Article: Is Your Practice in the Gap?

 

-Is Your Practice in the Gap?-
© 2015 Stonemill Partners

 

When he made the decision to sell to Stantec in 2010, Burt Hill – CEO said it best, “We’re too big to be little, and we’re too little to be big.”

Being in the middle can be difficult, just ask any middle child. You can see the same characteristics in mid-sized engineering and architectural firms as you see in middle children. Even a better example might be the size, “medium.” When is the last time that anyone ordered a medium anything? We want the “biggie” size, right!

Just like the size, medium, many architectural and engineering firms are stuck in the middle or “in-between.” These sized firms are always looking for more resources to fit in, survive and thrive. The large projects are harder to obtain, the key employees are harder to keep and it’s harder to keep up with the bigger firms in marketing and advertising budgets. This phenomenon has led many firms that are stuck in the “gap” to sell or merge to become larger and move out of the “gap.”

What constitutes a “mid-sized” architectural or engineering firm? If you ask 100 people, and believe me we have, you will get 100 different answers. There is no shortage of opinion on this topic. The industry is so fragmented with thousands of niche practices, some define “mid-sized” as 10 to 20 employees, 25 to 50 employees while others define “mid-sized” as 100 to 200 employees. Some say a single-discipline firm is “mid-sized” while others say that a firm with a single location will only be “mid-sized” at best. Then there are firms like Halcrow (6,000 staff) and PBS&J (3,900 staff) who, because of their “mid-size,” sold out to industry giants. This is too big of a range to accurately define “mid-size!” Regardless of size, the real questions are, are you stuck in a gap, can you get out of the gap and will more resources allow you to reap the benefits of a non-gap size?

We find that “mid-size,” firms have the following general characteristics:

  • Multi-disciplined service offerings
  • Mix of public and private sector clients
  • Anywhere from 1 to 50+ office locations, with activities often dominated in one state or several regional footprints
  • Privately held, with ownership profiles ranging from sole owner to 100% ESOP

 

  • Formal management structures, governance policies, and IT/financial reporting systems

A/E firms above 1,500 employees tend to get exponentially larger, are often publicly owned and focus on the largest building or infrastructure projects. Those below 50-100 employees typically tend to focus on several cities/counties in a particular geography, have higher client concentrations, fewer owners, and simpler organizational structures.

So why sell if you are “mid-sized?”

  • Higher Valuation – Most “mid-sized” firms typically do internal transfers at book value or at some other deeply discounted value as a means of affordability and simplicity. External buyers are offering much higher valuations usually in the 4 to 5 times adjusted cash flow range. For principals whose ownership stake in an architectural or engineering firm is their biggest asset in their retirement portfolio, they should get the greatest return on their investment as possible.
  • Ownership transition – Many “mid-sized” architectural and engineering firms are “top heavy” with principals in their late 50’s to 60’s who own the majority if not all of the stock. There just aren’t enough 30 to 40 year old licensed architects and engineers willing and able to buy out the senior owners with market values that will not take at least a decade or more to pay down. In addition aging principals of “mid-sized” firms haven’t done nearly enough to prepare and groom the next generation of principals.
  • Diminishing returns – “Mid-sized” firm principals are becoming more frustrated with the decreasing margins that they are experiencing because of the steady increases in corporate overhead, fixed costs, branch offices and slower decision making processes. This has caused lower shareholder returns!
  • You gain ability to gain new skill sets, additional people that means additional capacity, maybe brand equity and other resources that allow you to get bigger projects.

Are you stuck in the gap?