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Five Takeaways on 2019 A/E M&A Activity

Fueled by a national economic expansion that appears to have no limits, the A/E industry is undoubtedly finishing this decade exhibiting some of the highest levels of confidence, optimism, and growth that we can recall. The ENR 500, a good a barometer as any for the health and vibrancy of design firms, delivered record U.S. revenue in 2018, up an astounding 8.9%, and all indications are 2019 will exceed those heady levels. Many leaders we speak with express sentiments of “record years” powered by “strong backlogs” despite “challenging hiring and retention conditions” for almost every level and discipline. If ten years ago the industry’s mantra during its recessionary depths was “we have the people, but not the work,” then today’s landscape is a complete 180 degrees.

But can overconfidence be a bad thing? We’ve heard A/E teams tout market sector ebullience before – only to be whipsawed by the cruel lessons of client cyclicality (recall this decade’s instability in oil & gas, mining, housing, manufacturing, and federal spending). Yes, low-interest rates, a healthy consumer, and state governments taking the lead in infrastructure spending, along with favorable tax reform kicking in for A/E owners, offer heightened assurances going into 2020. However, we also enter this new decade with a contentious election on the horizon, uncertainty over trade wars, an architectural billing index displaying mixed signals, debt bubbles quietly percolating, and a lingering sense a slowdown just has to be around the corner.

This crescendo of executive enthusiasm, along with strong balance sheets, has resulted in yet another stellar year for A/E mergers and acquisitions. When the dust settles, we’ll see the number of 2019 North American transactions up 3% over 2018 levels, which itself was a record year. And while there was a noticeable absence of transformational “mega-mergers,” niche “tuck-in” deals to add geographic reach and discipline extension are ruling the day. But not everyone is going along in this buying frenzy. Interestingly, several serial acquirers chose to sit 2019 out, believing they can achieve annual growth targets organically and a wariness of potentially overpaying for targets at a market cycle top.

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

1. It’s been a huge decade of industry consolidation – While 2019 has indeed been a robust year for deal-making, in aggregate, the 2010s have produced over 2,500 transactions, fundamentally reshaping the A/E competitive landscape for decades. This extraordinary wave has joined together some of the industry’s largest and iconic brands, created new global entities, witnessed dozens of ENR 500 firms sell to strategic or financial buyers, and fulfilled the exit strategy needs for thousands of small firm owners across the country. Has all this rampant amalgamation been healthy? Obviously, some deals work out, and some don’t, but growth through M&A will continue to be a tool for how organizations adapt and expand in the 2020s.

2. The private equity march continues – Ten years ago, the notion of A/E organizations partnering with private equity firms was rare and even scoffed at. Today, that couldn’t be further from the truth. With financial sponsors increasingly pursuing professional service firms and the desire to put cash to work for investors seeking higher yields, a new form of industry marriage has unfolded. This year other venerable A/E names have recapitalized with the help of financial buyers, including STV, Pond & Company, Prime AE Group, BCC Engineering, and many more. These “platform” investments are often aggressive purchasers of other boutique A/E and environmental companies (not to mention active hirers of executive and operational talent). We expect to see other prominent names go the private equity route in 2020.

3. Sellers are taking chips off the table vs. rolling the dice – Despite delivering recent strong financial performance and cash flows, which can serve as great foundations for customary internal transitions or ESOP options, more A/E Baby Boomer owners are deciding to sell externally. Many have generated solid growth rates and EBITDA levels in the last three years, have elevated levels of backlog, and feel they can attract the right valuation multiples and buyer universe. Owners also remember the flush times during the mid-2000s before the recession hit and have vowed not to make that mistake again. Better to sell today rather than risk an economic downturn tomorrow.

4. Some companies have audacious growth goals, which only M&A can achieve – Realistic or not, robust times like these can often be extrapolated into sizable strategic growth goals for leadership teams. Whether it’s engineering or environmental, buildings or infrastructure, we’ve seen several eye-popping revenue targets being offered by executives. Through bravery or bravado, they wish to double their firm’s size in 3, 5, or 7 years! With workforce retirements accelerating and the unemployment rate for design professionals under 2%, adding talent organically becomes increasingly difficult. The only way for these groups to realistically get there is through synergistic acquisitions.

5. Buyers are getting much better at integration – A frenetic decade of acquisitions goes a long way to applying the learning curve of integrating organizations of disparate cultures, processes, policies, and clients. In our view, buyers have dramatically improved their post-merger integration planning and execution by confronting thorny operational and personnel challenges together. This includes a critical understanding of key staff employment agreement needs, openly articulating benefit plan differences, proactively rolling out client communication and branding changes, and immediately finding shared projects to work on to build collaboration and comradery.

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.

We are pleased to have assisted our clients with the following recent M&A transactions: https://rog-partners.com/transactions-2/

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

What’s a Good Outside Board Director Worth?

So you’ve finally decided to add an outside, independent director to the board of your privately-held A/E firm. You’ve even identified several candidates. Now the question is what (if any) compensation to offer them. For an independent party to take on the time and responsibility of serving on your board, you expect some level of compensation is appropriate, but how much?

Before addressing that question, here are a few background statistics on board compositions in the A/E industry. According to a 2015 study on ownership and ownership transition conducted by ROG together with Practice Lab (Boston, MA), of the 57 A/E firms participating, the average board consisted of five directors with a lower quartile of three and an upper quartile of seven, and 25% of the surveyed firms reserved at least one board seat for an outside director.

Anecdotal observations suggest that the larger the firm and the more distributed and active its internal stock market, the more likely it is to have one or more outside directors. Additionally, firms that sponsor employee stock ownership plans (ESOPs), particularly 100% ESOP-owned firms, are more likely to have outside directors. In fact, we frequently see independent ESOP trustees insisting on outside directors when negotiating the terms of an ESOP transaction to ensure a higher level of corporate governance. A recent study conducted by the National Center for Employee Ownership (www.nceo.org) reported that approximately two-thirds of responding firms had at least one outside director.

This trend toward outside directors at ESOP-owned companies have been driven by a number of recent court cases and regulatory actions, according to David Solomon, an attorney at Levenfeld Pearlstein specializing corporate law. Solomon indicates that, “there is a strong trend for ESOP trustees to insist that the board of directors of an ESOP company include several outside, independent directors, and in many cases the trustees will ask for the board to consist of a majority of outside directors. The goal of this request is to both show that the ESOP trustee has some control over activities of the board, such as a decision to pay a control premium in a stock transaction, as well as to add a level of accountability and professionalism to the board room that is many times lacking in a closely-held, privately owned company. This level of oversight and implementation of professional governance practice has the effect of protecting the employees’ investment in the company through their ESOP participation which is a positive development.”

Having established the value of independent outside directors, the question of how to compensate them remains. The aforementioned NCEO study explored the subject of outside director compensation (note that this study includes firms outside the A/E industry). The study found that among the 241 respondents with outside directors, the median annual compensation was $12,000, with a fairly wide range from a lower (10th percentile) of $2,600 top a high (90th percentile) of $40,160. The most common form of payment for outside directors was a fee per meeting at 47%, with the median respondents holding four meetings per year. The second most common form was a fixed retainer at 37%.

In deciding what to offer your outside directors, consider the following:

  1. How many meetings will you hold per year, how long will they be, and how much preparation will be expected (e.g., reviewing board package)?
  2. Will the director be traveling to attend meetings?
  3. What is the experience and background of the director? What unique knowledge and skills to they bring to the board?
  4. Will the director be sitting on any sub-committees of the board (e.g., audit committee, compensation committee, etc.)?

This discussion of how much compensation to pay outside directors raises another interesting question. If you compensate outside directors, can and should you also pay additional compensation to internal (employee) directors? After all, a director’s role and responsibilities are distinct from their role and responsibilities as an employee or manager. While still uncommon, some firms provide additional compensation to internal directors. This can be a way to reinforce the distinction of the internal directors’ roles as a member of the board and their roles as employees.

In summary, outside directors can bring value to boards that internal directors often cannot. This value can include: Outside perspective uninhibited by internal politics; Expertise in subjects such as law, finance, human resource, etc.; The “been there, done that” experience of a retired industry executive, and much more. So what is that worth to your firm? Survey data above suggests a fairly wide range of compensation, but here, the old adage “you get what you pay for” rings very true.

What Is Your Ownership Strategy?

Does your firm have an ownership strategy that clearly defines how you will be able to exit your firm? Are you relying on selling your firm to a third-party or the next generation of leaders? According to the Census Bureau and assuming age 67 for retirement, more than 9,000 people a day are hitting retirement age, and this is expected to increase to over 12,000 by 2028. During this same period, the gap between the number of buyers and sellers will likely narrow and, in some years, will be negative. This gap will not widen to significant levels until 2035. Over the next 15 years, transitioning ownership will be one of the biggest challenges for A/E firm leaders.

The chasm between buyers and sellers seem to be increasing, which is making ownership planning more challenging. Buyers – likely Millennials – have a different appreciation for risk/rewards trade-off, and many have higher student debt obligations than previous generations. Compounding this chasm are the sellers – likely to be Baby Boomers – who are reluctant to give up control and are not satisfied with their valuation because they’ve invested so much into their company, but have not been taking anything out. They are banking on the “End of the Rainbow” value.

Many firms elect an internal ownership transition plan because sustaining their business and ensuring the welfare of their employees is most important to them. While an internal transition plan is often the path that most firms choose, it doesn’t take the external ownership plan off the table. Many firms develop their internal transition plans with the desire to sell to a third party in the future. However, will the market be in their favor? If not, they still have the option of transferring internally.

The share repurchase obligation is one of the biggest risks of a closely held company. Since the redemption of shares is not a tax-deductible expense, for every $1.00 of stock value that is redeemed, a company needs to generate about $1.41 of cash flow. Managing this tax risk leads firms to seek alternative ways to improve liquidity for their shares by discounting their value, tying in equity-based deferred compensation plans, or sponsoring partial or 100% ESOP ownership plans.

Selling shareholders are finding it more difficult to get a fair value for their ownership interest in a closely held A/E firm. As a result, I am seeing more firms relying on discounted stock valuation and delivering high returns in the form of dividend payments to offset low stock appreciation. Also, more firms are sponsoring ESOP ownership plans to take advantage of their tax benefits – especially 100% S-Corp ESOP ownership plans – as these firms become tax-exempt entities. Over the past two years, I have rendered more fairness opinions for firms converting their ownership to 100% S-Corp ESOPs than the previous 15 years. Will this trend continue?

Learn more about the latest ownership and value-enhancing trends that are occurring in the architecture, engineering, environmental consulting industry at the ROG Growth & Ownership Strategies Conference in Naples, Florida, November 6 – 8. For more information feel free to contact Michael at mobrien@rog-partners.com.

Are You Tracking The Right Metrics For Your Firm?

I stopped counting at about 200.  That was the number of metrics I found in various publications that track financial results for the design profession. Though the sheer number was overwhelming, they all seemed perfectly good and most of them understandable.  So, if they are all useful, which ones are the right ones for your firm?  The simple answer is – the ones that drive action toward the results you want.  Said another way, the metrics you use should show you what action you need to take to reach your goals.

Let’s begin by saying that metrics are a powerful tool for running your business.  Combined with timely and accurate financial statements, they are key to driving the value of your firm.  If you are not using metrics, I encourage you to start.  If you are using metrics, great; now it’s time to re-think the ones you are using.

As a design professional, you are probably very familiar with the usual (dare I say mundane) utilization rate, direct labor rate, overhead rate, net multiplier, etc. Those are the industry favorites, and you might be tracking those right now.  I challenge you to ask yourself if those are driving action in your firm.  If they are not and are merely nice to know, then you should start taking action on them or ditch them in favor of some that will create action.

Here are my suggestions for deciding which metrics are right for your firm.  First, limit the number to no more than 10. Any more than that is unnecessary. Keep things simple.  Next, pick 5 or 6 that are based on getting the work, doing the work, and getting paid for the work.  To that end, I would suggest the following metrics as a foundation:

Get the Work

New Contracted Work (in $’s) – it’s important to know if and to what extent your marketing, sales, and business development programs are working.

Proposals Let (in $’s) – this will let you know if you are too busy doing the work to find new work.  You need to know the dollar volume of proposals that have been sent out.

Do the Work

Revenue Factor – this is net revenue divided by total wages. This is the king of all metrics. If you were only to use one metric, this would be it. It tells you how effectively you are using your labor cost to produce revenue. Make sure you use revenue factor on actual revenue AND forecasted revenue.  Using forecasted revenue will let you know if you need to increase or decrease staff cost. Also, if you choose to use utilization rate as a metric (and I’m not able to talk you out of it), you will want to use revenue factor to get a more complete picture of labor efficiency.

Direct Labor Percentage – direct labor divided by net revenue.  This is another labor efficiency measure but at the project level.  If your rate is too high, it could be that you have inefficiencies in producing the work, or you have the wrong cost mix of labor on the projects.  It could be that your fees are too low.  In any case, monitoring this metric will create action.

Pre-bonus, Pre-tax Profit (as a % of net revenue) – seems obvious, but you’d be surprised in how few financial statements or metrics presentations this percentage appears.

Get Paid for the Work

Percentage of Total Accounts Receivable under 91 Days (in $’s) – or it could be 75 days or any other amount that works for you.  I prefer this to Average Collection Period (ACP) or Days Sales Outstanding (DSO) which are expressed in number of days.  I think it is more impactful to see money than days, and it’s a lot easier to calculate and explain than ACP or DSO.

Now that you’ve picked 5 or 6 from among the categories above, it is time to bring the total metrics to 10.  You do this by adding 4 or 5 metrics that are specific to driving your strategic plan, eliminating a problem or simply putting focus on areas of your business that need specific attention.  Let’s say that one of your strategic goals for this year is to diversify your client type and, in particular, you want more government work.  You could use a metric that measures the amount of new contracted work in government.  Or you could track the percentage of government revenue or sales to total revenue or sales.  If you are having trouble with your employee retention rate, how about a metric that tracks employee attrition?  If you have debt covenants, how about a metric that tracks those covenants? Let’s say you have an initiative to diversify your client base.  You could use a metric that tracks the revenue from new clients.

There is an endless number of metrics that you could use, but the main points to keep in mind when choosing the ones to use and when implementing their uses are:

  1. Start with a few from the basic groups of get the work, do the work, and get paid for the work
  2. Keep the number of metrics you use to no more than 10
  3. Make sure they are simple and understandable
  4. Track them against specific targets
  5. Make sure they create action and accountability
  6. Report on them monthly and year to date (or better yet, latest 12 months)
  7. Follow up on corrective action items

The right metrics can be a powerful tool in achieving operating excellence.  If you are not using metrics and would like help in getting started, or if you are already using metrics but maybe not as effectively as you would like, please give us a call.

See Carl and learn more at:

September 18, 2019
Arizona Grand Resort, Phoenix, AZ
Successful Ownership Transition Strategies: One Day Seminar
Click here for more details and to register.

Or listen in on this Webinar:
October 24, 2019 at 2:00pm ET
3 Ways to Drive Value Within Your A&E Firm
Presented by Deltek and ROG+ Partners
Click here for more details and to register.

Wednesday, November 6 – Friday, November 8, 2019
Ritz-Carlton Golf Resort, Naples, FL
Growth & Ownership Strategies Conference
Click here for more details and to register.

Is Your Company’s Stock a Good Investment?

“The best investment I ever made!”  I can’t tell you how often I’ve heard owners in the architecture, engineering and environmental consulting industries say something to this effect when I’ve asked about the performance of their company stock. There are exceptions for sure, but this is by far the more common refrain.  Still, many firms struggle with their ownership transition plans due to a lack of demand for stock among their next generation of leaders.

When a company offers stock to new shareholders, it’s competing for capital with many other investment options, such as real estate, the public stock market, government bonds, etc., and buyers often have minimal financial resources. A key to a successful ownership transition plan is ensuring that your company’s stock compares favorably to the many investment alternatives a buyer has for their limited capital.

So, is your A/E firm’s stock a good investment? To answer that, you first need to look at its return on investment or ROI.  Your firm’s ROI is the sum of the dividend or distribution paid per share and the appreciation of its share price over the course of the year, divided by its starting share price.

To illustrate this calculation, let’s take the example of a firm generating $10 million in net service revenue and employing approximately 70 people. The table below shows the cash flow available to the shareholders of this representative industry firm using industry median financial performance levels as footnoted.

Representative Median A/E Firm
Net Service Revenue $10,000,000
Pre-tax, Pre-bonus Profit (12.3%) [1] $1,230,000
Incentive Bonuses [2] -$436,000
Working Capital Investment [3] -$113,000
Income Taxes [4] -$238,000
Cash Flow Available for Distribution $443,000

Based on latest available survey data, the following table details this representative firm’s return on investment.

ROI Analysis
Beginning Market Value of Equity [5] $3,715,000
Ending Market Value of Equity [6] $3,967,000

[1]Median pre-tax, pre-bonus profit from A/E Business Valuation and M&A Transactions Study

[2]Staff bonuses estimated based on median bonus per employee from 2019 Deltek Clarity industry survey

[3]Working capital investment based on median 3-year compounded annual growth rate of 6.8% and a working capital turnover rate of 6x/year

[4]Income taxes (combined federal and state) estimated at 30% of taxable income

[5]Equity value based on the median multiple of pre-tax, pre-bonus profit (3.02x) from A/E Business Valuation and M&A Transactions Study

[6]Equity value assumed to grow at the industry median 3-year compounded annual growth rate of 6.8%

In this case, an investment in this firm would indeed be very attractive relative to alternatives. For perspective, the S&P 500 produced a return of 12.8% in 2018 and an average return over the past 20 years of slightly over 8%.

Shareholder Dividend or Distribution $443,000
Dividend Return (as % of equity value) 11.9%
Capital Appreciation (equity value growth) 6.8%
Total Return on Investment 18.7%

Of course, there are some substantial differences between investing in the public stock market and investing in a privately held A/E firm that must be considered.  The first is liquidity or lack thereof. Unlike a publicly traded firm, your ability to sell your shares in a privately held A/E firm will likely be governed by a shareholders agreement. In most cases, you may only sell your shares back to the company, or to other shareholders, and only upon retirement, termination of employment or other circumstances.

Stock in a privately held firm is also considered more at risk for loss of capital than that of larger, publicly traded firms. These much larger firms tend to be much more diversified and not overly dependent on particular markets, clients, or individual employees.

To overcome the greater risk and lower liquidity, a privately held A/E firm’s ROI needs to be higher to attract investment, and based on the industry analysis above, on average it is. So why do firms still struggle with a lack of internal demand for company stock? In some cases, this may be because the ROI is not strong enough, either due to poor financial performance, overly aggressive stock pricing, or both.  More frequently, however, it’s because the firm has failed to communicate how its stock has performed historically effectively.

If fairly priced, the stock in your A/E firm could very well be one of your best-performing assets. And it’s one of the very few investments that you have the power to influence.

If you’d like to learn more about maximizing the ROI of your company’s stock and creating a sustainable and successful ownership transition plan, please consider joining us in Phoenix Arizona on September 18 for Successful Ownership Transition Strategies: One-Day Seminar.

This one-day workshop will cover:

  • The available options for ownership transition and the pros & cons of each
  • Ownership structure norms and trends in the A/E industry
  • Approaches to establishing your company’s stock value
  • Ways to facilitate an internal transition to the next generation
  • How employee stock ownership plans (ESOPs) work
  • Corporate governance and management structures
  • Balancing incentive compensation with owner return on investment
  • Preparing and marketing your firm for a sale or merger

2019 Mid-Year Executive Outlook

Summer is already here and with the first half of the year behind us, it’s once again time to connect with A/E leaders across the country for our annual Mid-Year Executive Outlook. An industry characterized by solid revenue growth, rising backlogs, rampant industry consolidation, and acute talent shortages present both challenges and opportunities. These individuals touched on a wide range of subjects, including factors driving their firm’s 2019 performance, recruiting and retention strategies, client needs and concerns, and plans for the summer.


Kimberly Moore
President
KDM Engineering
Chicago, IL

 

Tell us about KDM Engineering and your capabilities and markets.

Founded upon a vision of challenging and changing the energy infrastructure to help light up the world, KDM Engineering has set itself apart as a leading power utility, gas distribution, and telecommunications engineering firm by consistently delivering outstanding project support and service to our clients. We are based in downtown Chicago but also have offices in Pennsylvania and Maryland to service our clients in the Midwest and Mid-Atlantic regions. Our services include full service engineering, drafting, permitting and utility coordination.

How has KDM’s performance fared so far in 2019? What’s been driving it?

The KDM team revisits goals for the following year in the 4th quarter of the current year.  We kept blowing through our goals so we decided to set the bar higher and then looked at what work it would take to get to that higher goal.  So far we are on track for those new goals.  Our teamwork, strategy sessions and communication has set the tone on how to get things done at KDM.  We also have current M&A goals that will push us even further.

You started the firm in 2012 and now have over 75 employees? What’s been your strategy for KDM’s rapid growth?

We are currently at 85 people and still growing!  As fast as that growth sounds, it has been tamed by me so we can at least try to seem like we have some control! We are very fortunate to be in an industry that is seeing a lot of change and also a lot of growth.  For a while, the utility sector was a steady industry but not necessarily a high growth one.  With the recent push for carbon free emissions, renewables, storage, etc, there is a push for innovation, change and updated systems, so we feel KDM is in a good place.  We are also involved in the push for 5G with our telecom partners.  This is another area for rapid growth.

What are the biggest challenges facing your power and utility clients today?

Currently I would say a challenge is the search for talent.  With all of the growth our industry is seeing, we are all searching for the same talent. This makes the talent pool scarce and the talent that is available is more expensive than normal.  This increases the cost of doing business and ultimately increases the cost to the customer.

You’ve been a strong advocate for increasing awareness in STEM fields for women and underrepresented groups. What can our industry do better in terms of bringing more into our profession and retaining them long-term?

There are great STEM programs that aren’t located at the Harvard’s, Yale’s, and Princeton’s of the country, but are at the Howard’s, FAMU’s, and North Carolina A&T’s, and those are just examples.  We have this mindset that the greatest minds come from certain universities and we consider other colleges the “B team”. I also believe in meeting people where they are at various times in their lives.  For instance, there are some good people that I know that never went to, or finished, college and know more about certain topics in our industry than those of us that went.  We have to be more creative in our searches and make sure those underrepresented groups don’t feel alienated once they arrive.

What are your plans this summer for rest and relaxation?

I plan on heading to Las Vegas for a few World Series of Poker events and getting a couple days of relaxation while I’m there.


Ernesto Aguilar, P.E.,
Chief Executive Officer
Ardurra Group
Tampa, FL


Tell us about Ardurra and your capabilities and markets.

Ardurra Group is a national firm with expertise in the following disciplines: water/wastewater, public works, surveying, disaster management, environmental, and structural. Geographically we are in eighteen offices in the Southeast, Northeast, Texas, and California serving private, municipal, state and federal markets.

How has Ardurra’s performance fared so far in 2019? What’s been driving it?

We are having a fantastic year with a strong backlog going forward. Organically we are growing at about 20% with company concentration on cross selling. Acquisitions also play a large role in our growth, with three in 2018 and one so far in 2019.

Given very tight labor markets for engineering professionals, have you had to change your approach to hiring and retaining talent?

Recruiting and retaining talent is priority one for us.  We have invested a lot of resources in the last year to develop employee programs including: the launch of a comprehensive training platform, Ardurra Academy; the introduction of an Employee Council to serve as advocate for employee programs and investments; and the launch of our flagship Ardurra Leadership initiative. We are acutely focused on building a people-centric culture that provides development opportunities for all levels of the business.

We have also made significant investments in recruiting over the prior year, optimizing technology for brand building and targeted sourcing. We have hired dedicated recruiting staff who are adept at actively finding and sourcing talent, and we rely heavily on staff referrals (aided by aggressive referral bonuses) to help reel in the increasingly hard to find talent.

Ardurra has made numerous acquisitions of engineering firms as a means of growth. What do you typically look for in targets and their management teams?

We follow what we call the “Three Fs” when we evaluate engineering firms and their teams:

  • Fit – Will the teams get along (culture)?
  • Future – Are we both better off together than separate? Do our strategies for growth align?
  • Financials – Do the financial terms for both sides work?

What are the biggest concerns your clients face today?

It is no secret that infrastructure in the U.S. needs a lot of attention. Our clients have the hard task of prioritizing their most urgent needs with their available funds. I am optimistic that we will eventually have an Infrastructure Bill in place that will ease the burden of these difficult decisions for our clients.

You joined Ardurra after working at several larger engineering organizations. How has that experience helped you today as CEO?

I have been fortunate to have worked for both private and publicly traded firms. I worked for an international firm managing one of their national business units as well as a fast-growing acquisitive public traded company before Ardurra. Those experiences have been invaluable, as they have provided me a network that I use extensively in my current role. Ardurra is a fast-growing firm, and my experience allows me to introduce the efficiencies of those larger businesses, balanced against the strong entrepreneurial nature of the composite firms.

What are your plans this summer for rest and relaxation?

My daughter competes with a swim club so some weekends will be spent cheering her on.  My son is off to college this fall so we plan to do some activities together like going to a couple of Red Sox games.


Ed Alizadeh,P.E.
President & CEO,
Geotechnology, Inc.
St. Louis, MO


Tell us about Geotechnology and your capabilities and markets.

Geotechnology was established in 1984 in St. Louis as a geotechnical firm and we have expanded into a geotechnical, environmental, materials testing, exploration and geophysics company serving the Midwest and Midsouth.  We have 10 offices in 8 states including Missouri, Kansas, Tennessee, Kentucky, Ohio, Mississippi, Arkansas, and Illinois.  We are somewhat unusual for an engineering firm due to our heavy investment in capital drilling, testing and geophysics equipment.  We are continually trying to invest in the best equipment to optimize our site investigation capabilities.  Recently, we added a high-powered Geoprobe Combo rig that is capable of switching rapidly from direct push sampling to conventional auger drilling and coring.

How has Geotechnology’s performance fared so far in 2019?  What’s been driving it?

Our revenue has been essentially flat but we have increased our profitability by increasing utilizations and lowering overhead expenses.  Our backlog has grown to a historic high but the combination of very wet weather and client project delays have hurt our performance, particularly in the first 5 months of 2019.  We are heavily vested in the high-capital exploration business and we can’t make up all those lost days.  However, we had a stellar June and are expecting the remainder of the year to be very strong.

Given very tight labor markets for engineering professionals, have you had to change your approach to hiring and retaining talent?

The labor market is indeed very tight.  Hiring engineers is challenging but we continue to have success with our summer intern and coop programs leading to full-time employees.  Probably our greatest challenge has been in our field representative and drilling positions.  Those don’t require a college degree and with the unemployment rate at historic lows, finding good candidates is tough.  We have traditionally relied on recruiting/temporary staffing agencies to do the sourcing of candidates.  However, our new human resources manager is taking a hands on approach and focusing on our internal referral program and social media presence to find candidates. We need the right attitude, aptitude and work ethic and we can teach the rest.

Geotechnology has made several acquisitions of engineering firms this decade as a means of growth.  What do you typically look for in targets and their management teams?

We made two great acquisitions in the last nine years.  Both were the result of our strategic planning team identifying geographic diversity as a key goal.  If you look back to January, 2010, Geotechnology was very St. Louis centric with other offices only in Kansas City and southern Illinois.  Our leadership determined that we need to diversify geographically for our long-term health and growth.  We focused on finding firms with the right culture, strong next level managers, strong technical proficiency and a strong market position. We also decided we would stay within a six-hour drive of our other offices so that we could physically support the new offices.  That geographic proximity has been critical as we frequently share drilling, geophysics and personnel resources between offices as needed to meet our client’s needs.

What are the biggest concerns your clients face today?

Like us, clients live in a very competitive marketplace.  We serve a very diverse client mix including industrial, institutional, public infrastructure and private commercial and multi-family development.  We try to understand the key drivers for each client by utilizing a client relationship manager model.  There is no one size fits all solution and we will only be successful going forward to the extent we understand what is important to each client.

How do you describe your leadership style of approach?  Has it evolved as the company has grown over the years?

I am working very hard to improve as a leader.  When we were smaller and St. Louis centric, I was very hands on and led by example.  I was in the trenches on most significant issues and knew all the employees well. Now, I focus on working with the management team to meet key metrics.  We broke the key metrics down to weekly bites this year to help us really execute on a consistent basis.  I am working hard not to dive into every topic myself and that is a continual learning process for me; hands off and patient is not my natural state.

What’s on your summer reading list?

I just finished Roger Daltrey’s autobiography (yes, The Who is my favorite band!) and Howard Schultz’s book describing his Starbuck’s story.  I am just starting The Longest Day by Cornelius Ryan.  This book about D-Day was written long ago but I was inspired to read it when I observed some of the 75th anniversary events in Normandy.  The everyday heroes of D-Day are the folks your readers should listen to, not this engineer from Missouri!


John Lucey
President & CEO
McKim & Creed
Raleigh, NC


Tell us about McKim & Creed and your capabilities and markets.

McKim & Creed is a 550-person engineering and geomatics firm with 22 offices in 7 states providing civil, mechanical, electrical, water/wastewater engineering, and design/build services and a full array of land, hydrographic, aerial, and mobile LIDAR, geomatics services. We serve the municipal and industrial water and wastewater; residential, commercial and industrial land development; educational and health care institutions; transportation; and traditional and renewable energy markets.

How has McKim & Creed’s performance fared so far in 2019? What’s been driving it?

We are forecasting 20% annual revenue growth in 2019 and 36% operating profit growth. These are consistent with our 24% CAGR of revenue and 41% CAGR of profit since 2015. Our growth has been driven by our motivated and entrepreneurial employee owners providing impeccable service to our clients as we add talented recruits to serve our healthy, diverse markets. We have also added two tuck-in acquisitions in the past year.

Given very tight labor markets for engineering professionals, have you had to change your approach to hiring and retaining talent?

We have brought onto our staff a full time talent recruiter and have established a generous employee recruitment bonus system. We have also increased our focus on engagement with universities to connect with students early in their educational process.

McKim and Creed has made several recent acquisitions of engineering firms as a means of growth. What did these firms specifically bring to your organization?

We acquired an MEPS engineering firm in Pennsylvania that doubled the size of our MEP staff serving the educational, health care and commercial development market and provided additional design capacity to support our growing industrial design/build business. We also added a civil, water/wastewater, and geomatics firm in the Florida panhandle that allowed us to fill in that gap in our geographic presence in Florida.

McKim & Creed has an Employee Stock Ownership Plan (ESOP) in place. How has that benefited the firm and your culture?

Our ESOP has been a tremendous tool in transitioning ownership from the founders while establishing a culture of employee ownership. Our employees treasure the concept of owning their firm and ESOP ownership has grown to over 50%. The number of individuals who have purchased shares of McKim & Creed stock outside the ESOP has also increased in the last 5 years from 24 to 118.

You joined the firm this decade after working at several larger engineering organizations. How has that experience helped you today as CEO?

Every firm has certain things that do very well. My experience with other firms has exposed me to those successful elements of managing an engineering firm. Some of my favorite lessons are to drive business growth through a delicate balance of discipline and entrepreneurial spirit and to maintain a continuous focus on incremental improvement initiatives.

What’s on your summer reading list?

Just finishing Sapiens, a gift from an engineering management class that I speak to at Duke University.


Roseline Bougher
President
A.D. Marble
King of Prussia, PA


Tell us about A.D. Marble and your capabilities and markets.

A.D. Marble is an environmental and engineering consulting firm serving clients in the Mid-Atlantic and New England regions. Our work is predominantly in the public sector with our main focus on transportation. We are a one-stop shop for our clients who are looking for expertise in all aspects of environmental, cultural, and water resources services. We also have a communications division which provides public outreach, environmental education, and signage and wayfinding services.

How has A.D. Marble’s performance fared so far in 2019? What’s been driving it?

2019 has been a record year for us when it comes to wins as a prime consultant. Usually, as an environmental firm, A.D. Marble serves as a sub-consultant to larger engineering companies. This is due to the lack of contracts that will select an environmental firm as a prime. However, this year we reached the record number of contracts that we have won as a prime.  The driving factor has been our business development approach accompanied by an excellent group of scientists, cultural experts, and engineers who by doing excellent work have taken the company to the next level. With more contracts as a prime consultant, we have the opportunity to better control our workload and have direct contact with our ultimate clients.

Given very tight labor markets for environmental and engineering professionals, have you had to change your approach to hiring and retaining talent?

I wouldn’t say that we have changed our approach all that much, but we have increased our use of social media to announce our openings. This seems to be the best form of recruitment right now. For some higher level positions, we still rely on recruiters but even those are turning more to social media to find job openings.

A.D. Marble is employee-owned through an ESOP. How has that structure been a competitive advantage and for your culture?

We have been an ESOP company since 2002 so we are now considered to be a matured ESOP in many respects. From the beginning, we have been very proud of the fact that we are employee-owned and our culture has been a great fit for the ESOP. I think the competitive advantage comes from having employees that enjoy what they do, love the company and their co-workers, and are always willing to go the extra-mile to get the job done right. The ESOP did not create our culture, but it definitely enhances it.

What can our industry do better in terms of bringing more women into our profession and retaining them long-term?

We need to start sending the message to our girls that engineering is for everyone and that females have just as much to offer to the industry as men do. As a woman in this industry, I wished I had a mentor to guide me and advise me on how to navigate this male dominated industry. As an industry, we need to come together and present opportunities to men and women equally. That way, our elementary and middle schools girls do not see engineering as an industry that is more available to men than women. There is a lot of work to do in this field, but it is possible if we work together at all levels of the industry.

What are your plans this summer for rest and relaxation?

I must admit that I am not very good at making time for R&R. However, my husband and I have few long weekend getaways planned during the summer and one trip to North Carolina to visit my daughter at the end of the summer. My usual go-to for relaxation any time of the year is a short spa getaway. Once in a while, I try to escape the routine and go to the spa to decompress and relax.


Dan Adams
President
McMillen Jacobs Associates
San Francisco, CA


Tell us about McMillen Jacobs and your capabilities and markets.

McMillen Jacobs is a mid-sized multi-disciplined firm focused on underground engineering and water resources.  We serve water, wastewater, transportation, power, and water resource markets across North America, New Zealand and Australia. Our services on a typical project range from early planning to self-performing construction. About 60% of our work is professional services with most of that being related to tunnels and underground structures. About 40% of our work is engineer led design-build on dams, power stations, and other related facilities.

How has McMillen Jacob’s performance fared so far in 2019? What’s been driving it?

2019 so far has been a very good year for us and is projected to be a record breaker in nearly all markets.  The primary driver is a backlog that includes a higher percentage of work that started “late” due to delays on our clients’ side.  For example, one of our largest projects on the east coast was “awarded” in September of 2017, yet we did not receive NTP until December of 2018. We have four major projects, all design-build, which are in this situation. And of course meanwhile while these delays occurred, we continued to pursue opportunities, many of which have come to fruition.

Given very tight labor markets for engineering professionals, have you had to change your approach to hiring and retaining talent?

In January we re-organized our HR group to put a larger emphasis on recruiting. We also commissioned an external compensation review and changed our key-hire offers to sweeten them a bit and simultaneously expanded our ownership transition.  This is because we are continuously challenged on compensation. Our total comp is competitive but our equation is tied to the company’s performance, typical for a mid-sized firm. It’s tough to keep our motto of “hire good people when they come available, regardless of workload” alive when the staff we’re looking to hire comes from the big/public AE firms.

Given the highly-visible and complex nature of the projects you undertake, how does the firm maintain innovative and technical excellence?

We run as one-firm and the entire company buys into this.  We spend quite a bit of energy on communicating who within the company is on the front end of technology or a given engineering issue, and hold an annual meeting called “what’s next” in terms of predicting the changes we’ll see in our industry. We encourage and support (financially) development of new ideas and choose teaming partners, particularly in design build, who are willing to try something new. In 2019 we received our fourth patent for a drilling device that was developed by our team, tested on a project, deployed and tested the concept with a builder, and celebrated within the company.  One of the reasons we’re here (back in the day we called them core values) is to advance the industry through innovations, so it’s in our DNA and something that people come to us to pursue.

This year marks the five year anniversary of the merger between McMillen and Jacobs. How have you measured its success? Is there anything you would have done differently?

We measure success against the goals/objectives established as part of our merger agreement:  Our shareholders have achieved a good rate of return on investment, we are much more diversified in what we deliver and where we deliver it from, and our brand has caught-on to the extent the days of “little Jacobs” are behind us.  Lastly, our ownership transition effort that started in 2007 has continued into its 3rd generation.

Taking a broadly held company and merging it with a family business has not been easy. Our culture checks and agreed trial period working together prior to merging focused too much on projects and clients.  We would have benefited from a deeper dive into the business of running the companies, with a step-by-step comparison down each other’s 2nd and 3rd tier management levels to compare decision philosophies.  We also under-estimated the resistance of some very senior engineer/managers toward the move into design-build delivery.  30 years in cost+ work doing solely professional services creates habits and practices that don’t easily convert to lump-sum, turnkey delivery.  Both of these issues were challenging to work through but are now behind us.

What’s on your summer reading list?

The Overstory by Richard Powers; Dreamt Land by Mark Arax, Make Big Happen by Mark Moses, and The Old Man and the Sea by Hemmingway.  A mixed bag as it always is (I read quite a bit).  The last one I read every now and again for a quick escape from reality and a reminder to create the time to do what you love.


Coming!

ROG+Conferencelogo_perspective_may18
November 6-8, 2019
Ritz-Carlton Golf Resort
Naples, Florida
Click here for more details and to register.

Do the Valuation Multiples You’re Using Actually Apply to Your Firm?

In my last Perspective (November 2018), I touched on the importance of why using the “right” level of profit was important when comparing valuations of one’s firm to others on an earnings multiple basis (e.g., 4.2x EBITDA, 3.9x EBIT, etc.). Although there are various levels of profit that firms rely on for quick pricing indications, I focused solely on EBIT (earnings before interest and tax) and EBITDA (earnings before interest, tax, depreciation & amortization) for the sake of simplicity.

This prompted a number of readers to ask for specifics about exactly what the multiple was that they should be using for their firms. Some offered that they were relying on data published in our A/E Business Valuation and M&A Transaction Study, while others were basing their assumptions off of transactions that either they or their peers at other firms had been a part of in the past. As part of my response to these questions, I countered by asking a question of my own: Would you rather your firm be valued by a high or low multiple? The replies were universally consistent: all respondents desired a high multiple.

In actuality though, the greater a firm’s profitability is compared to the profitability of its peer group, the lower the implied multiple, and vice-versa. This probably seems counterintuitive at first thought. After all, why should a firm that’s found a way to deliver enviable profits be subject to a lower multiple, and why should a firm that trails its peers benefit from a higher multiple? The reason is straightforward: The inherent value realizable to an investor lies in that investor’s ability to effect change, change that results in a better-run (more profitable) firm. The value placed on control, as represented by the pricing multiple, should be higher for a firm that isn’t run optimally. On the other hand, investors would balk at paying the same multiple for a median or worse-than-median performing firm, realizing that there is very little they could to that would lead to a positive change of the firm’s performance.

If pricing indications for a group of like firms point to a pre-owner bonus EBITDA of 5.0x, that multiple reflects a result that is applicable to at or around median-performing firms from the perspective of pre-owner bonus EBITDA.

What do I mean by this? Let’s consider three firms, all generating $10 million in net service revenue. Each of the firms can be considered substitutes for one another from the market’s perspective, and the median pre-owner bonus EBITDA for the group to which these firms belong is 12%.

The first firm delivers a profit margin of 12%, meaning that the implied valuation would be $6 million. At a glance, this value indication appears to be reasonable.

Net Service Revenue 10,000,000
Pre-owner Bonus EBITDA margin of 12% 1,200,000
Implied Valuation Based on a Median Multiple of 5.0x 6,000,000

However, if the same multiple were applied to firms whose performance out of the range of at or around the median:

The second firm, which has a much more robust profit margin of 30%, would have an implied valuation of $15 million…

Net Service Revenue 10,000,000
Pre-owner Bonus EBITDA margin of 30% 3,000,000
Implied Valuation Based on a Median Multiple of 5.0x 15,000,000

…and, the third firm, whose profitability severely lags compared to its peers, would have an implied valuation of $1 million.

Net Service Revenue 10,000,000
Pre-owner Bonus EBITDA margin of 2% 200,000
Implied Valuation Based on a Median Multiple of 5.0x 1,000,000

The fact is that the implied valuations of the second and third firms aren’t realistic, and if such valuations actually existed in the wild, they would be considered significant outliers. In the case of the second firm, an investor would question the sustainability of a profit margin so much greater than the median, resulting in a downward adjustment of the multiple based on factors specific to said investor. The third firm, while falling behind the industry by a large margin, would present an opportunity for an investor to extract greater profitability than a measly 2%, meaning that the multiple paid should be higher than the median of 5.0x.

Profit multiples offer a handy way to provide firm owners with a rough estimate of value, but what constitutes an appropriate multiple should always be given ample consideration. One way of counterbalancing the misapplication of a multiple would be to rely on a range of multiples, which can be a useful way of estimating the high and low ends of value.

Is Your Business Focus Hurting Profitability?

Companies often say they’re client-, design- or employee-focused. The purpose of identifying your focus helps to communicate how you execute business strategies with your employees, clients, competitors and shareholders. Firms employ these focused strategies to create a path for delivering value and enhancing profitability. These are excellent examples of the types of possible focus areas to consider for your company. However, do they truly capture the essence of your company?

An increasing number of engineering firms enjoy earnings before interest, taxes, depreciation and amortization (EBITDA) margins ranging from 20 to 35 percent of net service revenues. They possess strong labor multipliers of 3.4x to 3.8x (even with public clients) and utilization rates of 60 to 65 percent. You get the idea: they’re profitable, and they’re not sweatshops.

The size of these companies doesn’t matter. The number of employees ranges from 40 to nearly 700, and most of these companies have employee headcount in triple digits. The majority of these firms have multiple offices and, in some cases, operate in multiple states. So why are these companies so effective at generating healthy profit margins? I think the reason is a lot simpler than you might think.

 

The Secret Sauce

First I want to share a common theme I picked up on during the “Great Recession.” At the start of the economic decline, many firms rapidly reduced the size of their workforce to stem their losses. During this same period, many firms confided to me that several of their employees probably shouldn’t have been hired by them in the first place. Harsh, I know, but these same companies also told me that before the market collapse, they couldn’t find project managers quickly enough to keep up with project demands from their clients. And there it is: project managers.

My high-profit-margin clients understand that project managers are the key to driving profit margins, not the department heads, market leaders, technical/discipline leaders or even the CEO. After all, an architectural, engineering and environmental-consulting firm is made up of a collection of projects. Focus on the one thing your firm does over and over: managing projects.

 

Projects Before Clients

It’s my experience that architectural firms, for the most part, enjoy stronger profit margins when compared to engineering firms. I thought this was because of the nature of the work they perform, but I stand corrected. It’s now my belief that their studio business model may play a more-significant role. Many architectural firms center their business around project management of a particular type of building design, which resembles the studio model.

Engineering firms, however, tend to center business around clients. They focus on meeting the needs of the clients—not the needs of the project—by delivering their services in a client-centric manner. This focus on clients may come at the expense of profitability because your employees are likely focused only on one small part of the project delivery: the discipline of what they know. A project manager looks at the whole picture of project delivery. To deliver a more-complex suite of services to a client requires a great project manager, not a great engineer.

Everything your firm does involves leading a project for your client. The client is only concerned about you delivering the value of services needed in a timely fashion, and your project managers should function as the CEO of all their projects. The corporate division should be in the role of leading and supporting the project managers to ensure they have all the tools needed to be successful. Corporate will provide finance, accounting, business development and human resources (training, hiring, etc.). In other words, your project managers should be leveraging what corporate provides as well as directing the technical staff on project delivery.

Services may change from project to project, but how you manage those projects should be consistent. Firms enjoying EBITDA margins well above industry norms are project-management-centric organizations. They’re very particular about how they select and develop project managers. The project manager might not be the most technically competent, nor will they be required to be well versed in all aspects of engineering solutions of a multidiscipline firm, but they should possess strong business acumen.

A great engineer might not make a great project manager, just as a great project manager might not make a great engineer. The path to efficient project management should not be based on years of experience, but instead should be an exalted position based on the skills of the individual.

 

Leading Stats

I reviewed some critical statistics of several of these companies that adopt this belief. The typical ratio of employees to project managers ranged from 4.82 to 5.35, so if you have 500 employees, you may only have 100 project managers, and they must lead their many projects—not manage their projects. If your project manager spends a lot of time working in their projects, it’s very likely that they’re not leading.

So how do you organize your firm to be a project-centric organization? Let’s use a multi-state, multi-office scenario as an example. The executive team will lead the regional leaders, the regional leaders will lead the project managers, and the project managers will lead the services. Keep in mind that the expertise of your service will have technical leaders: this is where you see your matrix organization formed. But now you’re leading with a project-management focus because, after all, that’s the foundation of your business: delivering projects.

But Who’s Going to Buy ME Out? Three Paths for A/E Owners

Earlier this year I met with the senior leadership team at an 85-person multi-discipline engineering firm in the southeast. Coming off the best year in company history, the group felt proud of their financial success and client accomplishments and, with the possibility of a few big projects breaking their way, felt 2019 could be even better. The nine owners present were between 45 and 65 years old and had a good sense of their collective mission, culture, and values. Unfortunately, not everyone was on the same page regarding which course they should take with their ownership evolution, so I was there to help assess various strategic alternatives with them.

Underlying our discussion was a feeling that while prospects for our industry and economy were still generally upbeat, there was the reality we could also be at a mature cycle stage. As such, for some, particularly the older shareholders who have seen the ups and downs of industry waves play out over 40 years, the timing felt “right” to capture this value and implement a formal transaction. The goal was to also bring a structure of long-term sustainability and survivability for their people and clients. As with most A/E firms considering similar scenarios and challenges, there were three viable options for them.

1. Traditional Internal Transition– For the vast majority of A/E and environmental consulting firms the internal transition remains the most common form of ownership transfer. Like those at accounting and law firms, senior management cultivates the next generation of leaders and managers and subsequently sells blocks of stock to them in a coordinated manner over many years. This struck a chord with several individuals at the meeting, particularly the younger leaders coming into their own, who enjoyed their independence and possessed a desire to perpetuate the firm’s legacy. They saw minimal disruption with their clients and staff under this approach.

Fortunately, many A/E firms today are doing quite well, and growing, profitable organizations with little debt and strong cash flow can serve as a great mechanism for internal transfer programs. In fact, there are many creative ways to implement these transactions, from the company itself redeeming shares, to direct buyouts and installment notes between individuals, to hybrid deferred compensation models that could balance the needs of both buyers and sellers.

Others in the room acknowledged the need for price affordability but believed this plan would generate the lowest value to the senior shareholders who felt they were most responsible for the firm’s recent success. In addition, while the firm was on solid footing today, the prospect of assuming sizable shareholder redemption liabilities left some wary as well as taking over seven years to get fully bought out! There was a realization that the company would have to serve as a financing conduit, either through raises, loans and/or bonuses, to the next generation, potentially leaving fewer funds available for other growth pursuits and incentives.

2. Employee Stock Ownership Plan (ESOP)– Some were intrigued with implementing an ESOP, which is basically a form of qualified retirement savings plan. In fact, hundreds of A/E and environmental consulting firms have them as both an ownership transition tool and employee benefit. ESOPs are often implemented to provide a market for the shares of senior owners who have sizable concentrations of shares, to incentivize and reward all employees (ESOPs are non-discriminatory plans), and for the firm to establish a trust to make tax-deductible cash contributions or borrow money at a lower after-tax cost. Generally, we see companies around $10 million and above in revenue as the right size to pursue an ESOP, so this firm was a good candidate.

While some of the owners agreed with the powerful tax benefits and a likely higher valuation than the straight internal ownership approach, others noted the higher upfront costs of implementing it as well as a possible dilution to the remaining shareholders. And while having an ESOP doesn’t mean that other motivational arrangements like incentive compensation or stock appreciation rights go away, some felt it would be overly complicated to administer and that “there’s no going back” once it’s put in place.  Some saw it fitting right in with their culture and others weren’t so sure.

It seemed there were strong opinions one way or the other on ESOPs, as many had friends at competitors using them with varying levels of satisfaction and motivational effect.

3. External Firm Sale– The final option we tackled was perhaps selling the company outright to a larger buyer. All saw the ramifications of a consolidating A/E industry with growth-oriented companies snapping up others and taking root in their region. For all their success, this firm frequently felt squeezed between those national behemoth and super-regional engineering firms with deeper marketing, recruiting and financial resources and the small, local boutiques with lower fees and focused service or market niches.

The younger owners seemed most resistant to selling but recognized it would most definitely yield the highest valuation and quickest liquidity for everyone. The entire group shared war stories of familiar deals that seemed to succeed and others that didn’t.  Professional services combinations can be fragile and integrating two disparate firms with different cultures, operations, processes, clients and egos, even with the best of intentions and expectations, are fraught with risk. Some realized the thorny challenge to make the transition from entrepreneur/owner to employee in a large firm, giving up control and “having to work for someone else.”

However, the consensus among them was that they might not have the number of interested and motivated next generation of engineers and planners to make an internal transition work. While their staff in their 20s and 30s were bright, capable and eager, there was a lingering worry, whether real or perceived, that they did not have an intense desire or aptitude to become owners. Despite the compelling argument that the rate of return (stock price appreciation plus annual dividends) has proven to be a strong investment for this team of senior owners,  all saw a younger group as overburdened with college debt, a zeal for “work-life balance” first, and risk-averse to their career and ownership pursuits.

* * *

Which path is the best? Obviously, not an easy decision among a group of veteran practitioners with similar, but varied timing and personal goals. And all of these options need to be carefully balanced with each shareholder’s specific tax, wealth/estate, and professional goals and situation. Many A/E owners don’t start a company with the endgame in mind, but better to be in control of your own firm’s destiny than leave it up to chance.

ROG + Partners is the only financial advisory services firm dedicated to the A/E and environmental consulting industry that offers trusted advice and experience with each of the paths described above.  Whether you are seeking a valuation or evaluating your firm’s strategic and ownership alternatives, please contact us as to how we can help your organization.

Our one-day Ownership Transition Strategies Seminar scheduled for the Four Seasons Hotel in St Louis on May 8th will detail the options owners have in developing a plan that is sustainable for A/E firm owners.  Click here for more details or give me a call.

Want to Increase Value for your Firm? Pull these Levers!

As advisors to design professionals, we are often asked by owners and key executives, “How can I make my firm more valuable?” While value is in the eye of the beholder, there are some things you can do to make your firm more valuable to whomever you eventually transition your firm, whether that transition is an internal or external one. At Rusk O’Brien Gido + Partners,  we call these things “value levers” because the more focus and action you place on them (pressure), the more you drive up the value of your firm.

Architects and Engineers must have a process to acquire work, do the work efficiently, and get paid. And that work must be of sufficient quality and must be delivered with excellent service to your clients.  Many firms make the mistake of thinking that putting in this “ante” is all that is required to create value. While doing this will get you in the game and create average value, to create exceptional value (and get paid for it in a transition), you will need to incorporate into the culture of your firm the value levers I outline below.

Simply put, firms with exceptional value are those that are scalable, profitable, and have longevity. Let’s define those terms and look at the value levers that drive them. Please note that the value levers of a particular category can also be a value driver in the other two.

Scalability: the ability of an organization to increase its relative production capacity to respond to present and future economic conditions proactively. Investors place a value premium on firms that can show solid and stable growth. Exceptionally valuable firms demonstrate the ability to grow revenues in times of economic expansion and increase market share in times of economic contraction. Here are just a few value levers you can use to drive scalability:

  • Bullpen – make sure you have a list of people you can hire if the need arises. Identify who they are, where they are, and how you can get them. This list should always be current.
  • Marketing – too often, firms market only when they need the work. This practice, however, just replaces the completed work and often results in a “sawtooth” picture of revenue where one period looks great and the next not so good.
  • Project Management Capacity – growth has put more firms out of business than lack of work. Why? Because, often, the existing management structure is incapable of managing the increased workload. As a result, the risk of mistakes increases, profitability and quality of work suffer, and invoices go uncollected. Confirm you have the systems, processes, and people that can handle increased business without sacrificing quality and profitability.
  • Credit Capacity – growth sucks up cash. Make sure you have the funds to fuel this growth which can be existing cash, the ability to temporarily draw on a line of credit or take out a loan. And, collect your receivables promptly.

Profitability: the ability of an organization to consistently and predictably generate a return to its investors of time and money. Would you rather invest in a firm that had profitability one year of 5%, then 35% the next, and then back down to 10%? Or would you instead invest in one that achieved 16% to 17% consistently? On average, over the three years, they are both achieving roughly the same profitability, but one has considerably more risk and the other shows consistency and stability. Here are some value levers you can use to get consistently better returns for your firm:

  • Timely and Accurate Financial Reporting – better decisions equal better results. You can only make better decisions if you have the information to base them on. Your financial reports should provide you with the data that you need to evaluate prior to making decisions and taking corrective action. In this regard, they must be simple, concise and actionable. Furthermore, they must be accrual-based as the cash-basis format is by nature not timely nor accurate.
  • Processes for Reducing Risk and Increasing Efficiency – as an owner and leader, you should be relentlessly and mercilessly driving unnecessary risk and inefficiency out of your organization. One of the best ways to do this is by developing processes and systems that can be repeated with accuracy and simplicity and that are not dependent on certain personnel.
  • Pricing – increase your prices. There is no greater or easier way to increase profitability than by raising prices. Any increase in price drops straight to the bottom line without any additional cost associated with it. Almost every business in the world raises its prices – because costs go up, like your cost of labor. You give raises and bonuses  – so you need to pass along that increased cost to your clients or face the dreaded margin squeeze. When is the last time you raised your prices?

Longevity:  the ability of an organization to last. Said another way, a valuable organization is one that can not only survive the inevitable ups and downs, challenges and changes in business but can flourish in spite of those. A/E firms face particular challenges in this regard and here are some ideas for you to consider:

  • Bench Strength – organizations with a team of capable leaders are more valuable than ones in which one person holds all the knowledge, client relationships, and rain-making capabilities. By being the center of power and control in their firms, owners create more risk and drive down the value of their firm by limiting the longevity of the firm to their own tenure at the helm. Whether external or internal, buyers like to know that the firm can survive the departure of the current leaders, as it takes time to recoup their investment and make a profit.
  • Diversification – in the pursuit of revenue and “that big project,” it can be quite tempting to allow revenue to concentrate in a single client or client type. However, the risk profile of such a scenario will deter most investors, and rightly so. In small companies that are just starting, it is very likely that concentrations will occur. But whether you are a new or an established firm, you should focus on growth in new clients and project types that increase your diversification and not your concentrations. A good rule of thumb is that no more than 15% of your revenue should come from a single client or client type.

Of course, we’ve only scratched the surface on the ways to make your firm more valuable. There are many value levers that you can use, depending on your situation. The important thing is that you begin to use these levers intentionally to increase value for you or the next owner. Hopefully, this helps, and if you would like to discuss or further explore how you can increase the value of your firm, please give me a call. You can also find me at our one-day Ownership Transition Strategies for A/E Firm Leaders Seminar in May.