An Overview of Architectural/Engineering Firm Valuation
How much is your A/E firm worth? Certainly an important question, and unfortunately it is one that many A/E firm owners cannot easily answer!
First let’s start with a discussion about why it is so critical to understand the value of your firm. There are many reasons to understand the value of your A/E firm, including
- Plan for growth in value
- Internal ownership transition
- Merger with another A/E firm
- Outside sale of your firm
- And even acquisition of another firm!
Growing the value of your A/E firm
If you know the value of your firm and understand the critical factors that influence its value, that should better allow you to manage your firm to produce not only current earnings but also increase the firm’s long-term value. A specific target value can be set for some future point, such as the retirement of key shareholders. Goals and strategies can then be established to help achieve this target value.
Internal ownership transition
When you transition ownership within your firm, you are really transitioning value. To understand the amount in dollars that must be bought and sold, as a starting point, you must know the value of your firm. From there, you can begin to consider how to best plan for transition of that value. There are many opportunities and complexities in planning for internal ownership transition, and these will be the subject of a future blog post! We also teach a full day course on ownership transition for A/E firms and upcoming locations are listed at www.dmconsultingseminars.com.
Merger or outside sale to another firm
Sure, most firms are not actively being marketed, however for the right price just about any owner would consider a deal! It is important to understand the value of your firm so that you can evaluate any offers you might receive. The A/E industry has been very healthy in recent years, and this has increased firm values and the ability of acquiring firms to consummate an acquisition.
Acquisition of another firm
Yes, it is also important to know the value of your firm if you are looking to acquire another firm. How you view the value of your firm will help you to understand the potential value of a target firm. In addition, an acquisition might be paid for with your firm’s stock so a value will be needed to determine the number of shares to exchange.
Determining the Value of Your Design Firm
There are a number of different ways that A/E firms determine the value of their stock. These range from educated guesses to values based on an established formula to detailed valuation reports prepared by qualified appraisers. Following is a summary of some common methods for valuing A/E firms along with comments on their application and usefulness.
It is very common for small A/E firms to use book value as their method of determining the value for share transactions. However, an A/E firm is usually worth much more than its book value! Even if your accounting is properly performed on an accrual basis, book value only includes tangible assets and represents nothing more than liquidation value if you collected your receivables, paid your payables and sold off other assets. Surely your firm is worth more than just its liquidation value!
Capitalization of earnings
A/E firms can also be valued by assigning a valuation multiple to “capitalize” the historical or projected future earnings of the firm. Depending on the type of earnings that is utilized in this calculation, an appropriate valuation multiple might be in the range of three to seven times. This type of valuation will only be effective if a firm’s earnings are “normalized” to addback discretionary expenses and adjust for other nonrecurring income or expense.
The A/E Approach
While book value is not by itself sufficient to determine value, consideration must be given to the value of the assets retained in the firm. Under the A/E Approach, the adjusted book value represents the floor value or starting point in determining value. To this base value, an earnings or goodwill factor is added to determine the overall value of an A/E firm. The earnings factor is most often determined by capitalizing the weighted average earnings of the firm for the most recent five-year period. This hybrid approach was developed years ago by our consulting firm Dannible/McKee and Associates, Ltd. and is commonly known as the A/E Approach. It has been successfully utilized to value hundreds of A/E firms across the U.S.!
Industry rules of thumb
There are a number of “rule of thumb” valuation multiples that are often talked about in the A/E industry. These are generally not sufficient to rely upon in determining value as they ignore many of the individual characteristics of a firm. However, they can provide a great sanity check in support of other more detailed valuation methods. The most common industry rule of thumb indicates that A/E firms are valued in the range of 45% to 60% of annual net revenue. Another useful statistic shows that values fall into an average range of $60,000 to $70,000 per full-time equivalent employee.
Impact of the Pandemic on A/E Firm Valuations
The COVID 19 pandemic had a dramatic impact on the 2020 operating results for many A/E firms. Additional scrutiny will be needed to determine how this unusual year may have impacted the firm’s valuation. While operating profits were generally lower, for many firms this was more than offset by the Paycheck Protection Program (PPP) loan proceeds and forgiveness, possibly resulting in a growth in book value. These items require careful consideration in determining whether the methods used and value determined for the firm is still appropriate.
I hope this article has helped to show the importance of knowing the value of your A/E firm and provides at least a starting point to understanding how that value might be determined. Please visit the website of our consulting firm Dannible/McKee and Associates, Ltd. at www.dmconsulting.com for more information about A/E firm valuation. If you would like to discuss the valuation of your A/E firm, feel free to reach out to me anytime!
Victor Vaccaro, CPA/ABV, CFF, CDA
Partner, Dannible & McKee, LLP
Principal, Dannible/McKee and Associates, Ltd.