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.
A guide to help you better understand how AE firms are valued and – perhaps more importantly – what you can do to build value now.Read Newsletter