Risk is something that architecture and engineering firm leaders live with every day. Liability comes from any one of a number of angles and the probability of damage or injury or loss resulting from a firm’s actions can be very real. However, put that type of risk aside for a moment.
In this article, we are speaking specifically about investor risk. Accordingly, we are speaking about the probability that the actual return on investment will differ (in reality, be lower) than then expected return on investment. All other things being equal, a higher level of risk translates into a lower valuation.
But what exactly are some of the elements of risk that an investor or potential buyer considers? Well, the truth is that investor risk in an A/E firm can come from a wide range of sources and, whether an external or internal ownership succession is in the cards for your firm, it is always important to understand these sources of investor risk and have a clear plan for managing or mitigating them.
Following are some common sources of investor risk for A/E firms:
• Firm size.
• Ownership concentration
• Leadership concentration
• Client concentration
• Market/Geographic concentration
• Earnings margin, growth, and consistency
• Business development methodology (sole source versus competitive bid)
• Project type (on-going versus singular)
• Project size
Of course, none of these variables operate in complete isolation. For example, a firm may have a relatively significant client concentration but have those clients locked in with long-term agreements and/or sole source project opportunities. As another example, there may be significant ownership concentration, but the firm may have a Shareholders’ Agreement that clearly articulates how stock redemptions will be managed under various scenarios.
Additionally, the firm may have secured insurance products and conducted extensive redemption liability modeling to manage the risk associated with this ownership concentration. In short, particularly if you are considering an external sale of your firm, it is important to understand the risk profile of your firm and
what factors mitigate the risks.
Once you understand the risk profile of your firm, the next step in the context of business valuation is quantifying the risk, i.e., determining an appropriate “discount rate” in financial valuation.
In the meantime, we leave you with a simple question to evaluate the risk associated with an investment in your firm. That is, if you had $1 million to put to work in any number of investment opportunities, would you invest this capital in your firm? If not, what makes you think that a potential outside buyer will?
About the Author: Brad Wilson joined PSMJ as a consultant in 2002 as one of the senior M&A consultants. Additionally, Brad regularly facilitates PSMJ’s CEO Roundtables on Mergers & Acquisitions.
Merger & Acquisition (M&A) activity in the architecture and engineering space is certainly on the upswing and well on its way to reaching pre-recession levels. But, how ready are you for taking on the task of buying or selling an A/E firm? If you are looking for tips to help your firm navigate through the M&A process, check out PSMJ complimentary ebook M&A Survival Tips for A/E Firm Leaders.
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