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AE valuation & ownerhship transition advisor > Volume 3 Issue 1
AE Valuation & Ownership Transition Advisor: Volume 3 Issue 1
A guide to help you better understand how AE firms are valued and—perhaps more importantly—what you can do to build value now.
In This Issue
valuation resources
ownership transition
valuation resources
How Can You Increase Your Firm’s Value?
If you are considering selling your firm externally or transitioning ownership internally, you might be wondering: “How big could my payday be?” An A/E firm’s value comes from its future profits (actually, cash flows) or the potential future cash flows it may bring to its owner or owners. Those in turn depend on client relationships, staff expertise, intellectual property, market position and other factors.
Future Profits. When you invest in a stock like Apple or Amazon, you’re actually buying a tiny slice of the company’s future cash profits. A closely held A/E firm is no different. For example, if you own 25% of a firm with $1 million in annual cash profit, your share is $250,000 per year. But how do we as design professionals value how much that potential stream of cash flows is worth over time? It depends on how reliable that profit is, and how fast it will grow over time. But as a rule of thumb, investors in A/E firms in today’s economic environment expect to see annual returns of about 12%-20%. Higher profits, faster growth, and/or more predictable profits will all increase a firm’s valuation.
Client Relationships, Staff Expertise, Market Position and Intellectual Property. Each can be a critical component of a firm’s ability to turn a healthy profit. But more than that, they are assets a larger external buyer can leverage. For example:
- Does your firm have a long-standing relationship with a regional transportation authority that would be valuable to larger firms seeking an entry into that market?
- Is your firm at the cutting edge of engineering for a niche market, such as oil refineries or building control systems, that would complement a larger firm’s service offering?
- Has your firm developed intellectual property with broader applications than you are currently realizing?
Any of these can increase your firm’s value to an external buyer, often beyond what the firm would be worth on a standalone basis. But to be fully valued, these assets must be part of the fabric of the firm, so that the buyer can be confident that built-in value will survive the acquisition. The same is true for internal valuations and share transfers – institutional assets and attributes not dependent on a specific individual or team will drive higher value.
General Economic Conditions. External investors will compare your firm to other investments available in the marketplace. Usually, your firm will command a higher valuation when there is more interest in investment in your sector, the economy is stronger and/or interest rates are lower.
Building a valuable firm isn’t rocket science, but it’s far from easy. It takes management discipline, strategic choice of markets and strong attention to institutionalizing your firm’s unique assets so they are not dependent on one or two employees. All increase the firm’s ultimate source of value: its future profit potential.
ownership transition
When Should a Leader be an Owner?
As your firm grows, you may find others in the company acting like leaders of the firm: making sustainable use of staff and financial capital, delivering great value and a great experience to clients, and making enough money to pay for today and invest in tomorrow. When should these individuals be co-owners of your practice, and why is it worth considering sharing those benefits? Fundamentally, leaders should be shareholders when a significant share of the firm’s value derives from their work or expertise.
The why boils down to two issues:
- Self-Interest. Having additional shareholders can help protect the value of the firm. Who do you want to run the firm once you are no longer around? Making that person (or people) a shareholder and having an ownership transition process in place sets the stage for long-term continuity of the business.
- Fairness. If someone is driving value in a significant way, he or she should share in the benefits.
It’s also worth considering making an employee a shareholder when you have identified him or her as a potential future senior leader of the firm and ensured they share this ambition. These are people you’re going to make a significant investment in mentoring and developing, and you want to know you can count on them to be around for the long haul. Making a rising leader a shareholder creates a reciprocal commitment that can help lock in a future leader and ensure the long-term viability of the firm.
Just how big a part of the firm’s value does an employee have to be before you consider them for ownership? That depends on the firm’s philosophy. Some firms prefer to have only a small group of shareholders that run the firm as a tight knit group. Others prefer to share ownership more broadly over a significant fraction of the staff. In fact, we’ve worked with firms with hundreds of staff and a just a handful of owners, as well as firms with just a few dozen staff and nearly as many owners. Your personal and management philosophy and your firm’s culture will help determine where on this spectrum is right for your firm.
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