AE Valuation & Ownership Transition Advisor: Volume 7 Issue 1

valuation 101

How AEC Firm Valuations Vary for Internal Transitions and External Sales

Different approaches and metrics are used to value firms for internal buyouts and external acquisitions. 

There’s no single answer to the question of how much an architecture, engineering, or environmental consulting firm is worth. In addition to the multiple methods that can be employed in AEC firm valuations, companies can have different values depending on the buyer. 

The AE Valuation & Ownership Transition Advisor spoke with Morrissey Goodale principal advisor and AEC firm valuation expert Alexander Tepper, PhD, to learn more about the fundamental differences between calculating firm values for internal buyouts and external acquisitions—including the metrics that are examined and the discounts that are applied.

AE Valuation & Ownership Transition Advisor: What are the primary differences between AEC firm valuations for internal transitions and external sales?

Alexander Tepper: When determining valuations for external sales, we’re looking at the price an outside buyer would pay—and that can fluctuate considerably based on market conditions. We also consider what the buyer might be able to achieve by taking advantage of their strategic plans and the synergies of the combined entities. External valuations are more sensitive to recent results and are based in part on what buyers think they can do with a business. For valuations for internal ownership transitions, there is a smoother value over time and less sensitivity to up-to-the-minute market conditions. 

AEVOT Advisor: What do you typically examine in valuations for external transitions?

AT: External valuations tend to be very focused on both a firm’s recent EBITDA history and what EBITDA buyers think that they can achieve going forward, so it’s much more focused on earnings and recent history. To determine the appropriate multiples of EBITDA, we look primarily at Morrissey Goodale’s proprietary deals database, which contains data on the transactions of hundreds of small- to medium-size architecture and engineering firms. That is a much better metric than the public markets, which are more appropriate if we were looking at a really big company. 

AEVOT Advisor: What do you typically examine in valuations for internal transitions?

AT: For internal buyouts we’ll look at a wider range of metrics that typically measure firm size and profitability, such as number of employees and net and gross revenue. And we’ll typically look at trailing historical averages of those to avoid sudden outsize fluctuations of the value of the business over time. 

AEVOT Advisor: Why do you look back over a longer time period for internal valuations than external ones?

AT: Most companies don’t want to see their stock valuations going up and down with the vagaries of the stock market every year. That tends to be disruptive to ownership transitions. Most internal valuations for ownership transition create a more stable program with less risk for participants by taking a longer perspective than the quarter-to-quarter view the stock market often takes. On the other hand, external valuations go up and down with the stock market because that’s what you’re competing against.  

AEVOT Advisor: How do you account for the value of goodwill? 

AT: Whether for internal or external transactions, the valuation methods we use will always take into account what architects and engineers tend to think of as the goodwill value of their firms, which is the value of their franchises above and beyond what the balance sheet says. That includes the firm’s reputation, customer base, infrastructure, and franchise. That’s a crucial part of what we consider. Our valuations are based on the future earnings of franchises, and that automatically takes into account goodwill.

AEVOT Advisor: Are there discounts particular to valuations for internal or external transactions? 

AT: Yes. Internal valuations will typically have discounts for lack of control—meaning that no one individual has control over the company—and lack of marketability—meaning those stakes can’t be freely bought and sold.

AEVOT Advisor: Do valuations for internal buyouts tend to be lower than those for external sales?

AT: Internal valuations are typically lower than external ones because of those discounts for the lack of control and marketability. A strategic buyer may also have synergies that they can exploit that internal buyers can’t.