“You got to know when to hold ’em…know when to fold ’em…know when to walk away… and know when to run.”
– “The Gambler,” Kenny Rogers (1978)
Over the next few weeks, as we typically see at the end of every year, there will be a flurry of press releases announcing A/E mergers and acquisitions of all shapes and sizes. Some of these transactions will be fairly surprising; others may not be, particularly if you are familiar with the motivations and circumstances behind the deal. Buyers and sellers, along with their teams of attorneys and bankers/advisors, are working overtime to get as many deals closed before the end of the year as possible.
As we saw in 2010, one of the key motivations for sellers this year is tax minimization. Uncertainty remains in Washington on how exactly to solve the dreaded “fiscal cliff,” although there is (dare we utter?) hope that a compromise may in fact be reached soon. However, the fundamental reality is that tax rates, across many forms, could be on the rise. The table below, provided by David Sullivan, an A/E accounting and tax Partner at DiCicco, Gulman and Company, showcases some of the possible scenarios individuals and small business owners may be facing in 2013:
|Top ordinary income rate – Individual||35%||39.6%|
|Corporate tax rate – QPSC||35%||35%|
|Long-term capital gain||15%||20%|
|Qualified dividends – top rate||15%||39.6%|
|Unearned income surtax – Over $250k (MFJ)||N/A||3.8%||Medicare|
|Fica tax – ER||6.2%||6.2%||Limited|
|Fica tax – EE||4.2%||6.2%||Limited|
|Medicare tax – ER||1.45%||1.45%|
|Medicare tax – EE – up to $250 (MFJ)||1.45%||1.45%|
|Medicare tax – EE – Over $250K (MFJ)||1.45%||2.35%|
|Self- employment tax||Combined||Combined|
Source: DiCicco, Gulman and Company
As you might expect given this scenario, a frequent question from A/E owners and executives is “So when is the right time to sell?” Naturally, after a pace of frenetic “event-driven” deal-making, there will likely be a slight pause in 2013 and some individuals who didn’t consummate a transaction will ask themselves if they missed a good opportunity to “take some chips off the table.” That question touches on many complex organizational and personal goals that we thought we would objectively address from two lenses.
The case for pursuing a firm sale now
As we have discussed in prior Perspectives, selling and joining forces with another firm is driven by many factors. For larger A/E firms ($15MM+ in revenue) those issues might be driven by organizational limitations, lack of scale, capitalization deficiencies, and intense competition. Smaller firms are often impacted by similar forces, but typically also have pressing sole owner or partner ownership transition challenges, lack of management depth, and health/age related issues.
The case for selling in the short-term is fairly straightforward; many don’t expect the economy and A/E industry to be materially better (in fact, things could get worse) in the next few years; today’s competitive environment remains unforgiving; the tax and regulatory environment is increasingly unfavorable; and as scores of baby boomer owners prepare to retire, personal net worth diversification through monetization of their ownership stakes will be a larger personal and firm objective.
Complimenting those factors is that while industry valuations are not at pre-recession levels, they are certainly back to historic, normal levels. In fact, some strategic buyers are paying higher multiples for firms in resilient and growing sectors such as power/energy, environmental, infrastructure, and manufacturing. In addition, private equity firms are increasingly active and interested in our space, seeking new “platform” acquisition opportunities as well as making add-on purchases to their existing A/E investments.
Finally, with organic growth prospects limited, many buyers are aggressively ramping up their M&A search efforts for 2013 and are interested in talking to motivated participants. Today’s buyers, unlike 2009, have excess cash sitting on their books (earning practically nothing!) that they want to put toward higher yielding pursuits, such as synergistic and accretive acquisitions. In addition, the cost of debt capital/acquisition financing remains at record lows, adding more fuel to the fire.
The case for holding off
The fact of the matter is that there are thousands of A/E management teams that are perfectly happy with their current independent path and market position. Many either have a formal ownership transition plan in place or would much prefer to go that route than selling to a larger entity with an unfamiliar culture, management compatibility, and design philosophy. While escalating taxes is an unfortunate predicament, other professional and personal priorities are more paramount.
And many owners that would like to sell someday also recognize that their firm’s last 3 or 4 years of financial results have been lackluster. When multi-year growth rates have been flat (or down!), consistent profits have been elusive, backlog is not where it needs to be, and balance sheets are upside down, oftentimes that is not an ideal time to engage with a buyer or test the waters. This economy has produced a number of profiles on small business and A/E and construction owners who would like to sell, but don’t want to settle for lowball offers and are simply resigned to keep working while delaying retirement.
Other A/E executives, particularly those who have seen the natural cycles of the design and construction market for decades, aren’t as gloomy on the economic outlook. They realize excesses have to be worked off, debts paid, and “animal spirits” need to return. They know their organizations will grow alongside that rising industry tide again. Their argument for holding pat is that better bottom line performance and higher valuations down the road will easily compensate the opportunity cost of lower capital gains rates missed today. As Kenny Rogers also wisely concluded in his song, “There’ll be time enough for countin’ when the dealin’s done.”
At ROG+ 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 and Prosperous New Year from all of us here at ROG!
“Behold the turtle. He only makes progress when he sticks his neck out.”
– James Bryant Conant
This year our team has spent a healthy amount of time interacting and consulting with A/E and environmental owners, executive teams and boards of all shapes and sizes on evaluating various strategic alternatives and ways to enhance shareholder value. Like a football coach drawing plays on the chalkboard, every option potentially looks like a touchdown until you actually have to play the game.
For some organizations, it’s been another year of frustratingly slow progress, of gains that come in fits and starts and the breakout momentum that rarely happens due to a never ending list of “almosts” and “shoulda beens” (e.g., fewer mega projects to pursue, key contracts still on hold, etc.). However, other firms are having a banner year of record top and bottom line performance despite a 2% GDP climate, a moribund single family housing market, federal and state budget blues, and a tougher competitive environment than anyone can remember.
Talk to leaders in the latter group and what leaps out at you is that there is no one ideal model to consistent, profitable growth. Some have grown through organic means and tighter organizational and project discipline, some via acquisitions and bold ventures, while others have benefitted from cyclical market timing and just plain luck. However, these organizations are also embracing something that has been seriously lacking over the last few years – taking risks! I’m not talking about the “bet the house” type of risk with win big/lose big ramifications, but the steadfast courage and leadership to not become paralyzed by inaction and watching competitors pass you by.
Fortunately, the A/E industry is in a healthier financial position today. Cost cutting exercises are mostly in the past and many firms are well capitalized and possess strong cash positions. Leaders seem more eager than ever to reinvigorate or maintain their growth pace. Getting your firm from here to there in this environment takes planning (of course), communication, execution, as well as a certain (healthy!) paranoia to not become complacent when things seem to be going their best.
Here are some of the growth alternatives firms are utilizing:
Certainly there are other growth avenues A/E firms are pursuing. However, keep in mind that all of these initiatives require a foundation of sound firm and project management discipline, such as open book management, timely cash collection, effective client communication, and investments in new information technology. As organizations look ahead to 2013, it helps to have an “everything on the table” mindset in terms of growth possibilities in your playbook. Happy New Year indeed!
Planning for ownership transition is a challenge in any firm, but for small firms, sometimes it can seem like the deck is stacked against you. Imagine this: You’re the founder and majority owner of a 35-person civil engineering firm. You’re 62 years old, and while you still enjoy what you do, it doesn’t feel quite so fun anymore. The recession set you back four or five years in terms of your revenue and staff levels, and unfortunately, that included the loss of two key managers. You had envisioned an internal ownership transition that would involve your next tier of managers, but now those ranks have dwindled, as has their enthusiasm for buying stock.
So what do you do now? Is it possible to resuscitate your internal ownership transition plan? Would a strategic buyer (a larger A/E firm) be interested in a small firm like yours? Maybe an employee stock ownership plan (ESOP) would be the way to go, but is your firm big enough?
This is the dilemma many small firm owners are facing right now. Unfortunately, there are many misperceptions and no small amount of misinformation out there when it comes to ownership transition strategies. Here are some common misperceptions and our own attempt to “fact-check” them.
“We’re too Small a Morsel for the Serial Buyers”
It’s the big deals that often make the headlines, like AMEC’s acquisition of Mactec, or CDM’s purchase of Wilbur Smith. But for every headline-making mega-merger, there are scores of small transactions, including acquisitions of firms of ten or fewer employees. In fact, of the 170 or so transactions in the architecture, engineering and environmental consulting industry so far in 2012, the median staff size of the selling firm has been just 30 employees.
The key for a small firm is having some unique value to bring to a strategic buyer, like access to a niche market, a specialty service, or strong relationships with “blue chip” clients. Take the recent example of Perkins+Will’s acquisition of 15-person Envision Design in Washington, DC. In its August 13th press release, Perkins+Will cited Envision’s market leading position in sustainable design and listed its many high profile clients and numerous design awards.
Unfortunately, the days of firms making acquisitions just to add bodies are over. If you’re a small firm considering a sale to a strategic buyer, you must first identify those unique benefits you would bring to a buyer then identify the buyers that would benefit the most by acquiring your firm.
“We’re not big enough to sponsor an ESOP”
While ESOPs have a certain level of fixed costs that are easier for larger firms to manage, you don’t need to have 100 or more employees to make an ESOP work. In fact, a recent study by the National Center for Employee Ownership (Oakland, CA) indicates that 38% of the 10,900 ESOP companies in the U.S. have 50 or fewer employees. As the chart below indicates, ESOP companies are most heavily represented by small firms. And in case you were wondering, the A/E sector is among the four most common industries represented by ESOP companies.
Source: National Center for Employee Ownership
There are other considerations as well. Company culture, management structure, and corporate governance structure are all factors to consider. Generally speaking, firms that practice open book management and promote employee participation in management are better suited for ESOP ownership than those that do not. So don’t let your firm’s size be the only factor in considering an ESOP as part of your ownership transition plan. A feasibility analysis prepared by a qualified financial advisor is the only real way to tell if your firm is financially capable of sponsoring an ESOP.
“We just don’t have the next generation of leaders needed for an internal transition”
This is an increasingly common refrain among owners in our industry. Small firms by definition have a smaller pool of leadership candidates to begin with, so they often feel this constraint much more acutely. Compounding this is the tendency of small firm owners to hoard management responsibilities and even client relationships, rather than training the next generation in business management and business development.
There’s also a tendency among some baby-boomer owners to fail to recognize the potential of the younger generations within their firm. Let’s face it; owners in this sector are a rather homogenous bunch of 50-somethings, and often they look (unsuccessfully) for their successors to be carbon copies of themselves. Generations X and Y may think and work in different ways than baby-boomers, but that doesn’t make them unfit to lead. For proof of this, just look outside of our industry; CEOs under 40 years old abound in the technology and internet sectors (think Larry Page of Google).
Owners of small firms (or any size firms for that matter) would benefit by re-examining their pre-conceived notions of what qualifies an employee to be an ownership candidate. Must every owner be a licensed professional? Must they have a certain number of years of experience or tenure? Cast a wider net and you might be surprised to find more leadership potential in your small firm than you first believed.
Yes, the ownership transition journey is often a tougher one for smaller firms, but virtually all the paths available to larger firms are also available to smaller ones. For small firm owners, a successful transition simply requires more careful and thoughtful planning.
It’s that time again, when many of the publicly traded A/E firms release their earnings reports. On Wall Street, public company earnings reports are often followed by a Greek chorus of commentary by industry analysts and pundits, and the stock market often reacts by rewarding strong performance and punishing lackluster results. This can be high drama for stockholders, directors and officers of these firms, but even small firm owners and managers can gain some valuable insights by following the action.
We decided to take a closer look at the performance of five A/E stocks—Tetra Tech (TTEK: Nasdaq), AECOM (ACM:NYSE), Jacobs Engineering (JEC:NYSE), Stantec (STN: NYSE), and URS Corporation (URS:NYSE). Together these firms employ over 175,000 people and generate approximately 22% of the total revenue of the ENR 500 and 10% of the total domestic A/E sector. With such a large share of the market, the financial performance and outlook of these firms, together with Wall Street’s reaction, can tell us quite a bit about the outlook for the overall industry.
Earnings, Earnings, Earnings
Tetra Tech posted quarter over quarter gains in revenue and earnings, with an increase in gross revenue of approximately 11% (compared to the same quarter of last year) and an increase in earnings before interest taxes depreciation and amortization expenses (EBITDA) of 16%.
Wall Street has reacted positively to Tetra Tech’s performance. The firm’s share price has increased steadily over the last eight months from a low of around $18.50/share in August of 2011 to its present level of $27/share.
According to the firm’s quarterly SEC filing (Form 10-Q) growth was led by the U.S. commercial markets, which were up 29.4% in the first half of fiscal 2012. Public sector growth was mixed, with Federal markets down 7.7% and state and local work up 12.4%. Management is guarded about the outlook for the U.S. federal government markets, stating in its quarterly SEC filing that “During periods of economic volatility, our U.S. federal government business has historically been the most stable and predictable. However, due to U.S. federal budget uncertainties, we remain cautious.” The firm expressed a slightly more optimistic outlook for state and local markets, remarking, “Although we anticipate that many state and local government agencies will continue to face economic challenges, we expect our U.S. state and local government business to experience strong growth in fiscal 2012 compared to fiscal 2011 because of our focus on essential programs.”
The increase in Tetra Tech’s stock price brings its enterprise value/EBITDA ratio to 7.9x. This is a strong, but not unreasonably high valuation multiple, indicating expectations for continued earnings growth.
Sometimes it’s all about expectations
AECOM stock fell to a just under $18/share following the release of its earnings report. The $4/share tumble in value is blamed on the firm missing analysts’ consensus forecast for the quarter by 2 cents per share, and management’s downward revision of its annual forecast from $2.45.share to $2.30/share. Curiously, Wall Street seemed unmoved by the Company’s 4% growth in gross revenue and record high level of contract backlog.
On its May 3rd earnings call, Chief Financial Officer Stephen Kadenacy noted that AECOM’s EBITDA margin declined to 7.9% (roughly 1 percentage point), driven mostly by a decline in its Management Support Services (MSS) division. The MSS division, which provides support services to the U.S. government operations in Iraq and Afghanistan, was impacted by the faster than expected draw-down of forces in Iraq.
Looking ahead, AECOM’s focus is on emerging and natural resource markets. The company hopes to capitalize on an anticipated $5 trillion in infrastructure spending in India and China over the next five years, as well as natural resource markets in Brazil, Australia and the African continent.
As for North American markets, CEO John Dionisio also appeared optimistic about private sector growth, noting significant capital expenditures in domestic natural resource markets (shale oil and gas markets in particular) as well as improving commercial construction activity. As for the public sector, Dionisio remarked that, “Although the United States public sector expenditures remain challenged, we have solid visibility with over $2 billion in backlog supporting our civil infrastructure business in the United States.” On the state and local level, Dionisio cited the example of Southern California Water District’s 5% rate increase as an example of the sort of dedicated funding sources expected to drive local capital projects.
The drop in AECOM stock price brings its enterprise value/EBITDA ratio to 6.3x, a slightly lower multiple compared to its peers. This could reflect concern over the firm’s growth prospects, or shaken confidence due to the downward revision in earnings forecasts. Either way, AECOM’s stock appears undervalued and is probably poised for a rebound.
Oil & gas markets buoy Jacobs’ stock
Jacobs Engineering also made a downward adjustment to its earnings guidance for fiscal year 2012, lowering the upper end of its earnings per share range from $3.20/share to $3.00/share. Jacobs’ posted growth in revenue and earnings for the 2nd quarter and year-to-date compared to the same periods of last year, but this did not keep its stock from falling as a result. Over the past three weeks, Jacobs’ stock has fallen from over $43/share to approximately $39/share.
During its investors call, Chief Financial Officer John Prosser cited a number of factors that contributed to the lower than expected margins in the 2nd quarter. These included competitive pressures on billing rates, and lower labor utilization caused by a high volume of new hires. At the same time, both Prosser and CEO Craig Martin pointed to positive forward indicators and growth prospects, including an 8% increase in Jacob’s contract backlog.
Martin acknowledged the increased competitiveness in the U.S. government sector as well as budget constraints, but stressed the strong position that Jacobs holds in the best funded areas of the government sector. “The national governments business, believe it or not, is actually improving from our perspective,” states Martin. “What’s happening in terms of the technical complexity of projects and this trend toward multi-award task order contracts, the so-called MATOCs, actually puts us in a position to expand our share of the market. We’re also very well positioned in the well-funded segments. Cyber security and IT, environmental management are all areas where we expect strong funding relative to the overall government markets going forward.”
The Company is particularly optimistic about upstream and downstream oil and gas markets that it serves, which make up approximately 28% of its revenue. The undeniable strength of these markets has likely insulated Jacobs from a more substantial hit to its stock value.
After the drop in its share price, Jacobs’ enterprise value-to-EBITDA ratio stood at 6.9x, somewhere in the middle of the range of the other publicly traded firms.
Organic growth and acquisitions drive Stantec forward
Stantec announced that its first quarter gross revenue increased by 7.4% to approximately $438 million USD. Its earnings also increased during the quarter, with EBITDA up 3% to approximately $47.3 million USD. Stantec’s share price has been on the rise since last September’s low of approximately $20/share. Following its earnings release, the firm’s shares were trading at approximately $30/share.
“We began 2012 on a positive note, and despite the continuing challenges of the business environment, we achieved a third consecutive quarter of organic growth” says Bob Gomes, Stantec president and chief executive officer.
Stantec’s organic growth has been augmented by a series of 15 or more acquisitions since the start of 2010, resulting in the addition of over 2,000 employees. These have ranged from small firms of 50 or fewer employees, to its 2010 acquisition of 600-person architecture firm Burt Hill. Just last month it announced the planned acquisitions of Baton Rouge-based ABMB Engineering, and Newfoundland-based architecture firm PHB Group.
Like the others, Stantec has seen its growth driven by the private sector. Gomes states, “Our results for Q1 12 were positively impacted by an increase in revenue due to organic growth in our Industrial and Urban Land practice areas, including strong activity in the mining and oil and gas sectors.”
The increase in Stantec’s share price over the last eight months brings its enterprise value-to-EBITDA ratio of approximately 8.0x.
URS expands its presence in North American oil & gas markets
URS reported this week that its gross revenue for the first quarter of 2012 increased approximately $40 million over the same period of 2011. Most of this increase went right to the bottom line, contributing to a $31.8 million increase in operating profit (a gain of 24%).
URS recently announced the acquisition of Flint Energy Services, a 10,000-person construction services firm serving oil & gas markets, including the Canadian oil sands. CEO Martin M. Koffel, stated: “We are looking forward to successfully completing our previously announced acquisition of Flint Energy Services, which will significantly expand our presence in the growing oil and gas sector, particularly in the North American unconventional oil and gas segments.”
The company reaffirmed its revenue and earnings guidance for 2012, indicating that revenue should be between $9.9 billion and $10.1 billion and net income should be between $292 and $300 million. These forecasts do not include growth in revenue and earnings resulting from the Flint Energy deal.
The company’s stock price has improved over the last six months, rebounding from a low of under $26/share in October of 2011 to its present level of approximately $40/share. However, this represents a relatively low enterprise value-to-EBITDA multiple of 5.2x based on the most recently reported 12 months earnings. The market may be taking a “wait and see” approach to the Flint Energy acquisition.
An interesting consensus appears to be emerging from these five players. Based on divisional performance trends and management’s commentary, it appears that public sector markets, particularly federal government markets may be beginning to wane, while certain segments of the private sector (oil & gas, manufacturing, industrial) are rebounding and are expected to drive growth for the remainder of 2012 and into 2013.
On the public sector side, those agencies with access to dedicated sources of funding are expected to continue to invest in capital improvements, while those dependent on state and/or federal funding will be most vulnerable to budget cuts and the present political stalemate. In balance, Wall Street seems to approve of the shift toward private-sector driven growth, with valuation multiples pointing to a continued recovery for the industry.
“Never make predictions, especially about the future.” – Casey Stengel
As we settle into 2012, there are many reasons to be upbeat about the prospects for A/E and environmental consulting firms. First and foremost, many presidents and principals we talk to across various geographies and capabilities just sound more optimistic and confident, which in many cases is more than half the battle. After “hunkering down” and slashing costs for most of the last three years, many firms are soundly growing again, profits are up, and morale has improved. Backlogs are firmer, utilization rates have improved, and while many organizations continue to do “more with less,” incremental hiring is starting to take root. The private sector, slumped at the wheel since 2008, is reviving from its slumber and the early embers of sensible construction lending activity appear to be picking up.
For the half-full crowd, there are many A/E firms of all shapes and sizes that continue to stand out. These organizations have clearly benefitted from core market capabilities in thriving sectors, skillful penetration of new markets, stronger business development initiatives, and/or seasoned management teams who knew how to steer the ship when the storm clouds emerged. And while many of these firms are well-positioned in “hot” sectors like energy and power infrastructure, industrial and manufacturing, mining/extraction, and water, there are just as many firms in general architecture and renovation, transportation, environmental science and compliance, and (gasp!) land development who can also tout their improved performance and outlook.
However, we’ve all been around the block long enough to know that it’s way too early for the end zone dance. The recovery (are we allowed to say that word now?) has come in frustrating fits and starts and many A/E firms that have grown are simply bouncing back from huge drops in historical performance. A good number of firms are, in fact, still struggling along. Leaders that predict sunnier days ahead are also quick to acknowledge a laundry list of factors that could spoil the party, from yet another economic recession, Congress (everyone’s favorite piñata), looming election uncertainties, potentially higher taxes, and dramatically slower government spending. Add to that hand-wringing over internal leadership and ownership succession issues, elevated fee and billing pressures, and rising costs for healthcare and other benefits, and the half-empty crowd starts to roar. And don’t forget that no sustained economic recovery has ever occurred without major contributions from housing. Hey, no one said this would be easy!
These divergences have played their way out in the A/E M&A market, typically a barometer of overall industry confidence, capital allocation, and risk-tolerance. By our figures, after an impressive 2011 performance, M&A activity is down roughly 30% to start the year and is mirroring a general slump in global M&A across all industries. Today’s A/E and environmental deals that are getting done are increasingly dedicated to international combinations or targets in well-fortified niches. And yes, while we certainly feel strongly regarding the long-term rationale that M&A activity will ramp up (i.e., – it’s a consolidating industry, aging demographics amid glum internal transition prospects, firms should evaluate M&A to accelerate growth in a 2% GDP world, etc.), the short-term headwinds still have to be considered (i.e., – many serial A/E buyers remain gun shy about jumping back in, potential sellers are holding off to showcase better future financial results, etc.).
Buyers – Beggars Can Be Choosers
A/E leaders and M&A development teams continue to express heightened interest in speaking with firms that match their well-defined target criteria, and we here at ROG + Partners remain quite busy with numerous buyside engagements. Many of the factors that we outlined in last year’s M&A outlook remain in force, including publicly traded and large privately-held A/E firms seeking international franchises in emerging economies or access to natural resource development, while international players continue to shop for platform companies here in the U.S.
However, in this stop and start economic environment, buyers of all shapes and sizes are also becoming a bit more “patient” and “picky” about the targets they are evaluating and the time and energy they are putting forth. Not acquiring simply for acquiring’s sake, they are thus seeking targets that will either enhance their market/service presence or allow them to penetrate into new markets or geographies. They are not spinning their wheels with targets with unrealistic valuations and demands or dire turnaround situations. However, buyers will negotiate on terms and show more structure flexibility and overall willingness for those firms that readily add synergistic and strategic value and fit their “square peg in the square hole” needs.
Another interesting development from our viewpoint is the growing number of leaders who share that they would be readily open to a “game changing” deal for their organization. By this metaphor they mean potentially acquiring a firm much larger than their preferred comfort zone, or even an outright merger of equals and talents, if it helped diversify the organization geographically and added complementary clients and services, while creating long-term shareholder value. As we lamented recently regarding the plight of many mid-size A/E firms, these organizations are most ripe for this type of transformational combination.
Sellers – Timing is Everything
There have been a number of sizable, well known U.S. firms that have sold in the last year. Two firms in particular, MACTEC (sold to U.K.-based AMEC) and ATC Associates (sold to Australian-based Cardno) were motivated, in part, due to private equity-related sponsors wishing to finally part with their portfolio companies. Both international buyers were motivated by further expansion of their environmental engineering and consulting capabilities in the U.S. Right place at the right time!
Ultimately, timing plays a huge role for sellers. Many owners who are considering selling realize that their last 3-4 years of financial performance isn’t exactly inspiring and are rightly worried about valuation expectations and selling on the “down slope.” Some may just hold out for a few more years or attempt to convince buyers of the (real or imaginary) “hockey stick” performance just ready to emerge in 2012 and beyond. But sitting on the sidelines doesn’t change the fact that these ownership teams aren’t getting any younger, and don’t have feasible internal transition plans in place. Add to the mix that tax rates will be a huge wild card coming out of the election this year (alas, 2010 all over again), with the possibility of capital gains and qualified dividend rates either remaining at existing levels or perhaps rising dramatically.
Unfortunately, complacency sets in and owners can become paralyzed to simply do nothing at all, exacerbating an untenable position and putting the organization’s overall future and sustainability at risk. Given that ownership stakes in A/E firms likely constitute a sizable portion of future retirement assets, we encourage many owners to start planning for a coordinated internal or external planning process sooner rather than later!
At ROG+ 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.
The perception by older generations of company owners is that members of Generation Y (aka “millennials”) are inert bodies when it comes to rising to the challenge of ownership. Maybe they were coddled too much by their baby boomer parents. Or perhaps the millennials as a generation are a result of a modern culture where no competition has a loser and everyone gets a medal for just showing up.
Whatever the case, because the reality of this might not be too divergent from the perception, here is the corollary: getting ownership into the hands of younger employees is paramount to ensuring the longevity of your firm!
Most owners are gradually coming to grips with the fact that millennials are the next generation, but I suspect that the greater issue at hand is that many millennials have yet to realize that the future is theirs for the taking. All too often preoccupied with promotions, raises, and more personal time, younger employees may not realize that the greatest measure of one’s worth to a firm is measured in ownership. So, for those who may be ready and willing to accept the beckoning of ownership, where to start?
Here are a few basic questions that millennials should be asking A/E firm owners to assist them on the path to ownership:
What is the ownership picture here, and what role can I play in it?
Chances are you won’t waste your time broaching this subject if you’re not serious about it, which is a good thing for both you and your company. Merely showing an interest in ownership might be the biggest catalyst in your becoming an owner, because frankly, management doesn’t always have the best read on what its employees want. This question also serves as an excellent prompt to getting a clearer understanding of what your employer’s short- and long-term goals are for you.
Some firms have a formal process in which ownership is tied to a certain title, meaning that there are generally very measurable goals set for each preceding position, while others will treat the issue of ownership on more of an ad hoc basis. Either way, and considering everything in between, the only way to proactively learn about ownership possibilities is to show interest.
What does ownership mean in my firm?
As broad a question as this may seem initially, it is actually easily reduced to a very specific concept – does ownership simply represent an additional financial benefit to an employee (with any and all corresponding responsibilities, of course), a symbol of gratitude (sometimes referred to as “sweat equity”), or is there also an inherent component of leadership with each share or unit owned?
Over the past winter holiday, I spoke with friends who, like me, are considered the earliest of the Generation Yers. While many work for firms where a meaningful ownership stake isn’t quite in the cards (i.e., publicly traded companies), a few are in positions not dissimilar to mine, and as to be expected, had varying descriptions of what ownership meant on a personal level. For one who works at a consultancy, it was a combination of the aforementioned financial benefit and leadership angle – for another who joined a budding Web 2.0 startup (yes, tech startups are back!), it was just the ability to have a voice as a firm leader… In any case, understanding the culture of ownership in one’s firm is a great place to start learning more about the opportunity.
How will I pay for ownership?
If you’re already at the stage of being considered in the next round of ownership offering, this is likely one of your primary concerns. The actual dollar cost of any investment is always part of the consideration put into estimating the true value of the investment, and although investments in privately-held firms often provide far greater returns than can be found in the external market, the additional risk assumed by such a purchase does not mean that the investment should be had for zero or next-to-nothing!
Not to fret, however, because rarely do sellers require significant outlays of cash or other forms of non-company financing, and many are actually willing to work through financing issues with buyers, generally through notes payable to the company or to the seller; such debt can often then be serviced by profit distributions. Although some buyers would prefer to have guaranteed bonuses or other forms of compensation to help cover the entirety of their loan payments, both parties should strive to strike a balance between the needs and desires of the sellers and the abilities of the buyers in regard to purchasing the shares.
The Future is Now?
Whether you’re a member of Generation X, Y, or even Z, now is the time to take a good look at your future, from both professional and financial perspectives. The opportunities for ownership are greater today than they ever have been before, but I can’t think of a truly good reason to put this kind of planning on the back burner. As for baby boomers or anyone else who’s got succession planning on the mind, find a way to engage the next generation of leaders in your firm, and avoid a “failed end.” Taking the appropriate steps to do so will, at the very least, help you avoid the unsettling position of not having much in the way of transition alternatives.
In the middle of a recent ownership and leadership planning engagement, I received a call from one of the two shareholders describing that the other owner suddenly developed a health issue and, as a result, they now need to explore new options. I had known both owners for years and they always had reasons for delaying a transition discussion, from general anxiety to “it’s not the right time.” Now, they are finally taking action in which the choices are much more limited because they ran out of time and viable structure options. In fact, within the last three months, I have had three clients that had unforeseen issues arise and they were forced to watch good employees leave because of uncertainty surrounding ownership and leadership discussions, because they dread the frankness of “The Talk.”
What goes through your mind when you hear, “We need to talk?” We all dread “The Talk,” and immediately go on the defensive. Why? It makes us uncomfortable. Now, after years of kicking the can down the road, we are seeing more A/E firms opening up discussions regarding ownership transition, and oftentimes (as illustrated above) because of forces beyond their control. As an average 10,000 people a day or nearly 80 million Americans through 2030 reach the retirement age of 65, many closely held companies are being forced to critically assess how they transition ownership and leadership.
I have been working as an advisor for more than 20 years and have seen my fair share of companies ranging from very poor management and operations to outstanding. But sadly a lack of ownership and leadership planning is common for firms of all shapes, sizes, and backgrounds. Failure to plan for ownership and succession planning will more than likely lead to a failed end. So why do firms do this, especially successful and well run organizations? Some of the most common themes I have come across include the following:
Today, it’s been my experience many A/E and environmental consulting firms of all shapes and sizes select the last category.
Giving up control creates anxiety for owners because ultimately they don’t want others directing or influencing the company and they don’t want to feel less valued by their employees and clients. If control is important to an owner or group of owners, then that company is not creating an environment for developing leaders. Leadership is a cultivated skill that gets created in an environment where the leaders themselves become replaceable.
Too often though, owners equate giving up responsibility to giving up control. Allowing for some decentralization of the decision making process, such as identifying people to hire, managing the project resource allocations, accounts receivable collection meetings, and the like, only encourages younger employees to feel that they can add value. Control lies in the power to shape the direction of the decisions that your managers make. It may seem counterintuitive, but the less you make your firm rely on you for business development and operational and financial management, the more value you create for your company. Giving up responsibility does not equate to giving up leadership.
Many firms are delaying their planning because of real or perceived generational differences. As one of my clients said to me a couple years ago, “I blame myself for this situation because we protected our younger generations too much from ‘bad experiences’ in life, thus creating an environment of entitlement.” With the lackluster economy, this sentiment about the next generation is changing.
Recently, I was working with a client who needed to redeem a large shareholder and sell shares to select employees– and I recommended that they offer ownership to some younger employees. My client did not think that this was possible because the younger employees might not possess the financial know-how to take full advantage of such an offer, nor did they think it would be fair to other, more experienced employees. Much to their surprise, the experienced employees were receptive to the idea of the younger ones having a meaningful stake in the company. Working with both the employees and the owners, we were able to better open the lines of communication – and allow for the sharing of ideas and concerns of all parties.
Weak Financial Performance
Owners nearing retirement want to obtain the highest price for their interest in the company. So why should owners sell their shares when the value is low? However, waiting for the market to return is risky, and selling shares does not mean sell ALL of your shares. It is common practice for owners nearing retirement to sell a portion of their interest over time to take advantage of the future value increases and reduce the risk against future decreases in value.
When large shareholders sell some of their shares in a valuation that is perceived low, they are sending a message to those key employees that the company is committed to them by sharing a greater upside potential than downside risk. The selling shareholder is also reducing his future redemption risk because he has a smaller stake going forward. Even if his reduction in percentage in ownership is marginal, any reduction is an improvement in managing the company’s future redemption risk.
Rusk O’Brien Gido + Partners have facilitated discussions between internal buyers and sellers of A/E and environmental consulting firms and are experienced at addressing valuation, management roles and responsibilities, ownership structures, and leadership development. The first step in having “The Talk” is often the most difficult, but you don’t have to do it alone. We can help you get started.