Employee- and ESOP-owned companies have traditionally been the dominant buyers of architecture, engineering, and environmental consulting firms. As recently as 2018, they were the apex predators on the savannah, accounting for almost three-quarters of all AEC industry acquisitions that year.

But then, private equity arrived on the scene with fistfuls of cash at close and business plans akin to blank canvases that allowed sellers to keep their brand names. The result? The percentage of industry deals done by employee- and ESOP-owned firms declined steadily and precipitously, bottoming out in 2021 at just over 50%.

“The AE Industry is changing as private equity, as distinct from, but in addition to, family offices, have seen our industry as a very good place for them to invest, make improvements, and get a return on their investments”

-Nick Belitz, Principal

Private equity investment has driven M&A in the AEC industry’s “great recapitalization” and propelled M&A activity to record levels in 2022. According to Morrissey Goodale’s 2022 AE Industry M&A: Year-in-Review and Look Ahead, private equity M&A transactions accounted for 33% of AE and environmental firm deals in 2022.

Why Is Private Equity Recapitalization Happening Now? 

This growth in private equity M&A raises two questions: (1) “Why is this private equity recapitalization happening to the AEC industry now?” and (2) “Where does this all end?” Based on Morrissey Goodale’s considerable experience in private equity M&A transactions, let us try to answer both of them here. There are three answers to the why”.

1. It’s not just happening in the AEC industry (we’re not that special)

First, private equity’s influence in the U.S. has been growing rapidly for more than a decade — and has become pervasive in almost every industry. Per McKinsey, global private equity (PE) deal volume grew at a 7.8% CAGR between 2017 and 2022 as PE firms ramped up investments in energy, financial services, health care, and information technology industries among others. With net global returns of over 14%, PE outperformed equivalent public markets by a considerable margin. 

According to KPMG Advisory, the private equity industry in 2022 reported a record deal value of $920.2 billion despite a slowdown in the second half of the year due to rising interest rates, economic concerns, and geopolitical uncertainty. In addition, the 8,845 transactions completed in 2022 made it the second-most active year on record, trailing only 2021. 

At the end of 2022, the global PE industry held more dry powder than ever with nearly $2 trillion (with a “t”) in cash. Private equity has played an important — some might say outsized — role in reshaping the U.S. economy after recent economic crises. Indeed, there was a dramatic rise in PE involvement in the economy after the Great Recession when bank lending became subject to tighter regulations. And the coronavirus pandemic set the stage for even greater growth.

2. Infrastructure writ large is attractive to private equity firms

The second reason why the AEC industry is seeing such an influx of PE investment is that infrastructure is an attractive investment vehicle for private investors with the promise of stable, long-term cash flows. The Public-Private Partnership (PPP) infrastructure model has worked well outside of the United States, and there is clearly a need for private investment in U.S. infrastructure — the public sector cannot fund it all. 

PE firms are active in the water and transportation infrastructure sectors domestically, and private investors are looking for more opportunities to directly participate in U.S. infrastructure projects. Also, in this socially conscious day and age, infrastructure is a great way for private investors to boost their ESG scores.

But, like a relationship status on Facebook — it’s complicated: The PPP model for infrastructure has and continues to face challenges here in the U.S. Private-sector participation is still minimal compared to the needs and the potential market.

This is why the AEC industry is so attractive to PE: We provide the ideal investment vehicle to participate indirectly in the infrastructure space. We are the perfect adjacent investment. Design and environmental firms provide PE investors with an “asset-light” way to exploit opportunities in the infrastructure sector.

With $1.2 trillion of federal investment coming through the Infrastructure Investment and Jobs Act (also known as the Bipartisan Infrastructure Law) over the next five years and the largest federal clean energy investment in American history from the 2022 Inflation Reduction Act, the opportunity is there to generate significant returns — with the right investments, of course. That has made firms that even remotely touch any part of infrastructure — especially transportation, water/wastewater, or power and energy — enticing prospects for private equity firms.

3. Endemic industry performance and structural features

This is the third reason why the AEC industry is seeing so much PE investment. Most firms in the industry never reach their potential in terms of ROI, ROE, and ROA. This is largely due to (a) sub-optimal business management practices on the part of the architects, engineers, and scientists who lead the firms and (b) a lack of accountability for performance. (We are an industry run by very smart professionals who, for the most part, are not business savvy and fail to hold those around them to task.) 

This tendency to underperform makes design and environmental firms very attractive investments for PE sponsors. These investors bring both business acumen and access to cheaper capital via debt to the acquired firm. Combined, these features dramatically improve ROI, ROE, and ROA.

And then, of course, bigger is better: The PE model is based on the simple fact that scale in a professional services firm translates to higher value. PE firms invest in a design or environmental firm at a certain size at a specific multiple of earnings before interest, taxes, depreciation and amortization (EBITDA), and then they exit their investment (typically after about five years) having grown the firm to a larger size (with improved bottom-line performance along the way) at a higher multiple. 

Since 2011, the median EBITDA multiple for AE and environmental firms between $25 million and $100 million in gross revenue is 6.44x while that for firms over $500 million is 11.26x. Buy low, sell high — usually to another PE firm. Our highly fragmented industry of over 40,000 firms — all of which are facing leadership and ownership challenges — is ripe for consolidation by PE.

Where Does This All End? 

So, where does this all end? In the long term, for a variety of socioeconomic and demographic reasons, we’re heading inevitably to an industry that is majority PE-owned and minority employee-owned. Already, 15% of the ENR Top 100 is PE-backed. 

While the economy is strong, the PE model works well — just like any other capital model. The question becomes what happens when we hit the next economic recession or crisis. How will this new cohort of debt-burdened AE and environmental firms fare when the industry faces headwinds instead of the tailwinds we’ve had for the past decade?

Industry savior or destroyer? There’s plenty of data that show that in the larger economy, PE-backed firms were able to navigate the Great Recession more successfully than firms with other capital models. So, there is less concern about the resilience of this new capital model in the AEC industry than the risk in the capabilities of the leadership teams guiding these firms through the next recession or economic crisis. 

The opening pitch by most PE investors when they meet an AE firm management team is usually: “We don’t know how to run a design firm — you do. We just want to partner with you to help you achieve your vision.” Come the next crisis, the PE investors better hope that the management teams actually do know how to navigate successfully through the storm. 

Morrissey Goodale Is the AEC Industry’s Leading Market Advisor for Private Equity M&A Deals 

With our deep experience in facilitating private equity M&A transactions and knowledge of the AEC industry, Morrissey Goodale’s expert M&A advisors are here to help architecture, engineering, and environmental firms evaluate PE options and complete transactions. In addition, we can assist private equity firms to gain a greater understanding of the AEC industry and match them with platform investments and add-on acquisitions. 

For architecture, engineering, and environmental firms, Morrissey Goodale’s M&A experts can:

  • Help you understand private equity, its pros and cons, and its suitability for your firm
  • Assist you in finding and selecting the right private equity partner
  • Help you negotiate the optimal transaction terms if you’re actively engaged with a potential PE partner
  • Allow you to make “apples to apples” comparisons if you’re interested in comparing recapitalization with private equity as part of a strategic options assessment
  • Be with you every step of the way in recapitalizing—from identifying private investors through the rollover into a new, recapitalized platform
  • Help you navigate the right offer for your firm

For private equity firms, Morrissey Goodale’s M&A experts can:

  • Help you understand the AEC industry to validate or guide your investment thesis
  • Identify and connect you with platform investments and add-on acquisitions using our unmatched industry network and database
  • Recruit executive-level talent to lead and grow your investments

Contact us today to find out how Morrissey Goodale can help your firm with private equity M&A.

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