deduction) 5.0% 12.3% 0.6%
Cost of equity 18.5% 87.7% 16.2%
Weighted Average Cost of Capital 16.8%

All other things being equal, this increase in the company’s cost of capital would result in a $700,000 decrease in value as illustrated in the application of the capitalization of cash flow valuation methods below.


Of course nobody knows for certain what sort of changes will actually be made to the tax code, monetary policy and other external factors that might impact companies in the A/E industry. Only time will tell. But it’s important to understand the potentially significant impact these proposed changes could have on companies’ stock valuations.

Five Takeaways on 2016 A/E M&A Activity

Well, you can’t say that 2016 has been dull. In a year that produced memorable comebacks, upsets and surprises across a spectrum of institutions, whether it was geopolitical (Trump victory, Brexit referendum), financial (Dow 19,000), sports (Cubs and Cavaliers’ wins, Villanova’s buzzer-beater) or cultural (alas, Brad and Angelina), the country is due for a much needed breather after these wild 365 days!

Given this setting, A/E executives pulled back and took a measured, “wait & see” approach to deal making this year. By our tabulations, the number of 2016 North American A/E and environmental consulting transactions will be down about 8% from 2015 levels. Overall we’re rather impressed at the resiliency and interests of both buyers and sellers in an otherwise turbulent period. When you consider the nonstop melodrama and uncertainty of the election, depressed oil prices, growing number of CEO successions, and a “stop & start” A/E industry defined by persistent unevenness, the fact that as many exciting combinations came together is a testament to the core M&A motivations of an ever-consolidating industry.

In fact, recent conversations with A/E executives and corporate development teams indicate a general relief that the election and rhetoric is over. Furthermore, many feel a promising (and overdue) renewal of American infrastructure, energy, building and environmental investments may be on the horizon. As a result, leadership teams are assessing the “where’s and how’s” of their 2017 planning exercises and it’s clear that acquisitions are a critical part of that effort and execution.

Notable A/E M&A takeaways include the following:

  1. A solid year for mid-sized deals – With the exception of the Stantec-MWH Global merger, 2016 failed to produce other large-scale, transformational combinations. However, underneath that level, there were a number of intriguing deals among ENR 500 mid-sized firms, most notably in architecture and facility engineering, such as: NV5 acquiring both JBA Consulting Engineers and Sebesta; Day & Zimmerman – Hankins & Anderson; DLR – Westlake Reed Leskosky; and Stantec – VOA Associates. And while publicly traded firms were somewhat quiet with the active exceptions of Stantec, NV5 and KBR, private equity backed A/E and environmental firms continued to recapitalize, acquire new platforms, and add niche targets to existing portfolio companies. Companies here include ATC, Jensen Hughes, Trinity Consultants, Cumming, RES, Surveying & Mapping, and Environments for Health Architecture.
  2. The Sunbelt is where it’s at. While a sizable number of industry transactions are motivated by fortifying local or regional footprints, M&A goals for geographic diversification continue to be dominated by pursuits to the South. Admittedly, this has been going on for many years and not a huge surprise given national trends in population migration, immigration, household formations, new industry clusters (energy, industrial, manufacturing, tourism), and their direct correlations in design and building activity. However, the Sunbelt deal trend is most certainly accelerating. Active engagements as well as talks with Presidents and Principals on desired target criteria profess a continued appetite for A/E and environmental consulting firms from Virginia through Florida, across the Gulf Coast into Texas, and westward through Southern California.
  3. A tough hiring climate tilts the “buy vs. build” calculus. The one clear takeaway from our recent Growth & Ownership Strategies Conference in Naples, as well as our conversations with industry recruiters and human resources managers, is that quality architecture, engineering and environmental professionals are simply in high demand. There is a consensus lament of being unable to consistently find (let alone hire!) people at practically all levels and disciplines (incidentally, this is also problematic with construction firms everywhere). As a result, signing bonuses, multiple bidding wars, and escalating offers are back in vogue as candidates ponder their career options compared to the uneasy environment of just five years ago. Given that tighter labor pools are a constrictor to growth and project delivery, the economics and efficiencies of acquiring talent through M&A as opposed to incremental organic methods is increasingly appealing.
  4. On the one hand, future infrastructure spending looks bright. It’s increasingly likely that U.S. infrastructure spending could be a major policy, economic and jobs driver for the Trump administration. In fact, E&C stocks have rallied since the election in anticipation that their companies will be direct beneficiaries of major investments in new roads, bridges, pipelines, dams, ports and tunnels. Obviously, the amount, timing and composition of such a massive legislative package will have to be negotiated as well as how it will ultimately all be funded given budgetary pressures elsewhere. At the state level, voters approved major transportation and education construction-related initiatives in Colorado, Texas, California and North Carolina with a combined value in excess of $135 billion. Engineering firms with dedicated expertise in civil and transportation/transit are well positioned and promising acquisition targets.
  5. But are we reaching the top of the industry cycle? Although both the macroeconomic and A/E recoveries have been relatively slow and sluggish since 2010, they haven’t been outright recessionary. The U.S will enter 2017 in its third-longest recovery without a recession since the Great Depression, so an argument can be made (as some prominent banks and economists have done) that the likelihood of a recession will rise. Interest rates are heading higher, inflationary forces may accelerate, and there is always the possibility of a systematic or event-driven risk that policymakers can’t predict. We saw this in 2007. We’ve spoken with A/E executives who privately express their firm’s growth and profitability levels are topping out while here at ROG we’ve mused if the A/E industry can truly reaccelerate its growth. In the long-run, M&A is a confidence game on outlook and convictions, so time will tell.

At Rusk O’Brien Gido + Partners, we possess strong relationships and years of experience navigating A/E and environmental buyers and sellers through the M&A process and towards winning combinations. Whether you are seeking to grow through acquisitions or by evaluating your firm’s strategic and ownership alternatives, please contact us as to how we can help your organization.

On a final note, Season’s Greetings and a happy, healthy and prosperous New Year from all of us here at ROG + Partners!

ESOPs – Often Lauded, Sometimes Maligned, Usually Misunderstood

“Too often, people have pre-conceived notions about ESOPs that are based on one or two anecdotal experiences, but ESOPs come in all shapes and sizes.”

As business owners in the A/E and environmental consulting industries examine their ownership transition options, we’re finding more and more are considering employee stock ownership plans (“ESOPs”). But too often, people have pre-conceived notions about ESOPs that are based on one or two anecdotal experiences. Perhaps they worked at a firm in the past that had an ESOP. Or maybe they have a professional colleague that instituted an ESOP in his or her firm. The problem is that ESOPs come in all shapes and sizes. An ESOP strategy that might have been successful for one company, may not be appropriate for another. Conversely, because a particular company had a disastrous experience with an ESOP, doesn’t mean that an ESOP couldn’t work for your firm.

General ESOP statistics

Here are some ESOP statistics that many readers may find surprising. The National Center for Employee Ownership (NCEO.org) reports that there are approximately 7,000 ESOP companies in the U.S., with the most common industries being manufacturing, banking, construction and, you guessed it, engineering. In fact, NCEO’s 2016 list of the top 100 ESOP companies include some of the country’s most prominent A/E firms, such as Gensler, HDR, Black & Veatch, Burns & McDonnell, HNTB, Terracon, Kleinfelder, and STV Group, among others.

However, ESOPs are not solely the province of large firms—on the contrary. NCEO’s latest study reports that 41% of ESOP-sponsoring companies have 50 or fewer employee-participants, and 60% have 100 or fewer employee-participants. So if you had dismissed an ESOP as an ownership transition alternative for your firm because you thought you were too small, you may want to reconsider.

Various Shapes and Sizes

One of the most common misconceptions is that all ESOPs must take the form of a leveraged transaction (i.e. the Company takes on debt to fund the ESOP’s purchase of stock from a retiring shareholder), or that the ESOP will end up as the controlling shareholder. In fact, ESOPs may be funded and accumulate stock in a number of ways, and the plan may hold ownership stakes ranging from a small minority interest up to 100%.

Many of the horror stories about failed ESOP companies involved highly leveraged transactions, where companies took on more debt than they could afford, or conducted a leveraged ESOP transaction and then experienced an unexpected downturn in their business. This is a legitimate concern in cyclical industries, or for businesses that have volatile earnings histories, but there are ways to address this.

An increasingly popular ESOP structure in the A/E industry is the non-leveraged or “pre-funded” plan. As an example, let’s say a firm is planning for the retirement of a group of shareholders anticipated to take place three years from now. The firm could establish an ESOP, and begin making cash contributions to the plan, effectively building a fund using pre-tax profits (contributions to an ESOP are a tax-deductible expense) that may be used at a future date to purchase stock from the retirees.

The advantage to the pre-funded plan is its flexibility. If the sponsoring company has a particularly strong year, it could increase its contribution to the plan (within statutory limitations), thereby sheltering more profit from taxation and potentially accelerating the timeline of the transition. And if the company had a weak year, it could reduce or postpone its contribution to the plan.

Controlling the process

The tax benefits that ESOPs provide to the sponsoring company, and in some cases to the sellers, are often what accounting and financial advisors focus on. However, while the tax savings of the ESOP structure can be significant, another advantage is often overlooked. Unlike orchestrating a sale to a select group of employee-managers, or seeking to sell to or merge with another firm, transitioning ownership to an ESOP is a process that can be planned and executed with a much higher degree of predictability.

With a sale to an ESOP, the company’s directors decide when and how to structure the transaction, and the share price is informed by an independent appraiser engaged by the ESOP’s appointed trustee to ensure that the ESOP does not pay more than fair market value for the stock in order to comply with the Employee Retirement Income Security Act (ERISA).

The afterlife

Once an ESOP has been established, its ownership level can be actively managed in accordance with the culture and strategic objectives of the Company. Our own A/E Ownership Transition Study, conducted in partnership with Practice Lab, indicates that the average ESOP ownership interest in the industry is 51%, and ranges from a low of 8% to a high of 100%. Many firms in the A/E industry maintain their ESOPs at a level that provides a meaningful employee account balance, while also allowing direct ownership opportunities for the management team.

The ESOP’s ownership level can be managed by controlling how repurchases of ESOP shares are handled (are the shares redeemed and cancelled, or recirculated to remaining plan participants), what is contributed to the plan, and the ESOP’s purchases of stock from retiring shareholders and the treasury.

The bottom line

When it comes to ownership transition planning, ESOPs are not the panacea. But if such an ownership model is in keeping with the culture and strategic direction of your firm, they may very well be an option worth considering.

***

Ian Rusk will be co-presenting an informative session on ESOPs together with Attorney David Solomon of Levenfeld Pearlstein, and Pete Prodoehl of Principal Financial Group on November 4th at the Growth & Ownership Strategies Conference in Naples, Florida. Registration for this popular educational and networking event is still open. Visit http://conference.rog-partners.com/ to register.

2016 Mid-Year CEO Outlook

What a strange and unsettled year 2016 has turned out to be! The A/E industry marches along resiliently despite mixed economic signals, uneven growth and global headwinds, and restless political uncertainty. To help us make sense of it all, we’ve assembled our biggest and broadest Mid-Year CEO Outlook ever. We touched base with 7 prominent A/E leaders from across the country to gauge how their years are shaping up, where they see promising opportunities for growth, what are their client’s top concerns, and their post-election hopes for our industry and nation. 

Jack Bedessem, P.E., President & CEO, TriHydro, Laramie, WY

BedessemHow has Trihydro’s performance fared so far in 2016?

At the beginning of FY 2016, we established conservatively optimistic financial performance goals. These goals were less than our standard target range because of the economic challenges in the energy markets. Trihydro’s top-line performance has been flat, but our bottom-line performance has been strong through the first three-quarters of FY 2016. In general, our growth trend has flattened somewhat this year following more than ten years managed increases on the order of 14% annually.

In what market or service areas are you seeing promising opportunities for growth?

Focused and managed diversification has been extremely important to our success, particularly during the great recession and more recently with the uncertainties facing the mining, oil and gas industries. All of our business units are realizing solid prospects for growth, but we anticipate our technology, water, air and ecological services will be more in demand over this coming year. Last year we opened a new office in Alaska, which created growth opportunities for staff, as well as new avenues to expand our environmental and engineering services.

What are the biggest concerns your clients face today?

Trihydro is fortunate to have an extensive long-standing client base, including many directly associated with the energy industry. Most clients, both private and government, are dealing with the same challenges and issues that our engineering and environmental consulting industry is facing. Planning for any type of major project or development becomes very difficult, if not impossible, during times of volatile markets. Uncertainty slows business decisions and undertakings to almost a halt, except for essential activities. Second, the price of oil, gas and commodities has caused many companies, as well as some local and state government entities to cut budgets, refrain from hiring, lay off employees and defer capital projects. Continued low prices appear to be having some impacts on other sectors in many areas and an underlining root for concern about the frailness of the overall economy. Lastly, there seems to be at least some concern about how to overcome the loss of experienced managers, as numerous baby boomers retire within the next five years.

Have you had to change your style of leadership over the last few years due to the uncertain and tepid economy?

I would say the messaging has had to change, but not necessarily style. The issues dominating news headlines over this past year have the potential to create subtle distractions and feelings of gloom and despair. We have been reinforcing information about the company’s health and our expectations for top-quality and responsive services, along with encouragement to work proactively with clients in solving their problems. It is also important to remember that the bearing of global and economic issues can be less evident, yet have very serious effects on field employees and subcontractors. As such, leadership actions and communications have emphasized the importance of working safely, so every employee gets home safe and healthy every night.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle?

There is really only so much that an individual, group or industry can do to influence the mega issues going on around us. It is important to track and understand those issues that can directly impact us, in order to sustain and grow our businesses, and safeguard our employees and clients. As far as hope beyond the elections, it would be nice to see less drama, more cooperation and forward-thinking real efforts that actually result in solving many of our national and global problems.

What are your plans this summer for rest and relaxation?

This summer has been busy and will continue that way. My wife and I are planning a couple of long weekends at our cabin, as well as a week-long camping trip to celebrate our 30th anniversary. Our daughters and their friends are also planning to visit and take in some western entertainment during Cheyenne Frontier Days. There is no better way for rest and relaxation, than spending time with family and casting for rising trout.

Kumar Buvanendaran, P.E., President & CEO, Prime AE Group, Baltimore, MD

BuvanendaranHow has PRIME’s performance fared so far in 2016?

PRIME has been extremely successful so far in 2016. We have been strategically aligning our projections for growth with our year-end goals. We have pursued and won large, complex projects with new clients; hired top talented professionals to enhance our geographic and strategic footprint; and broadened and strengthened our service areas to provide comprehensive professional A/E and technology services. PRIME started the beginning of 2016 with just over 300 professionals and by mid-year, we are at almost 360 and on target to exceed our revenue and staff-count projections. Our success can be directly attributed to the hardworking professionals who make up this company! At the end of the day, all you have are the relationships you fostered with your clients, and our success speaks to these valued relationships.

In what market or service areas are you seeing promising opportunities for growth?

PRIME is seeing tremendous growth opportunities in the water/wastewater markets on a national level. With the federal government mandating consent decrees on local governments, we are seeing aggressive and ambitious project schedules within the capital programs of our targeted clients. Because of this, we have positioned ourselves with qualified key staff who will align with the projects administered through our current and prospective clients.

What are the biggest concerns your clients face today?

Our clients today are typically facing great pressure to “do more with less” in a faster timeframe. Budgetary demands tend to dictate the overall feasibility of a project but not the overall functionality that is still required. We see in our meetings the number of non-negotiables mandated within a project scope yet the flexibility to increase the budget to meet these items is unwavering. Our clients want to know the solution to their problem will not only be improved, but maintained and sustained for any unforeseeable future impacts.

You have acquired numerous firms as part of PRIME AE’s growth strategy. What do you typically look for in target firms and owners?

Strategic acquisitions have become an integral aspect for PRIME’s growth. I typically look for firms that can either supplement or complement a service we provide in-house, services that showcase a niche area expertise, and/or firms that expand our geographic footprint. I consider those to be my three most important considerations.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle?

I never thought I would be as politically invested in the election cycle for this year, but as PRIME continues to grow, I have to follow the platforms that will continue to endorse the importance of infrastructure improvement projects as well as the advancement of technological efficiencies. Every election year, I find myself more engaged with each political platform and how it relates to the A/E/C and technology industries. No matter who wins the election, I hope the emphasis on funding for transportation, healthcare, technology, and education improvements remain top priority.

Mark Israel, P.E., President, Universal Engineering Sciences, Orlando, FL

IsraelHow has Universal Engineering Sciences’ performance fared so far in 2016?

Our performance this year has been well above last year and well above plan. Revenues are above plan and up 29% year over year. Profits are 30% above plan and 168% above last year. Last year was a very good year for Universal. This year has been exceptional.

In what market or service areas are you seeing promising opportunities for growth?

We see opportunities in the larger design build and P3 projects. We began focusing on these projects several years ago and we are seeing the benefits of that effort. The pursuit effort for design build is significant, the time frame to win is longer, and the win ratio is generally lower, but the projects are much larger and can be very profitable.

What are the biggest concerns your clients face today?

The biggest concerns include uncertainty in the private sector markets. We have land development and homebuilder clients that are always concerned about economic issues that will affect home builders. Our larger construction clients are most concerned with labor and material availability. Some sectors are becoming super heated and prices are escalating quickly.

Florida has bounced back in a big way from the depths of the recession. How have you responded to hiring and retaining talent in a more competitive market for staff?

Our staff levels are almost where they were at our peak in 2006. Our biggest challenge has been hiring certified field inspectors. We have retained a staffing firm to recruit candidates for interviews. Additionally, we have increased our in-house HR team to help with on-boarding, training and retaining our existing staff.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle?

My wish for the coming election is that it would come sooner, so we can get it over with. This process is awful and reflects poorly on the United States. We are better than this.

What are your plans this summer for rest and relaxation?

We just returned from Italy with the family. Next, my wife and I will be travelling in California and then biking in the Canadian Rockies.

John Lee, P.E., President & CEO, Barr, Minneapolis, MN

LeeHow has Barr’s performance fared so far in 2016?

2016 has been a challenging year for us. We are focused on providing environmental and engineering services to the power, mining, fuels, and public market sectors. Prolonged low commodity prices have stifled investment by many of our mining and fuels clients, which has in turn negatively impacted our fees with those clients. Fortunately, we have seen continued strength in the power and public sectors. We have also benefited from our long-term strong relationships with several fuels and mining clients—while their total spend is down significantly, we are increasing our wallet share.

In what market or service areas are you seeing promising opportunities for growth?

We are still optimistic about the long-term prospects in our focus market sectors.  Early this year we opened an office in Salt Lake City to solidify our relationships with mining clients in the region and to expand our client base in the refineries and pipeline companies in the Rocky Mountain region. We continue to see our combination of environmental expertise and full-service engineering capabilities being valued by our clients.

What are the biggest concerns your clients face today?

Our clients struggle most with the continued uncertainty in today’s business climate associated with the economy, politics, and environmental regulations. While the general US economy is in recovery, many industrial sectors are lagging due to the lack of a robust recovery in their global markets. We need to help them navigate through the uncertainty, being aware of their fiscal constraints, but keeping an eye on the opportunities the future still provides.

You became Barr’s CEO in 2013. How has your leadership or communication style changed over the last few years?

It is interesting you mentioned leadership and communication together. Since I became CEO, the biggest change for me has been the need to focus on clear, consistent, and continuous communication. I’ve come to see that communicating openly about our intent and direction to our clients, our staff, and other external stakeholders is one of the most important things I do.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle?

I hope for less rancor and more bipartisanship to help eliminate the gridlock and uncertainty we have been seeing at both the federal and state levels. I do not expect a sea change, but perhaps incremental improvement is possible.

What are your plans this summer for rest and relaxation?

As a civil engineer, I find building things relaxing and therapeutic. I have been spending my free time this summer working on long-neglected projects at my home and lake cabin. Funny, but the two tons of flagstone I laid with my kids this past weekend seemed to reset me for another week at work. There are plenty more of those types of activities to carry me into the fall when my kids head back to college.

Ryan McLean, PLS, President & CEO, Psomas, Los Angeles, CA

McLeanHow has Psomas’ performance fared so far in 2016?

We’re on target in 2016 for a solid year with projected growth of 4.4%, after finishing 2015 with an unprecedented 14.7% growth – all organic. Following a year like 2015, where the firm was at a record high for utilization and profitability, 2016 feels slow, but we are really operating at more “normal” utilization rates and are still quite profitable. The firm’s trajectory from 2015 to 2016 may be unique to Psomas since there aren’t any substantive economic factors or market changes that have slowed our growth. Rather, several large dove-tailing projects moving through multiple teams at Psomas in 2015 have recently been completed or slowed. Our present backlog is now at more of a traditional historic pace.

In what market or service areas are you seeing promising opportunities for growth?

Of the firm’s four major services, engineering, surveying, construction management, and environmental, we are expecting the largest percentage growth to come out of our environmental services in the next few years. Psomas acquired an environmental firm in 2013 with extensive experience in the NEPA/CEQA space and there has been much synergy with our clients. Our environmental services are primarily Southern California based and the goal is to move this expertise throughout our western U.S. footprint.

While, the Land Development market has been generally slow in recovery coming out of the recession, there are still major needs for housing in the west and especially California. Apartments are hot right now, and traditional single family housing is gaining traction.

What are the biggest concerns your clients face today?

Coincidently, in preparation of Psomas’ 2021 five year Strategic Plan, we recently interviewed over 100 of our clients to better understand their future and how they see the trends in our space. Three concerns were brought up by nearly all of the interviewees: staffing challenges, unreliable federal and state funding streams, and election uncertainties. The staffing challenges focused on the continued war on talent, resulting in high turnover and also the difficulty engaging and keeping Millennials in their workforce. Election uncertainties and funding issues were definitely related. Our clients didn’t have an answer as to which administration would be best for our industry and friendlier towards the country’s infrastructure needs. The next greatest area of concern, with about 60% of the respondents commenting, was related to government regulation. One of the client quotes explains “government regulations will continue to drive up the costs and reduce the number of projects/programs that can be completed and owners can afford.”

You have acquired numerous firms as part of Psomas’ growth strategy. What do you typically look for in target firms and owners?

In addition to our geographic strategy which includes adjacencies or connectivity to existing locations rather than leap-frogging across the country, we do hope to add specialty skills and leadership to strengthen our core businesses. Significantly, before beginning any real negotiation, and continuing through the due diligence phase of the acquisition process, we spend quite a bit of time assessing cultural fit. We also hope that the owners and leaders of a target firm would want to continue with the combined entity for 3 to 4 years.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle?

That the Congress and the President will develop a strategic plan together for the country to solve our many problems and that this economy doesn’t fall back into a recession.

What are your plans this summer for rest and relaxation?

Friends have been encouraging my wife and I for years to take an Alaskan cruise and we’re finally going to do just that. Everyone who has cruised Alaska has raved to us about the great time and fantastic scenery so we are really looking forward to that time away from the action.

Ozzie Nelson, Jr., Chairman & CEO, NELSON, Philadelphia, PA

NelsonHow has Nelson’s performance fared so far in 2016?

It’s been a really strong year for us so far. For the first half of the year, we actually took a “strategic pause” in terms of additional merger activity to: a) make sure the integration of the 5 firms which we acquired over the past two years was progressing on schedule, and b) evaluate our internal infrastructure to support future growth.  Organic growth will surpass 10% and we will be ready to get back to strong acquisition pace by the end of the year. We’re looking at an annual revenue run rate of close to $100 million dollars with over 700 employees by the end of 2016.

In what market or service areas are you seeing promising opportunities for growth?  

It would probably be easier to identify markets and service that are not busy. We’ve been actively looking to add Teammates to almost all markets and service lines over the past few months. We’re also getting ready to launch our TAMI practice – a team of thought leaders and design talent dedicated to the Technology, Advertising & Media, and Information business sector.

What are the biggest concerns your clients face today?

The business world continues to evolve at an unprecedented pace. Move too cautiously and you will get left behind. Move too aggressively and you might make commitments that cannot withstand significant changes in the market. We are hearing requests for solutions that minimize exposure and maximize flexibility.

You have acquired numerous firms as part of Nelson’s growth strategy. What do you typically look for in target firms and owners? 

Yes, 30 acquisitions to date! Cultural fit and the alignment of strategic objectives are currently the most important early indicators for firms which we consider acquiring. Under those broad topics, commitment to the employee experience, to customer satisfaction, profitability, design capability and brand – those are usually the important subsets.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle? 

That we are able to gain bipartisan support for the reduction of U.S. debt.  That unfortunately is not just a math exercise, it is a matter of the general population recognizing the economic tsunami that continues to pick up steam as it gets kicked down the road.  With that understanding and strong leadership, we would then need to embrace a plan of shared sacrifice in order to spare future generations grave economic hardship.

What’s on your summer reading list? 

No one significant book this summer – instead I am embracing a broad range of inspirational and spiritual readings.  One I would recommend is The Seven Spiritual Laws of Success by Deepak Chopra.

Joseph Tortorella P.E., President, Silman, New York, NY

TortorellaHow has Silman’s performance fared so far in 2016?

This has been a very steady year for us. While the first three months were all record breakers, the next three stalled a bit and balanced off the year. We expect about 10% growth over last year with profits similar as well to last years. We are confident that we will finish the year off very strong as we have an excellent backlog and some really large projects about to start.

In what market or service areas are you seeing promising opportunities for growth?

We continue to see the affordable housing market increase. While this is not a profit center for us, it serves our social consciences. We have also seen growth in the museum sector with many RFP’s still coming into the office. Universities and colleges are spending again and this has remained steady from last year. Lastly, our healthcare division continues to see strong growth.

What are the biggest concerns your clients face today?

I will spin this to voice my concerns on how their demands are affecting public safety and quality. To us, they seem to be mostly concerned about schedules. We see clients getting overly aggressive on this front to a point where we have reached our limits on what we can successfully do. It has to take a set time to complete a project. Despite technology, you cannot keep cutting schedules (and fees). At some point, something has to give and they are putting quality control at a great risk. Everyone needs to slow down a bit and rethink what’s best for the industry.

How have you responded to hiring and retaining talent in a competitive New York City market for engineers?

We have had a successful hiring season, adding about 20 new engineers and several Revit drafters this spring season. Retention has never been a problem for us, although this past year saw several leaving either the profession or the NY market as they were tired of the constant push on their time. In exit interviews, they all struck the same chord…not enough time to do what they consider a quality project and owners are pushing too hard for faster results. We fear this is heading down a dangerous path. We strive for work-life balance and when we fail, we feel the results.

Regardless of the outcomes this fall, what are your hopes coming out of this election cycle?

We are always confident that the strength of our country’s economy and workforce will pull us through almost anything. Having never had a layoff, even after the 2008 recession, we believe we can endure no matter who leads this nation. If there is a hope, it would be that sane heads prevail and finally put money into our aging infrastructure. While we are not horizontal engineers, we believe money invested into infrastructure will reap benefits in the vertical market. Look at New York City’s High Line project and what it did for the neighborhoods surrounding it.

What are your plans this summer for rest and relaxation?

I like to play golf and find that is my “meditation”. Being outside and relaxing for four hours with friends is always a great escape for me. My eldest daughter just got engaged so relaxing this summer in anticipation of the wedding next year will not be easy!


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