Word on the Street: Issue 162

Five Things You Wish You Knew Before Selling Your Firm

If you’re considering selling your firm, this article is for you.

1. Promises Made: If a “commitment” by your buyer ain’t written down in the purchase and sale agreement at the time the transaction closes, then it’s essentially just vapor. Why? Things change after the transaction. Big things. Many times, the strategic and cultural reasons that led you to choose a particular buyer change. Examples? The buyer commits that your firm will be part of its transportation business line post-transaction. You’re fired up. You’ve met the leader of said business line—let’s call her “Shirley”—and you like her. She’s got vision. Great communicator. She’s an operator, can build a business. Oh yeah, this sale is exciting and is going to be great for your people and clients. Deal closes. Then 30 days later, Shirley announces that she’s leaving to join the firm’s #1 competitor for a truckload of money. Her replacement is a dud—a huge step backwards. Surely Shirley wouldn’t do this to you! What about your people?! Your clients?! Yup, it happens. OR consider this. You sell your firm that specializes in high-end residential development to one that works for national multi-family home builders. (They bought you to diversify their portfolio. Smart people. You’re impressed.) Sixty days post-transaction their biggest client goes bankrupt, and they need to slash expenses across their business—and that includes your staff and operations. Ouch. Sounds implausible? I suggest you talk with anyone who sold their design or environmental firm in the fall of 2008 to verify just how real this can be. The bottom line is that things can and do change post-transaction. And most of the time you’re not able to control them. That’s why it’s important to understand point 5 below. 

2. Regrets, I’ve Had a Few: Like Alice falling down the rabbit hole. Or Lucy discovering the secret garden through the wardrobe. Or Dorothy transforming from sepia to Technicolor. After you sell the firm—everything changes. For you. Especially if you’re the founder and CEO. To the pantheon of big life changes/transitions (marriage, birth of kids, changing jobs, founding your firm, kids going to college, divorce, etc.) you need to add “selling my firm.” The day before you sell, you’re in charge, you’re accountable to yourself alone. The day after, you’re not, instead you “report” to someone. The day before, your entrepreneurial spirit and ethos drive the culture of your firm. The day after, you need to follow rules and regulations that are—let’s face it—foreign to your nature. The day before, if you have an idea—regardless of how half-baked it is—you can galvanize your team to explore it, damn the torpedoes. The day after, you need to get the “OK” from managers (Exec VPs, Senior VPs, Regional Directors, COOs) who are “competing for limited resources” or who “have to get my boss to sign off on that” or need to “bring that to the strategy and growth and development committee” or “put that on the agenda for the next quarterly review and investment off-site.” The day before, you see a business development opportunity—whether it’s in Kalamazoo or Kathmandu—and you mobilize to pursue it. The day after, you need to “run that by the big guy.” For super high-functioning or (as we say in Boston) “wicked smaaht” founders who sell their firms, the days and months afterwards can be challenging psychologically. Many have regrets but are unable or unwilling to share them. Make sure you have someone you can talk to post-transaction. Don’t bottle it up—it’s not good for you or anyone around you. And realize, you may have regrets. That’s why it’s important to read point 5 below.

3. Sixty Days You’ll Want to Forget: Depending on whom you sell to, their due diligence of your firm’s finances and operations will take between 30 and 90 days. Let’s call it 60. This is the time between when you sign the Letter of Intent (LOI) to sell your firm and the purchase and sale agreement to finalize the transaction. Think you’re busy now? Well, you’re sadly misguided. Because during due diligence, you will take on THREE new full-time jobs (in addition to your current responsibilities) as follows: (1) Manager of Due Diligence—regardless of your delegation skills, you’re the one responsible for making the representations and warranties; (2) Subject of Due Diligence—sure, they are examining your firm, but they are equally interested in you—your quality, your commitment, your strengths, and your flaws; and (3) Chief Negotiator. This last one should not be underestimated as there are numerous deal points to be negotiated between the LOI and purchase and sale. And 99.9% of those need to be negotiated—with you on point. Also, depending on (a) who your buyer is (some are well known for pulling this move) and (b) your firm’s actual performance—you may encounter a “retrade” of the transaction by the acquirer. A “retrade” is when the buyer changes the price (always down, never up) or the terms (always worse, never better) depending on what they find in due diligence. It’s stomach-churning and one more reason why during the sale of your firm, you’ll experience 60 days that you’ll want to forget. This is one reason why so many sellers go on vacation within the first month after selling their firm. (More on deal retrades in an upcoming Word on the Street article this year.)

4. Ordinary People: To quote Rick Blaine, “Ilsa, I’m no good at being noble, but it doesn’t take much to see that the problems of three little people don’t amount to a hill of beans in this crazy world. Someday you’ll understand that.” Be prepared for lots of changes in the relationships that you have with your team and that they have with each other. There’s a goodly amount of drama before a transaction closes when a leadership team finally understands that the firm is inexorably on the conveyor belt to a sale. There will be jockeying for position—with both you and the buyer. There will be threats—to leave or to “vote against the deal.” There will be bargaining—for money, status, or protection. This can be all-consuming. But at the end of the day, it doesn’t amount to a hill of beans. In 99% of the cases, the personalities and people on the leadership team overestimate their individual importance relative to that of the firm’s brand.

5. It’s (Not) Not All About the Money: Strategic fit, cultural fit. Sure, they’re super-important. Indeed, they are the #1 and #2 factors that are foundational to your buyer’s decision-making. Your acquirer’s goals are driven by a strategic plan (if you’re selling to a strategic buyer) or an investment thesis (if your buyer/investor happens to be one of the 100+ financial platforms—see last week’s article, Of PE Platforms and Playlists—in our industry). Your goal however is to…what exactly? Sell, yeah, sure—but why? To facilitate a transition? Maybe. To “take care of my employees?” O.K. To provide continuity so your clients are taken care of? Sure, let’s call it that. To “de-risk” (six letters dripping of euphemistic business-speak) yourself in your 60s? Possibly. To find a way to sail off into the sunset and enjoy life without ever filling out a timesheet again? Probably, there is some truth to this. In 30 years of helping owners sell their firms, I’ve heard all of these “why” statements and more. They all hold some elements of the truth—just as they all mask the truth itself. Often, a seller will make these declarations out loud because they are embarrassed (or in some cases afraid) to state why they are really selling their firm. That is to move value into their bank account—be that in Zurich, Kansas, or Zurich, Switzerland. Your goal in selling is to maximize the price for the investment you’ve made over the years to build your firm. All these other decision-making factors are important for sure. But they are just variables in the linear equation of maximizing the financial terms that allow you to transition and ultimately walk away to the next phase of your life. Related: Check out Mark Goodale’s interview with Brendon Cussio, Getting the Best Deal as a Seller, from June.

For more movie quotes or references, you can contact Mick Morrissey at [email protected] or 508.380.1868.

Ratty Data

Mark Goodale

Former NASA engineer and flight director John Aaron earned the moniker “steely eyed missile man” for his remarkable composure and expertise, particularly during the 1969 Apollo 12 mission—NASA’s second trip to the moon. Aaron played a critical role in solving a “ratty data” issue caused by a lightning strike shortly after the launch of Apollo 12. His quick thinking and precise instructions helped the mission control team and the astronauts navigate through a complex and potentially mission-ending situation.

As part of our work here at Morrissey Goodale, we do a significant amount of financial analysis for AE firms to help them navigate through their own set of mission-critical challenges. And let me tell you, we see a good deal of ratty data. Nate Wentworth, Morrissey Goodale’s Senior Consultant and our own version of a steely eyed missile man, has dealt with his fair share. I connected with him last week to discuss how to produce accurate, reliable financial metrics and compare notes on which metrics are most important to track. Here’s how it went:

MG: Measuring revenue and profitability would seem to be pretty straightforward on the surface, but I know you’ve had to sift through more than your fair share of ratty data. How and why does confusion creep into these calculations? 

NW: Inconsistency is one of the main culprits. If your goal is to track progress toward a revenue or profitability goal or desired outcome, create a formula for how you intend to calculate the way they trend over time with the same, consistent methodology.

MG: What, in particular, throws profitability measures off kilter?

NW: Profitability can be skewed materially for a variety of reasons. Here are just a few examples: 

• Principal compensation not being included in labor. Sometimes a principal’s compensation comes in the form of distributions, which decreases the firm’s labor cost and inflates net income as a result. If some of the highest-paid individuals in the firm do not have their labor cost accounted for when calculating various metrics, it’s impossible to accurately assess the firm’s true profitability. 
• Costs incurred outside of industry norms. If a firm’s shareholders own their company’s office building separately and pay above-market rent for the space, it’s likely that the firm looks much less profitable than it truly is.
• Percent of completion invoicing. Some firms doing a significant portion of work on percent of completion invoicing contracts need to be mindful of when and how much to invoice. Revenue and costs should be recognized at the appropriate times. We’ve seen instances of firms frontloading the revenue but backloading the costs on certain projects.

MG: So, what’s best practice? 

NW: Separate your inputs, and make sure all revenue and costs are accounted for properly. The critical pieces of data necessary to accurately assess a firm’s performance include: 

• Gross revenue 
• Subconsultants and reimbursable costs 
• Labor (unburdened), tracked in two separate buckets—direct (billable) and indirect (non-billable) 
• Benefits and payroll taxes, including retirement match/Safe harbor 
• Bonus/Discretionary profit-sharing 

MG: Which financial metrics do you consider the most critical for measuring a firm’s performance and why? 

NW: Here are my top five in no particular order:

• Net revenue growth: As the saying goes…if you’re not growing, you’re dying. Focus should be on growing the firm’s net revenue (versus gross) year-over-year as that is the revenue that your firm generates, exclusive of any pass-through revenue related to subconsultants and/or reimbursable expenses. Growth is necessary to offer employees additional opportunities, position the firm as a leader in its markets, and continue to provide a top-tier customer experience. 
• Utilization (percentage of hours spent on billable projects vs. the total number of hours worked or percentage of direct labor expense vs. the total labor expense): In the AE industry, as with most professional services businesses, we sell time for money. It’s important to ensure that most of the time employees spend at work is billable time and generating revenue (and, in turn, profit) for the business. That said, excessively high utilization is not a good thing, especially in the current labor climate within the industry. Care should be taken to ensure that employees are sufficiently utilized but are not burning out. 
• Multiplier (net revenue divided by direct labor expense): This metric calculates the amount of net revenue generated per direct labor dollar spent. It’s a measure of labor cost arbitrage. The higher the multiplier you can charge for each labor dollar, the more revenue the firm generates. 
• Overhead rate (total operating expenses divided by direct labor expense): This metric compares the non-billable/indirect costs (including indirect labor) to the billable/direct labor cost as a percentage. The lower the overhead rate, the higher the profitability. As with other metrics covered above, consistency and accuracy are critical. If this metric is tracked but tracked incorrectly, it’s nearly impossible to price projects profitably with any accuracy.
• Average collection period/Days sales outstanding (accounts receivable divided by annual gross revenue multiplied by 365): This metric measures the average time (in days) it takes a firm to turn its receivables into cash. A lower figure is desirable as it reflects the overall quality of the accounts receivable and the extent to which the firm’s cash flow is impacted by delayed payments and other working capital requirements. 

MG: What are some of the more problematic ways you’ve seen KPIs like utilization, multiplier, overhead, and others calculated?

NW: I’ve seen lots of complicated spreadsheets and reports created that oftentimes are more trouble to update than they’re worth and there’s one gatekeeper in the firm who knows how it works. Keep it simple. Your accounting system should be able to accurately report most of the critical metrics. 

MG: What are your thoughts on budgeting and forecasting? How have you seen firms get into trouble, and what would keep them out of trouble? 

NW: Budgeting/forecasting is important, and firms that get into trouble treat it like a “check-the-box” activity. Budgeting is fundamental to running a growing, profitable, successful business. You need to have your headlights on to see where you’re going. We’ve seen firms get into trouble when the future is just a little too rosy. Have we historically grown at 5%? Why are we expecting 20% growth this year? Check your assumptions, ground them in reality, and, if needed, generate baseline, upside, and downside cases grounded by your firm’s near-future goals and strategies. 

If ratty data is jeopardizing your firm’s goals, call Nate Wentworth at 781.690.7863 or send an email to [email protected].

Market Snapshot: Conservation and Development (Part 2)

Weekly market intelligence data and insights for AE firm leaders.

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

Drivers

• Industrial, agricultural, and population water usage 
• Frequency of extreme weather events
• Inland river navigation trade
• Private and public infrastructure investment

Trends

• The U.S. Army Corps of Engineers (USACE) was allocated more than $17 billion from the Infrastructure Investment and Jobs Act (IIJA) and is prioritizing projects for dams, levees, pump stations, canals, and ecosystem restoration. Since conservation and development work crosses multiple disciplines, it may be common to see designs awarded to joint ventures, depending on the project size and scope.
• Hydropower accounts for about a third of renewable energy sources and about 6% of total U.S. electricity generation. The concept of Restoration Hydro, recently featured by the National Hydropower Association (NHA) and spearheaded by Natel Energy, combines techniques from river restoration with fish-safe turbines to improve watershed and ecological function.
• A recent shoreline protection and restoration project in Florida featured in ENR showcases wave attenuation devices (WADs), which is an alternative method for the construction of breakwaters. While WADs have been used throughout the U.S. over the last 20 years, this is the first time it is deployed by a government agency (Florida Department of Transportation). WADs create reefs, replenish shorelines, and reduce wave impacts by at least 70%. Concerns about rising sea levels, among other factors, influenced the decision to forego traditional breakwater building methods for this particular project. 
• With the increase in frequency of extreme weather events (e.g., precipitation, heat/drought, and wind), the private sector and government agencies are investing (or considering investing) in technology to more efficiently adapt their physical and planned assets to withstand damages. 
• According to McKinsey, climate tech equity transactions almost tripled globally in 2022 compared to 2019. Technologies such as 3D modeling, drones, artificial intelligence, machine learning, and digital twins will continue to be leveraged for designs, asset management, and regulatory compliance efforts.

Hot Spots

• Dams and levees: Combined, these structures need $115 billion in investments for upgrades (Source: American Society of Civil Engineers). 
• The following states have fewer than the national average number of full-time safety employees per dam: Nevada, Kansas, Oklahoma, Missouri, Texas, Illinois, North Carolina, Mississippi, Georgia, West Virginia, Connecticut, New York, Massachusetts, and Rhode Island.
• Hurricane and storm damage risk reduction projects in coastal states such as Florida, Louisiana, Mississippi, and Texas.

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

Congratulations to Atwell (Southfield, MI) (ENR #74): The industry leader and national consulting, engineering, and construction services firm acquired Bay Engineering (Annapolis, MD), a firm that specializes in land development services for commercial, industrial, retail, and residential projects. The deal marks Atwell’s seventh acquisition in the last twelve months. 

Another congrats to ARM Group (Hershey, PA) (ENR #370): The science and engineering firm that provides civil and environmental, electrical and automation, and technical field services in the Mid-Atlantic region acquired Resource International (Ashland, VA), a firm that provides civil and environmental engineering, surveying, and environmental consulting services. The acquisition will enable ARM to further expand its solid waste, renewable energy, geo-environmental, and other key practices into the Virginia market.

Eight more domestic deals announced: In addition to the two featured Mid-Atlantic transactions, we also reported domestic deals in Texas, Washington, Virginia, Illinois, and New Hampshire. To learn more on the latest happenings in the industry and the marketplace in Texas and surrounding states, register today to join industry executives, deal-makers, and investors in Houston on October 25-27 at our Texas and Southern States M&A, Strategy, and Innovation Symposium. You can check all the week’s M&A news here.