Maximizing Performance Growth &
Value in Your A/E Firm
Ian Rusk, ASA
ZweigWhite
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© ZweigWhite 2009
Introduction
Overview of Program
Day One:
8:00
Introduction / Program Overview
8:15
Why grow? The current state of the A/E/C industry and why
growth is critical to long-term success
9:00
Market outlook
9:30
[Break]
10:00
Financial Management and Cost Control
12:00
[Lunch]
1:30
Capitalizing a growing firm / M&A as a growth strategy
3:00
[break]
3:30
Planning for ownership transition
5:00
Program end
Why Grow?
Why Grow?
• High growth correlates to high profits
– Median Pre-tax Pre-bonus Profit (% of NSR)
•
•
•
•
•
High Growth Firms – 19.6%
Low Growth Firms – 12.7%
No Growth Firms – 5.9%
Slow Decline Firms – 1.8%
Fast Decline Firms – 1.3%
Why Grow?
• Contributing Factors: Better labor
utilization
– Median Chargeability (labor utilization)
•
•
•
•
•
High Growth Firms – 61.4%
Low Growth Firms – 59.6%
No Growth Firms – 56.6%
Slow Decline Firms – 59.5%
Fast Decline Firms – 53.6%
Why Grow?
• Contributing Factors: Lower relative
overhead
– Median overhead rate (overhead/direct labor)
•
•
•
•
•
High Growth Firms – 172.6%
Low Growth Firms – 167.9%
No Growth Firms – 186.3%
Slow Decline Firms – 159.5%
Fast Decline Firms – 202.4%
Why Grow?
• Other benefits
– Career opportunities for staff
– Opportunities to work on larger, more
interesting projects
– Greater job fulfillment
– Ability to diversify services, markets and
geographic footprint
Why Grow?
• High growth increases market value
– Size does matter! Larger firms are
considered less risky by the marketplace
Why Grow?
• A growing income stream is more
valuable - example:
– Two firms with $200,000 in earnings
– One is high growth (long-term growth
assumption of 8%), the other is low growth
(long-term growth of 3%)
– One is considered high risk, the other
low risk
Why Grow?
XYZ Company
After-tax, Pre-Bonus Earnings
Add Back: Depreciation & amortization
Deduct: Capital Expenditures
Deduct: Working Capital Needs
$
200,000
110,000
(90,000)
(20,000)
Cash Flow to Equity Holders
$
200,000
Apply Growth Rate (x1.03)
$
206,000
Divide by Capitalization Rate of 22% (25% - 3%)
$
936,364
Why Grow?
XYZ Company
After-tax, Pre-Bonus Earnings
Add Back: Depreciation & amortization
Deduct: Capital Expenditures
Deduct: Working Capital Needs
$
200,000
110,000
(90,000)
(20,000)
Cash Flow to Equity Holders
$
200,000
Apply Growth Rate (x1.08)
$
216,000
Divide by Capitalization Rate of 14% (22% - 8%)
$ 1,542,857
Good Growth
Profitable
Sustainable
Differentiated
Organic
Market Outlook
Market Outlook
• 2009 – A year of challenges, but
glimmers of a recovery:
– GDP decreased at a rate of 1% Q2 of ’09
– Federal Reserve forecasts are for a 1%
increase Q3 & Q4
– AIA Billing Index has been below 50
(indicating a decline) for over a year (currently
at 43)
– Even some of historically strongest markets
(e.g. healthcare) have softened
Market Outlook
• 2009 – A year of challenges, but
glimmers of a recovery :
– 12th Fed District (encompassing Oregon and
Washington States)
• Retail, Services and Manufacturing Sectors
continue to soften (exception being IT products)
• Construction activity remains low
• Demand for commercial real estate continues to
decline
Market Outlook
• 2009 – A year of challenges, but
glimmers of a recovery:
– On the positive side: S&P 500 up 33% since
February
– AIA New Inquiries Index has above 50 since
February (indicating an increase in new opp’s)
and is presently at 50.3
– Some positive impact from ARRA bill
– Public A/E firms “out-recovering” the broader
market
Relative Performance
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
-60%
Jun-07
Sep-07
Dec-07
ZW15
Mar-08
ZWI
Jun-08
Sep-08
S&P 500
Dec-08
Mar-09
S&P 700
Jun-09
Market Outlook
• Fundamental Drivers of Demand Aren’t
Going Away:
Market Outlook
• Water / Wastewater Market
– Water is the oil of the 21st century
– U.S. Water / Wastewater Industry is estimated at over
$120 billion
– While some short-term drivers such as residential
development have eased, long-term drivers remain
– Aging infrastructure: Some estimates put leakage
rates of aging water infrastructure at 50%
– Global drivers include population growth, and
changing consumption patterns (emerging middle
classes of India and China)
Market Outlook
• Water / Wastewater Market
Market Outlook
• Transportation / Infrastructure
– ARRA bill devotes 60 billion for construction &
government contracts of which:
•
•
•
•
•
$27.5 billion for highways
$17.7 billion for public transportation
$6.9 billion for transportation equipment
$12 billion for federal facilities
$4.6 billion to Army Corps of Engineers
– Another $110 billion devoted to energy & environment
•
•
•
•
$11 billion for electricity grid
$60 billion for renewable energy
$10 billion for clean water projects
$27 billion for “other projects”
Market Outlook
• Transportation / Infrastructure
– Oregon Stimulus Funding:
• $6.5 billion slated for the state with $333.9 million targeted
toward transportation (highway, road, bridge, port and rail)
Market Outlook
• Transportation / Infrastructure
– Washington Stimulus Funding:
• $10.4 billion slated for the state with $492.2 million targeted
toward transportation (highway, road, bridge, port and rail)
Market Outlook
• Demographic-driven markets
– U.S. census projected population age 65 and
over to double from 2006 to 2030
– By 2030, close to 20% of U.S. population will
be 65+ (72 million people)
– General health of this segment continues to
improve, and those with chronic medical
conditions are living longer
Market Outlook
• Demographic-driven markets
Market Outlook
• Demographic-driven markets
– Global population on track to reach 7 billion
by 2011, with China and India leading the way
– Represent a 1 billion increase in just 12 years!
– Highest growth is in least developed countries
(Africa and Asian continents)
– Still opportunities in the Middle East
– Population migrating from rural to urban
centers
Think about these and other drivers of
demand for engineering services as you
plan your long-term strategy
Market Outlook
• 2009 – A year of challenges and
opportunities:
– Credit markets notwithstanding, this could be
one of the best times to be a strategic buyer
– Valuations at a low point (but are they at the
bottom???)
– Economic decline stabilizing (but when and
how quickly will it rebound???)
Managing by the Numbers
Basic Financial Management
• More important than ever to “own” your
numbers
• What sort of metrics would you’d want to
see regularly (your “heads up display”)?
Basic Financial Measures
• Revenue and Revenue Growth
– Focus on net service revenue
– Growth over multiples years should be expressed as a
compounded rate (CAGR)
• Profit Margins (as % of net service revenue)
– Operating Profit (before non-operating expenses, interest,
discretionary expenses, extraordinary expenses and taxes)
– EBITDA (earnings before interest, taxes, depreciation &
amortization) – 13.6%
– EBIT
– Pre-tax, Pre-bonus Profit – 11.3%
– Net Income
Basic Financial Measures
• Balance Sheet Measures
– Working Capital (current assets less current liabilities)
– Current Ratio (current assets / current liabilities) 2.33
– Quick Ratio (cash, AR only) – 2.11
– Total Liabilities-to-Equity Ratio – 0.9
– Interest-bearing debt-to-equity – 0.2
* Numbers above represent industry medians from the ZweigWhite’s 2009
Financial Performance Survey
Basic Financial Measures
• Balance Sheet Measures (continued)
– Debt Service Coverage Ratio (cash flow divided by
principal & interest payments on debt)
– Return on Assets and Return on Equity (more
meaningful when based on market value of equity)
ROA – 23.1%, ROE – 50.3%
Basic Financial Measures
• Industry Specific Performance Metrics
–
–
–
–
Chargeability (Utilization) – direct / total labor – 59.5%
Net Multiplier – NSR / direct labor – 3.12
Revenue Factor – NSR / total labor – 1.80
Overhead Rate – overhead exp’s / direct labor –
170.3%
Basic Financial Measures
• Predictive metrics
–
–
–
–
–
–
Fee Backlog (at a point in time)
Sales of new work (over a period of time)
Proposals pending (at a point in time)
Proposals made (over a period of time)
Volume of inbound inquiries
Proposal success rate (dollar weighted)
Revenue, Proposal and Sales Volume
$1,400,000
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
Jan
Feb
Mar
Apr
Proposals
May
Jun
Sales
Jul
Aug
Sep
Revenue
Oct
Nov
Dec
Other Performance Metrics
• What other metrics are meaningful for your
unique business?
–
–
–
–
WIP or bad debt write offs
ACP and associated interest costs
Employee turnover
Others? (audience participation time)
Form and Frequency
• Various types of reporting might have
different frequency
– Annual – a corporate-style annual report (serves
many potential internal and external users
– Monthly or quarterly detailed performance report
– Weekly sales and cash flow reports
– Daily accolades
Form and Frequency
• Use the push/pull approach
– “Push” out reports such as those outlined above
– Allow staff to “pull” out info as they need it
– Particularly important for project managers and
department heads
Project-level reporting
Project-level reporting
Project-level reporting
Managing Costs
Managing Costs
• Managing costs in most engineering
firms means managing labor costs
– Labor is typically 50%-60% of a firm’s net
service revenue (not including benefits and
payroll taxes, which make up another 1020%)
– In a volatile economic climate, maximizing
profits requires close management of labor
costs
Managing Costs
• Managing costs in most engineering
firms means managing labor costs
– Watch staff utilization levels – median for
engineering and E/A firms is 61%
– Under-utilized principals are often the chief
culprits
– Typical principal utilization rate is 50%
Managing Costs
• Managing costs in most engineering
firms means managing labor costs
– Many firms have had to institute pay cuts over
the last 12 months.
• Try to limit principals or management if possible
• When cutting across the board, provide an
opportunity to make it back (i.e. through a profit
sharing or other type of incentive plan)
Incentive Compensation Plans
Performance bonus
65%
Profit sharing
43%
70%
Spot bonus
21%
60%
Referral bonus
17%
50%
Holiday bonus
13%
Project bonus
11%
Service awards
10%
65%
43%
40%
30%
21%
20%
Equity-based plans
8%
Signing bonus
8%
10%
Sales commission
5%
0%
Retention bonus
2%
17%
13%
Performance
Bonus
Profit Sharing
Spot Bonus
Source: 2008 Incentive Compensation Survey of Architecture, Engineering, Planning &
Environmental Consulting Firms (ZweigWhite)
Referral Bonus Holiday Bonus
Incentive Compensation Plans
Incentive Compensation Spending
Incentive compensation spending
as a percentage of NSR
Upper
Quartile
5.5%
Mean
Median
Lower
Quartile
4.9%
3.5%
1.9%
Incentive compensation spending
as a percentage of payroll
Upper
Quartile
12.2%
Mean
10.4%
Median
Lower
Quartile
7.5%
3.8%
Source: 2008 Incentive Compensation Survey of Architecture, Engineering, Planning &
Environmental Consulting Firms (ZweigWhite)
Incentive Compensation Plans
• Equity-based incentive plans
– Ownership transition plan
– Employee stock purchase plan (ESPP)
– Employee stock ownership plan (ESOP)
– Stock option plans
– Synthetic Equity (Stock appreciation
rights/phantom stock plans)
– Deferred compensation plans (careful of new
IRC 409a requirements)
Incentive Compensation Plans
• Elements of a good incentive comp
plan
– Consistent with core values and culture of the
organization
– Align individual objectives with firm-wide
strategic initiatives
– Recognize, reward and motivate outstanding
performance
– Structure/bonus formula that is easy to
understand
Managing Costs
• Other considerations
– Largest single fixed G&A expense for
engineering firms is rent
– Small, unnecessary branch offices are one of
the most frequent causes of high fixed
overhead
– Median overhead rate for engineering & E/A
firms is 165%
– If yours is higher, primary causes are likely to
be low utilization rates and/or an inefficient
office network
Managing Costs
• Other considerations
– The world is flat! Are there services that could
be done better and cheaper offshore?
– Consider things you may already out-source
(e.g. IT services).
– Offshore in-sourcing vs. inshore out-sourcing
Capitalizing a Growing Firm
Sources of Capital: Costs
• Costs of Debt
– Rates tend to be based on market indices, like the
Prime Lending Rate (3.25%), or LIBOR
– Current interest rates are low, but credit standards
are tighter
– Tax deductibility of interest payments makes effective
cost even lower
– Credit facilities: Revolving line of credit (short-term,
A/R is the borrowing base); Financing line of credit
(converts to term debt); Long-term debt
Sources of Capital: Costs
• Costs of Debt
– Short-term borrowing is generally cheaper than longterm (example: prime for LOC, prime + 1 for term
debt)
– Firms considered riskier will pay higher rates (risk
factors: credit history, financial leverage, financial
performance, debt service coverage ratio, collateral
coverage)
– Small firm owners must often sign personal
guarantees (strategies for managing risk – limitations,
indemnifications)
Sources of Capital: Costs
• Cost of Equity
– Rate of return = stock appreciation + annual payout
(dividend or distribution) as a percentage of the
investment value.
– Example: A shareholder owns stock worth $100,000
at the beginning of the year. By year-end, the stock
has gone up in value to $110,000, and the
shareholder received a $20,000 distribution. Total
return equals $30,000, or 30%.
– Cost of equity capital is much higher than debt
Sources of Capital: Costs
• Equity Rate of Return – Build-up model
Risk Free Long-term
Government Bond Rate 20-yrs
E rf
5%
Common Stock Equity Risk
Premium
Emr
7%
Small Stock Equity Risk
Premium
Es
9%
Subjective Risk Premium
Udc
???
Discount Rate
Er
21%+
Source: SBBI-Ibbotson Associates, Inc., Chicago, Illinois, Beta excluded.
Federal Reserve Statistical Release
Sources of Capital: Costs
• A growing A/E or environmental consulting firm
needs access to both sources
– Debt capital will be limited due to lack of collateral
– While cheaper, the default risk can be a psychological
growth barrier for firms with high debt levels
– Access to equity capital requires a well-considered
ownership plan
Sources of Capital: Costs
• Demographic trends are not in your favor
Sources of Capital: Costs
• Demographic trends are not in your favor
Sources of Capital: Costs
• Access to equity capital / ownership planning
requires:
– A detailed shareholders agreement governing all
transactions of stock
– A method of stock valuation (internal formula or
agreement to have company appraised annually)
– A plan for financing (or facilitating financing) for
buyers
Sources of Capital: Costs
• Access to equity capital / ownership planning
requires:
– On-going feasibility testing to be sure redemptions
can be managed
– A development program for future shareholders
Sources of Capital: Costs
• Other Capital Sources: Private Equity Financing
– The list of A/E and environmental firms with private equity
financing is growing
• CSA Group [Hispania Capital Partners]
• Schoor Depalma [Trivest]
• Callison Architecture [Blue Point]
• Apex Companies [Blue Point]
• Cummings, LLC [Long Point Capital]
• Natural Resource Group [Stone Arch Capital]
• EM-Assist [Venatus Capital Partners]
• Capri Engineers [Stone Capital Partners]
• Wildlands, Inc. [Parthenon Capital]
• Trinity Consultants, Inc. [Sentinel Capital]
• Clough, Harbour & Associates [Long Point]
– Recent private equity exits
• ENSR [sold to AECOM]
• EYP Mission Critical [sold to Hewlett Packard]
Sources of Capital: Costs
• Private Equity Financing
– PE firms typically take a controlling interest stake (but
not always)
– Management team retains a significant stake
(potential second bite of the apple)
– PE investor may leverage firm
– Expect big management fees, and pressure to
perform
– PE firms are NOT long-term investors—understand
the likely exit strategy
Management of Cash Flow
We’re Living in Dangerous Times
• Cash flow management is critical in economic
downturns like the present
– Accounts receivable at greater risk
– Must watch cash outflow carefully
– Cash flow forecasting is the key
Management of Cash Flow
• Even organic growth requires cash
– Example: A $10 million net service revenue firm
grows by 10%. It’s average collection period of A/R is
80 days. Growth will result in an increased
investment in working capital of $219k.
– Managing operating cash flow in a growing firm is,
therefore, critical
Management of Cash Flow
• Cash flow forecasting
Merger & Acquisition Strategies
M&A Activity
 M&A activity comes in waves coinciding with
economic activity
 In spite of weak economy, consolidation
continues (100 AE transactions YTD)
 Buyers stock values have recovered since this
time last year
 Sellers may still have high value expectations,
but values are generally down
M&A Activity
• 2009 Transactions in Washington & Oregon
Record M&A Activity
 Drivers of M&A activity
Difficulty in accomplishing internal ownership transitions
Challenge of firms with 100-500 staff – eat or be eaten?
Clients’ demands for scale and full-service model
What does a typical deal look like?
 Most involve an ENR 500 firm buying a
smaller firm*
–
–
Median size of selling firms was 30 employees
Median size of buying firms was 400
employees
 Vast majority of deals in our space are niche
deals; “manageable” bets either for scale (“do
more of what we’re good at”) or diversification
(“we need to be there/doing that”)
* Transaction
data from 2006 - 2007
What does a typical deal look like?
 Most are asset rather than stock deals
 Transactions often mix of cash, stock*, & notes
(no “credit crunch” here)
 Earnouts remain popular but can be barrier to
integration
 Employment agreements and compatible
salary/incentive compensation structures
are key
* This makes the method you use for your own firm’s stock valuation critical
M&A Risk Factors
Seller Expectations
– Valuation expectations will often be high: 75% of NSR,
6.0x EBITDA, 2.5x book value (median values).
– Actual deal values from same survey are lower: 60% of
NSR, 3.3x EBITDA, 2.2x book value (median values).
– Valuation of privately held AEC firms is both an art and
a science!
– Size, profitability, growth, capitalization all impact
valuation
Valuation by Multiples
Why aren’t AEC multiples higher?






Nature of industry (mature / stable growth)
Low barriers to entry = thousands of firms offering
“commodity” like service
Project-to-project, uneven cash flow stream
Lack of Scalability
Intangible assets (people-based business)
Reliance on rainmakers vs. institutional brand value
M&A Risk Factors
Retaining clients and motivating
key staff
– Resentment among the minority-interest or nonowners may linger
– Deal value will be significantly diminished if key
talent exits post closing
– Competitors will come after target’s clients and staff
– Cultural fit and firm integration is key and most
difficult part of M&A process!
2009/2010 M&A Outlook

Pendulum shifting back to buyers as markets recover

Continued weakness in U.S. economy will produce more
“distressed” sales?

Buyers will use more stock as currency and earnouts to
mitigate risk

Long-term, baby boomer retirement and lackluster
internal share demand will drive supply (recall
demographic slides)

When planned and executed properly, M&A still an
effective tool for strategic growth
Valuing a Firm for Acquisition
Approaches to Valuation
• Earnings Approaches
– Discounted Cash Flow (DCF)
– Capitalization of Cash Flow (Gordon Growth
Model)
• Market Approaches
– Publicly Traded Guideline Method
– Market Transactions (M&A) Method
• Asset Approaches
Required Rate of Return
Risk Free Long-term
Government Bond Rate 20-yrs
E rf
5%
Common Stock Equity Risk
Premium
Emr
7%
Small Stock Equity Risk
Premium
Es
6-9%
Subjective Risk Premium
Udc
???
Discount Rate
Er
18 - 21%+
Source: SBBI-Ibbotson Associates, Inc., Chicago, Illinois, Beta excluded.
Federal Reserve Statistical Release
Capitalization of Cash Flow
Capitalization of Cash Flow
Projected Cash Flow
Discount Rate (A)
Long-term Growth Rate (B)
Capitalization Rate (A-B)
$
Value = Cash Flow / Cap Rate
$
20%
5%
15%
Market Approaches
• Publicly traded guideline company method
– Attempts to use market values of similar, publicly traded
companies as a basis for determining value.
– Problem in the A/E/P & environmental consulting industries is
the small number of publicly traded firms.
– Vast size difference also makes comparison difficult.
• Market Transactions Approach
– Uses actual merger/acquisition data.
– Data more difficult to come by.
Market Approaches
• Market pricing data is applied to the
subject firm by determining various
multiples or factors such as:
–
–
–
–
–
Value / Revenue
Value / Earnings
Value / Book value
Value / Fee Backlog
Value / # of full-time employees
Market Approaches
ZweigWhite Merger & Acquisition Transactions Trailing Five Years
(A/E/P & enviro firms only)
Equity Value /
Book Value
TIC Value /
Gross
Revenue
TIC Value / Net
Service
Revenue
TIC Value/
EBITDA
Equity Value /
Net Income
2.23 x
0.56 x
0.62 x
4.9 x
6.8 x
TIC Value / #
of Employees
68,993
Other Considerations
• Marketability discount
– must account for the lack of liquidity of a
privately held firm [30% is typical]
• Controlling vs. Minority ownership
interests
– holders of small blocks of shares cannot control
the actions of the firm [20% discount is typical]
ZweigWhite Valuation Survey
• ZweigWhite’s Valuation survey is a good tool for a
“benchmark” valuations
• ZweigWhite surveys the industry annually, asking firms
to report their valuations and certain financial factors that
drive value
• Data is compiled and sorted based of firm types and
depending on the quality and purpose of the valuation
• Note that Z-formulas generally reflect minority interests
often for internal ownership transition purposes, so when
using for M&A purposes, you may need to apply a
control premium (25%+/-)
2009 Z2 and Z3 statistics
ZweigWhite Valuation Survey
TIC Value/Net Service Revenue
Equity Value/Pre-tax, Pre-bonus Profit
TIC Value/EBITDA
Equity Value/Book Value
TIC Value/Employee
TIC Value/Backlog
Z2 Formula
51%
4.21x
5.10x
1.76x
$54,426
67%
Z3 Formula
46%
2.60x
3.26x
1.77x
$49,118
68%
Evaluating an Acquisition Target
• Note that the strongest performing firms
may not make the best acquisitions as price
expectations will be high.
• Poorly performing firms that can be
“rescued” may be better opportunities from
a risk/return standpoint.
• Acquisitions must fit with the firm’s strategic
goals.
• Most buyers look for a 3-year payback
period.
Evaluating an Acquisition Target
• Understanding future earnings capacity:
– Backlog: How does it compare to prior years? What is
it composed of? How “firm” is it?
– Key Staff: Who are the people selling work and
managing client relationships? Are they at risk of
leaving post-closing?
– Are there concentrations of revenue with certain clients
that could be at risk?
– Will the acquisition result in loss of certain clients and
associated revenue (loss of MBE status, loss of subconsultant business, etc.)
Evaluating an Acquisition Target
• Subjective risk factors to consider:
– Revenue and earnings volatility
– Concentrations of revenue and lack of market diversity
(geographic, service type, or client type).
– High risk service types, history of quality problems.
– Poor collections and cash flow problems.
– Lack of management depth.
– Dependency on key rainmakers.
Key Points For Success
• Align yourself with a compatible culture
• Address issues involving seller head on (lack of
software licenses, unproductive principals,
unproductive offices)
• Pay attention to integration issues
• Understand the after-life (post-closing)
• Pay attention to the restrictive covenants
Key Points For Success
• Use intermediaries to negotiate and avoid head
to head clashes
• Understand your motivation to buy or sell
• Build a rapport with the buyer or seller
• Assemble a competent and experienced team of
external advisors
• Understand the ongoing employment obligations
Planning Your Exit
Exit Strategy Options
• Ownership Transition is a synonym for
developing an Exit Strategy
• An Exit Strategy is a process that owners
formulate when they reach a point in their
business life where they begin thinking about the
following:
Exit Strategy Options
– How to realize the fruits of their labor?
– When they begin to look forward to
"slowing down" or retiring
– When other firm members begin to push
for ownership and/or management
succession
Exit Strategy Options
– When health issues become apparent
– When the size of the firm begins to
require more owners, more capital, more
complicated operations
– When it feels to be the right time
(including watching peers transition)
Exit Strategy Options
• Internal Transition - Need time and second
tier of leadership to purchase the stock.
Perpetuates the firm, but may not maximize
price.
• External Transition – Maximize price, reduce
risk of exit
Exit Strategy Options
• Employee Stock Ownership Plan (ESOP) (Internal) Great tax benefits for Seller and company and also
establishes a stock bonus plan for employees. Form
of leveraged management buy-out (LBO).
Exit Strategy Options
• Leveraged Recapitalization – Borrow money and pay
it out to owners (dividend). Essentially means
mortgaging the firm's assets and future and while it
may increase some liquidity for the owners it
reduces firm's ability to finance future growth and
decreases flexibility to take advantage of
opportunities or weather an economic downturn.
Exit Strategy Options
• Initial Public Offering (IPO) - Not available
for smaller firms generally and brings new
reporting and regulatory hurdles/headaches
as well as a new constituency.
Motivations
•
Internal Transition is motivated by:
– Paternal/maternal feelings
– Loyalty to key long-term employees
– Lack of easy identification of outside parties
Motivations
•
Internal Transition is motivated by
(continued):
– A feeling that the process is simple (legally
and financially)
– Concern as to cost of an outside sale
(direct costs and labor costs)
– A fear of the unknown owner
– A desire to maintain culture
Motivations
• External Sale is motivated by:
– A desire to maximize the ultimate sales price
– A feeling that security is better from a third
party
– A concern that the next generation is not
capable of running the business and making
the required payments
Motivations
• External Sale is motivated by (continued):
– A concern as to risk tolerance on the part
of key employees
– A desire to see the company prosper and
expand
Motivations
Key Differences between an Internal Transition and
External Sale:
Internal Transition
External Sale
Sales Price
Lower
Higher
Security
More Risky
Less Risky
Outside Costs
Lower
Higher
Time to Complete
5-10 years (or more)*
6 months to 1 year*
Effect on Employees
Generally Positive
Sometimes Negative
Human Resources Issues
Not a big Concerns
Could be a concern
Effect on Clients
Little Effect
Requires attention;
Usually positive
* Time to complete differs on many factors
Top Reasons Firms Sell
• Exit strategy for owners - even for owners who
have planned a sale could be a better way to get
their equity out and perpetuate the business. This
approach provides liquidity for the exiting owners.
• Maximize shareholder return.
Top Reasons Firms Sell
• Turn-around or rescue situation (bailing out of a
sinking ship).
• Part of growth strategy - many firms think that
growth can only occur through acquisition or
hiring staff, but becoming part of a larger entity
can be a growth strategy, too.
Top Reasons Firms Sell
• Provide greater opportunities for employees - in a
smaller firm, employees' chance for advancement
may be limited. In a larger company, there may be
more opportunities for career growth.
Top Reasons Firms Sell
• Better services to clients (become one-stop
shopping) - can provide a wider array of services to
existing or new clients who may be expanding and
require more full-service providers.
Top Reasons Firms Sell
• Expansion into new market-sectors - many
firms are focused on one or two client types,
this provides diversification.
• Geographic expansion - serve clients in new
geographic areas.
Top Reasons Firms Sell
• Need for stronger management expertise to take firm
to next level - the owners of many firms have maxedout their ability to manage the firm.
• Ownership Transition Failure.
• Leadership Succession Failure.
• Unsolicited Offer.
• Principals leave the firm.
Making Your Firm “Transaction Ready”
(internal or external)
• Operate profitably and businesslike (steady, reliable
earnings are the key)
• Separate personal life and family matters from the
business
• Establish and sustain a bank relationship to allow for
growth and working capital
• Keep complete and well-organized records - HR,
financial, project materials.
• Have tight project controls and reporting
Make Your Firm
“Transaction Ready”
• Keep administrative policies current – overtime
policies, timesheets, vacation, etc.
• Confront Unproductive Principals – do not allow
“deadwood” to drag down your firm
• Resolve any pending liability issues if possible
(personnel issues, pending lawsuits, software
licensing deficiencies, etc.)
Make Your Firm
“Transaction Ready”
• Institute and implement an ownership program secure the commitment of middle managers. Internal
ownership transition and external transactions are not
mutually exclusive.
• Update financial reporting on an accrual basis
Make Your Firm
“Transaction Ready”
• Adopt a management succession and training plan allow the future leaders to learn how to manage.
• Be able to articulate the firm’s goals and objectives what is the firm all about? What is its mission?
Make sure all internal team members are on the
same page.
Q&A
Ian C. Rusk, ASA
ZweigWhite
321 Commonwealth Rd
Wayland, MA 01778
Phone: 508.651.1559
irusk@zweigwhite.com