Beyond Profitability: 4 Key Intangibles That Affect A/E-Firm Valuation
April 7, 2021
As we blogged about recently, it’s important as an architecture or engineering (A/E) firm owner to manage your firm’s valuation in order to ensure that it’s accurate and meets expectations. But it’s important to note that too much management of your stock value can cause internal buyers to be apprehensive. This is particularly true if you haven’t educated your employees (i.e., the next generation of owners) about how an A/E firm is run.
It is also extremely helpful to teach team members about firm finances and then to be transparent about those numbers. However, not every firm has taken that important step. As a result, employees may perceive that the people who are assessing the firm’s valuation have a motive for it to turn out a certain way.
After all, the thinking goes, they’re the ones selling the stock and they may be more focused on funding their retirement than ensuring that the price is fair and equitable.
That’s generally not true, of course. But architects and engineers are cautious people by nature, so the perception is common, and it’s one owners and principals have to overcome. How? You’ve got to connect the dots between observable firm characteristics and the firm’s valuation.
"If you keep people informed about elements of your firm's performance, you'll gain their trust and give them the confidence they need to invest in its future on their own."
How to Relate Firm Performance to Firm Value
In saying you have to make connections for employees between performance and value, we’re not talking about formulaic connections. The focus needs to be on linking your operations to your stock price.
Profitability is a main driver of valuation, but it’s affected by a number of other variables: how much the firm charges for its services, how much employees are paid, how much overhead you have, how much owners take home, etc. Consequently, from a team member’s perspective, there isn’t a clear relationship between profit and stock price.
What team members can relate to, however, are things like:
- Growth. If they see the firm landing more projects and bigger projects, doing more hiring, and creating larger project teams, that’s an indicator to them that the firm’s value is increasing. Growth doesn’t always mean higher valuation, but it’s true that bigger firms tend to be more insulated from economic events, and therefore they are perceived as less of a risk to invest in. We’re proponents of efficiency over growth, but certainly growth is an important part of the valuation puzzle.
- Diversification. Bringing new expertise into a firm by hiring an industry expert or two so you can break into new markets tends to be a sign of strength. It’s a factor in sustainability and mitigation of risk, and that’s tangible to employees.
- Increasing selectivity. Most firms have types of projects and/or certain clients that are more challenging than others. The work is difficult, the point person is always asking the firm to justify its invoices, etc. Choosing not to pursue new work in those areas and to cut ties with those clients is a sign to employees that owners are running the firm rather than letting it run them, so to speak. Potential stock purchasers see that principals are concerned not just about the quantity of revenue, but the quality of revenue and making life better for employees.
- Marketplace and client strength. Positive changes in your firm’s position relative to competitors and in the needs and financial resources of your target market—the availability of stimulus money or a city’s infrastructure expansion plans, for example—can also support a higher valuation in the minds of employees. Consequently, it can be helpful to share data that you’ve collected as part of your marketing efforts. And, this is “safe” information to provide, especially for firms that aren’t comfortable sharing financial results.
So, it’s a little counterintuitive: Employees often find intangibles like growth more convincing as a rationale for higher valuation than tangible measures like revenue and profit, if they’re even given that information. But what matters in the end is their comfort level with pursuing an ownership stake and making a stock purchase, so owners should not ignore the intangibles.
And, certainly, it’s a balancing act. You want to share positive developments, but you have to avoid looking like you’re advocating too strongly for the firm’s potential and therefore its valuation. However, if you keep people informed about both the tangible and intangible elements of your firm’s performance, you’ll gain their trust and give them the confidence they need to invest in its future and their own.
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