Word on the Street: Issue 142

Let’s Make a Deal in 2023

As we approach the end of the first quarter, the M&A market for AE firms continues to be robust. While overall activity may not be on the same scorching pace it was in mid-2022 and cracks are beginning to appear in the larger economy (last week’s Silicon Valley Bank implosion being the most recent example), there’s still plenty of deal-making to be had and we expect the field of would-be buyers to remain a crowded one in 2023. Undoubtedly, they’re already knocking on every door out there, so if you intend to be the one to close a deal, here are a half-dozen insights that will help you in your quest:

1. Strategic and cultural fit triumphs overall—at least out of the gate.
The starting point for sellers these days is fit. Recognize that high-performing firms, or those in high-growth markets and sectors, have buyers lining up around the corner as if there was a Black Friday door-buster—and they didn’t even have to offer any discounts to pull off the feat. By now, most attractive firms believe they’ve heard it all and been offered it all. So, ditch the buyer mindset, and start thinking like a business partner. Convey what makes you different aside from the check you’re willing to write. Does your firm embody a similar culture, core values, and similar aspirations for what the combined company could look like? Do you share a similar purpose in the world? Do you invest in your people first and foremost? Listen more than you talk in early discussions for what compelling parallels can be drawn between the two organizations.

2. Sure, sellers may have heard it all and been offered it all, but they’re still not above cash.
I know we just talked about fit coming first, but assuming there is one, sellers are still as interested in cash as anyone else, especially retiring shareholders who need to be cashed out as a part of the deal. Cash can range from 60%-100% of the total purchase price, so be as certain as possible about future growth projections if your deal is going to be particularly cash-heavy.

3. Borrowing money from your new partner might make sense.
Since the vast majority of deals aren’t 100% cash, you’re going to have to fund the balance of the transaction some other way. Debt can be used, but rising interest rates have pinched those buyers that rely on it for financing their deals—and they’re feeling it. One alternative to debt is a seller note. Just make sure the interest rate on the note is relatively close to market interest rates and have a reasonable repayment period. The cost of capital from a traditional lender in some cases is going to be SOFR (Secured Overnight Financing Rate) + 350 basis points (6.0%-7.5%). Wouldn’t it be nice to borrow from your new partner at 5.0%-6.0%? I think so (it’s better than any CD they are putting their money into post-close).

4. Your stock can be used to your advantage—if you can let some go.
I understand that equity is precious and not every buyer wants to give it up easily; but share the wealth-creation opportunity with your new partner so your interests are aligned with the seller indefinitely. Today, there are many more commonly used tax and legal structures, such as an F-Reorganization, that provide substantial benefits. The seller, for example, is able to roll over their equity on a tax-deferred basis, creating more dollars for them to invest in the combined company, while the buyer often gets a step-up in basis on the transaction and has preferred tax treatment for the life of the investment. Both parties can win.

5. Earn-outs can help you hedge your bet.
An earn-out is essentially a purchase price that can be earned by the seller. It’s based on the seller’s ability to meet future performance obligations, such as net revenue or EBITDA metrics determined by the buyer, which often closely resemble the firm’s recent performance plus a modest growth rate. Now, with the IIJA providing up to $1.2 trillion in available spending on improving the nation’s infrastructure, if you are acquiring a firm that even remotely touches any part of infrastructure—especially transportation, water/wastewater, or power and energy—then an earn-out may not fly. On the other hand, if the seller doesn’t serve the infrastructure markets, you might well be justified in questioning whether their current earning streams are, in fact, the “new normal,” and, therefore, a modest earn-out of, say, 10% of the purchase price might be a good way to protect you from overpaying while helping your seller believe they are getting a fair price.

6. Employment agreements can calm nerves.
An acquisition can rattle cages and create concern in the minds of the seller’s employees and key leaders. Questions like “Are they going to keep me around?” and “How are my clients going to feel about this?” are common. Despite your verbal reassurances, the jitters might cause some of the seller’s employees to consider looking for new jobs. To protect against this risk, consider offering employment agreements to key staff. These agreements combine assurances that sweeten the pot with restrictions that prevent hasty, string-free exits. These restrictions often include a promise from the employees to not compete (potential legislation regarding non-competes notwithstanding) or solicit any employees or clients should they choose to find another job. This arrangement has to benefit everyone involved, so look at different ways to give these key employees the opportunity to become material beneficiaries of the success of the combined business through profits interest units or stock grants. The more flexible you can be, the better chance you have of stemming key employee departures.

So keep it simple, keep it fair, and always put your best foot forward. The best buyers, defined as those who are most successful in finding great partners to grow the business, embody their brand and culture, and focus on becoming long-term business partners from the first conversation on.

Brendon Cussio is the host of the 500 Club panel at Morrissey Goodale’s Southeast M&A, Strategy, and Innovation Symposium in Miami later this month. The 500 Club consists of deal-making experts in the AE industry who, collectively, have closed more than 500 transactions. If you were unable to secure a spot for this sold-out event, make sure to join us in Las Vegas in June for our Western States M&A, Strategy, and Innovation Symposium by registering here.

To Be or Not To Be

With the incessant challenges you face from all directions these days as an AE firm leader, you may feel compelled to bow to every pressure, cave to every demand, and take the path of least resistance—all in the name of keeping the peace and the wheels on the wagon. But when does it end? Where will you draw the line? Are you hopelessly destined to suffer the slings and arrows of outrageous fortune? Or is it time to take arms (at least selectively) against the sea of troubles? That is the question.

Here are a handful of scenarios AE firm leaders find themselves in daily and some alternatives to simply taking it on the chin:

1. Your six-month employee asks for a raise after he just received a huge holiday bonus.
First, keep your cool—this kind of thing is par for the course nowadays. Be empathetic (even if through gritted teeth) and quickly pivot to managing expectations. Lay out the firm’s timeline for reviewing salaries, then reinforce what you’re looking for in terms of performance. Remind him that as long as he develops (read as specific outcomes you expect him to produce), his salary will reflect it—and so will his professional opportunities. Finally, if it wasn’t your plan to review his salary at the six-month mark, examine your firm’s interviewing and onboarding processes, determine the cause of the confusion, and fix it.

2. Your sure-thing “riser” gives her notice.
If you are surprised, say so. If you are disappointed, express it. But don’t just shake hands and wish her well. Instead, acknowledge that you know good employees are in high demand and you understand that she’s probably been recruited many times. Provide a narrative of the bigger picture—that there is a lot of desperation out there and competitors are giving out money hand over fist and promising the moon. If your riser feels like she’ll have more upward mobility somewhere else, acknowledge her view, but also reinforce the notion that she’d be giving up a bright and promising future with your firm (if that’s the case). Ask your riser to sleep on it and return for a morning discussion to explore all options together.

3. Your client, whose payment is 120 days past due and counting, keeps telling you they will process the check in the next “batch.”
The most important thing to your firm isn’t expertise. It isn’t loyal clients. It isn’t quality service. Believe it or not, it isn’t even your people. It’s cash, plain and simple. Cash is the air your company breathes (a firm can be profitable and bankrupt at the same time). You have to sell work, do work, bill work, and collect money to keep the doors open, never mind thrive. When it becomes clear missing payments are no longer an issue of invoices falling through the cracks, talk to your client. Convey your sincere appreciation for their business, but also share your concerns about getting paid. Find out if there is an issue with the service your firm is providing or if your client is dealing with a financial constraint. In any case, you’re not in business to finance someone else’s project. If your firm did its job, your clients need to hold up their ends of the bargain and make payments as stipulated in your signed contracts (I know all of you readers require those before starting work—ahem). That’s the deal. So, find out from the client what it’s going to take to get paid. You’re not a bank.

4. Your prime design firm partner (when it suits him) reads you the riot act for submitting proposals with three other teams on the same project.
Assuming you never signed an exclusive contract in the first place, you haven’t done anything wrong—in fact, hedging bets is the industry norm, so you need not take a backwards step. Now, if this firm wants an exclusive agreement with you, be open to it, but only if you get the right of first refusal on all of their work in that arena—meaning no more eating scraps off the kitchen floor.

5. Your former CEO sold all of his stock back to the company and is perpetually on vacation—but he still wants to call all of the shots and get paid big money.
Show respect for what he has contributed to the firm’s success, but also state reality—that he no longer owns the company. Others earned the opportunity to purchase the company from him. And when they did, he got paid—fair and square. Now the new owners are generating value and taking on risk; so naturally, they are the ones who will be making the strategic business decisions. As for his salary, you’re happy to pay him one that’s in line with his current level of involvement, but not his past performance.

You’ve got to rise to challenges in your own way, but if you prepare for them before they land in your lap, you and your company will be much better off.

Are you seeking an executive coach? Call Mark Goodale at 508.254.3914 or send an email to [email protected].

Market Snapshot: Residential (Part 2)

Weekly market intelligence data and insights for AE firm leaders.

Last week’s post featured overview, size, and outlook information about the residential market. If you missed it, you can check it out here. This week we will cover drivers, trends, and hot spots.

Drivers

• Population growth and geographical dispersal
• Demographics (e.g., age, income)
• Housing structures aging and deterioration
• Mortgage interest rates
• Price of materials such as lumber, steel, cement, brick, and gypsum
• Government policies (e.g., tax incentives and deductions)

Trends

• From a design aspect, trends are focused on well-being, connecting to the outdoors with natural lighting and exterior amenities, and an exacerbated need for office space. Concepts like biophilic design continue to be on the rise.
• With construction costs hitting record high growth, designers and builders are looking for new options and technologies such as 3D-printed and recycled materials. Nonetheless, brick is still a viable and popular option. 
• With affordability being low, smaller homes and simpler/basic interiors will rise in demand. Low affordability has also been driving demand for multi-family in recent years. Additionally, in many areas, the aging boomer generation is looking for low-cost, walkable communities.
• Most new multi-family projects include at least a handful of EV charging stations and the ability to expand the number. 
• Projects involving conversion of commercial properties into multi-family housing are more prevalent not only in large metropolitan areas but also in smaller cities and suburbs.
• The process of buying and selling homes has been (and will likely continue to be) relatively resistant to major technology disruption.
• Resiliency to extreme weather events will be driving construction changes and adaptations in home-building (think hurricanes in the East, fires out West). Furthermore, electric grid instability has added focus on self-reliant and renewable energy solutions in residential markets.

Hot Spots

• Areas with high population growth (mainly in the Sun Belt) such as Charlotte, Dallas, Nashville, Atlanta, Jacksonville, and Miami
• Midwest metro areas with strong jobs growth like Cleveland and Kansas City
• According to realtor.com, these are some of the most promising areas for first-time home buyers:
  • Portsmouth, VA
  • Moore, OK
  • Eggertsville, NY

To learn what’s ahead for other markets, check out Morrissey Goodale’s 2023 Market Outlook for the AE Industry. Click here to access recording and materials.

To learn more about market intelligence and research services offered by Morrissey Goodale, schedule an intro call with Rafael Barbosa. Connect with him on LinkedIn.

Weekly M&A Round Up

Slowdown continues: Last week we reported a total of nine domestic transactions with consolidation taking place in California, Minnesota, Florida, Texas, Pennsylvania, Massachusetts, Illinois, and Louisiana. Four new international transactions were announced in Brazil, the UK, the Netherlands, and South Africa. You can check all the week’s M&A news here.

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