Ep. 12: Beyond the Multiples: The Art and Science of AEC Valuations

What’s your AEC firm really worth? While it’s tempting to look at market multiples, the true value of your business lies in a much deeper story of risk, potential, and strategic fit. Misunderstanding this value can stop a great deal in its tracks.

In this episode of AEC Unscripted: M&A Edition, host Jeff Adams, Director of Mergers & Acquisitions at Stambaugh Ness, is joined by two leading valuation experts: Tracey Eaves, Managing Director of Transition Services at Zweig Group, and Becky Carlson, Director of Value Advisory at Stambaugh Ness. 

Together, they pull back the curtain on the art and science of AEC firm valuation, revealing what buyers and sellers must understand to navigate a transaction successfully. 

Listen to learn about:

• The critical difference between fair market value, strategic value, and final offer price.
• Why income-based approaches are far more important than book value for professional services firms.
• Common (and costly) misconceptions about EBITDA multiples, working capital, and deal terms.
• Practical steps you can take now to maximize your firm’s value for a future sale. 

Accelerate your success in AEC. Book a meeting with us to discuss your M&A future. 

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Chapters

• 0:00 Intro & Welcome
• 1:12 Meet the Valuation Experts: Becky Carlson & Tracey Eaves
• 6:06 What is in a Business Valuation? (And Why It's Not on Your Balance Sheet)
• 8:55 Why Get an Independent Valuation? (The "Valuing Your Baby" Problem)
• 14:34 The 3 Core Valuation Methods
• 20:22 Beyond the Multiples: The Trap of "5x EBITDA"
• 22:47 Why You Can't Compare Multiples (The "Deal Terms" Secret)
• 25:40 Fair Market vs. Strategic Value: Does the "Purpose" Change the Price?
• 34:00 The Difference Between Value, Price, and a Final "Offer"
• 43:00 Common (and Costly) Misconceptions in M&A
• 44:46 Misconceptions: "I'm Going to the Beach Tomorrow"
• 48:49 The "Gotcha" of Working Capital Explained
• 52:42 Practical Steps to Maximize Your Firm's Value Today
• 56:05 Conclusion and Final Thoughts

Transcript

[00:00:25] Jeff Adams: Welcome to AEC Unscripted. I'm your host, Jeff Adams, the Director of Mergers and Acquisitions at Stambaugh Ness. Coming to you from Studio B, also known as my basement. Today, we're going to be exploring M&A through the lens of a couple of valuation experts. Valuation is important in the M&A process to both buyers and sellers.

Confusion around valuation and how it relates to deal negotiations can cause an otherwise successful union to never take place. I'm delighted to have joining me for this episode, Tracey Eaves, Managing Director of Transition Solutions at Zweig. And Becky Carlson, Director of Value Advisory at Stambaugh Ness.

Thank you so much for joining me today, Tracey and Becky.

[00:01:11] Tracey Eaves: Thank you, Jeff.

[00:01:12] Becky Carlson: Thanks, Jeff. It's great to be here. 

[00:01:14] Tracey Eaves: It is. 

[00:01:15] Jeff Adams: Well, listen, I wanna give everyone a chance to get to know you first before we get started.

So if you wanna, take turns. Becky, why don't you go first and just tell people a little bit about yourself? 

[00:01:25] Becky Carlson: Sure, Jeff. Yeah, I started, doing valuations probably in the mid-2000s. Before that, I had a different career in inventory control. I stayed home with my kids when they were little, and my husband asked me to go back to work because times were a little iffy in the economy.

And instead, I went back to school and got my CPA. 

[00:01:49] Jeff Adams: Wait, you went and spent money rather than make money. Right. Okay. 

[00:01:53] Becky Carlson: Yes, he was like, okay. But, it gave me more opportunity, I think, having a CPA, and then the first job I got after that was being a controller and outsourced CFO for engineering and architecture firms.

And I traveled, so I had four clients, and I went on-site and did their books, which was so important for me to learn about financial information in this industry. And the person I worked with, we worked through PSMJ Resources doing valuations in M&A. And so, I learned how to do valuations before I was certified.

And then I went back and said, I'm doing this, I really need the credentials to make sure I'm doing it correctly. So I got a ABV, which is an Accredited Business Valuation certification, and realized we were doing a lot of things right, but also we could improve, in some ways, make our reports readable by the financial people using them, and making sure that we were using best practices.

So today, I do a little bit of fractional CFO work still, but the main focus is business valuations. 

[00:03:08] Jeff Adams: Very good. How about you, Tracey? 

[00:03:11] Tracey Eaves: Well, I'm probably a little more boring than Becky's background. Many moons ago, I actually came out of the nonprofit organization management world.

And from there I went to the Small Business Development Center program that's sponsored by the Small Business Administration. I ended up as the Center Director for two different SBA programs. And out of that process, of course, we were associated with universities and, there was always a continuing education component.

 One of the years that I attended some of our continuing education, I was looking for a program to sit in. As part of the day, looking through the agenda, there was a program that was valuing privately held companies. And it was being presented by a gentleman from the Institute of Business Appraisers.

 I thought, well, that sounds somewhat interesting. I think I'll go sit in that. It was a big commitment, though. It was all afternoon. So I went in, walked in the room. I just remember it was kind of like auditorium-type seating, very full room. went down and sat in the front, and this gentleman got up from the Institute of Business appraisers and began his presentation.

And about three hours later, I turned around and looked because there was some commotion in the back of the room. The room was almost empty, but I walked out of there and I said, "This is the most interesting thing that I have been exposed to in a very long time, and I think this is something I would like to pursue."

 The dean I was working for at the time was encouraging the continuing education. And so, I went back to the office the next Monday and I wrote a proposal to the dean and told him that this is what I'd like to do. He reviewed that and said, "Get going." So I started with the Institute of Business Appraisers. And went to my first program in Myrtle Beach, South Carolina, that was probably about 1998 - 99, somewhere in that neighborhood. So 25 years later, I have been in the valuation business for 25 years. I've got multiple certifications in valuation. I've also got a Machinery and Equipment Appraisal designation as well.

 I have been in the world of AEC for the last 15 years working with Zweig Group, and have really enjoyed the industry. I really enjoy the people in AEC. I like working with people who are in the professional services business, and a lot of very smart people. So it's fun.

It's just a fun industry to work in, and I have thoroughly enjoyed it. 

[00:05:51] Jeff Adams: Well, thank you both. It's great having both of you join me today. And it sounds like you both are the right people to have here on this topic of valuation and M&A. So, let me ask you, when should someone consider getting a valuation?

[00:06:09] Tracey Eaves: Oh, Becky, you wanna take that one? 

[00:06:11] Jeff Adams: Maybe before we go there, Becky, what is a valuation? We throw that word out there very easy, but tell what is it? What are we talking about when we say valuation? 

[00:06:21] Becky Carlson: Yeah. So, a valuation is pretty much an analysis of what your investment is, when you think about it.

 What do you mean investment? Well, it really is looking at your company and saying: What is the worth behind it? What makes up the company? And what's the dollar amount assigned to it? And you think, wow, that's crazy. How can you assign a dollar value amount to a living and breathing entity?

Well, that's the art of the valuation. And it's a way to communicate a really complex story in a report format that people understand. So buyers and sellers could both talk to each other. I think with that, I dunno. Tracey, what do you think? 

[00:07:07] Tracey Eaves: Yeah, well, I would say, you know, some people are probably gonna say, I already know the value of my company because I can look on the balance sheet and there's this little section that says equity.

Mm-hmm. And so people are gonna say, well, why do I need you? Because my balance sheet says that. And frankly, if the balance sheet was the proper representation of the real value of your company, people like me and Becky wouldn't be in the business that we're in. We would've had to have found something else to do.

 A valuation is not only determining what the market value of the tangible asset component of the business is, but it's also determining what the intangible asset component piece is. And you will hear a lot of different terminology thrown around. You hear blue sky, you hear all kinds of different terminology, um, goodwill, I tend to refer to the intangible asset component, particularly in AEC as a bucket of the goodwill component. Now, there are different elements to that. There's a workforce in place, there's a customer base that's in place, there's some other things. But if we think about it in a broader sense, that goodwill component. So, from the perspective of the intangible value, that's nowhere on anybody's balance sheet. And so what our purpose and process is, is to determine not only what the tangible value is that is reflected on the balance sheet, but what's the rest of it, and how is that achieved? Typically, that's gonna be achieved through the measurement of the performance of the company, the profitability of the company, and how that ultimately develops into a cashflow stream that would be available to, the investors or the shareholders in the firm? 

[00:08:56] Jeff Adams: You know, I think that Goodwill terms a good one to bring up because in M&A when a lot of deals get done, we always have this purchase price accounting that has to take place after the fact.

[00:09:06] Tracey Eaves: Yeah.

[00:09:06] Jeff Adams: To record, okay, what did you acquire? We know we bought some AR we bought some WIP - work in process, we bought some vehicles, things of that nature. But there's always a really large chunk that gets put toward goodwill because firms are trading much higher than the book value, i.e., the equity shown on their books. As a result of that. I think that's a good analogy and kind of ties things together a little bit for our audience.So, what are some times that people should consider getting an independent valuation. And why get an independent valuation versus just doing it yourself?

[00:09:42] Becky Carlson: I think doing it yourself is almost like valuing your baby, right?

[00:09:48] Jeff Adams: It's always prettier than my, my baby dog than anybody else's baby. 

[00:09:53] Becky Carlson: Exactly. And this, you know, I know the worth. And then you think, well, or let me stop myself. I've heard, Sam down the street got a 10 times EBITDA for his value for his company, and so mine must be worth the same.

And the valuation comes at it really holistically because I think talking about that goodwill, it's one thing to look at your earnings and the company and say, well, I've been making, $500,000 a year. That will continue into the future. Well, it may or may not.

So there's risk associated with anything that you're doing. And some of the risk is economic risk. It's coming from what's going on in the economy, maybe geographically in the industry, maybe in your market, but it's also what's the risk of your own cash flow. So the valuation takes a lot of inputs, and having an independent one, especially someone that's really keen on this industry, is just gonna help you take a look at your baby and say, yeah, your baby is gorgeous; however, your baby doesn't know how to walk yet.

And this is what people are looking for. So I think it's a way to communicate really complex thoughts into something that is usable for you to communicate whether you are going out to sell or you're gonna buy. 

[00:11:32] Tracey Eaves: Yeah, either. Either way. Either way. Yeah. And I would say even adding to the list, and Becky, that was a very comprehensive list of the things that we think about.

Um. You know, sometimes, I think that looking at the next level of leadership is a huge component piece of this as well. But really, from the perspective of the valuation, doing it yourself, as a business owner, it is almost impossible for you to divorce yourself from an independent opinion and a disinterested third-party because you're always going to have a vested interest.

And so we can come in and take a look at that from purely a disinterested third-party opinion because other than our valuation fee, we don't have a vested interest in the company. And ultimately, if it transacts or it doesn't transact, or you're going to transact and buy another firm. So, it really does allow for that purely independent opinion and a deep dive into the company. We're looking at things that you, as a business owner, may not even be thinking about that you would consider to be a risk profile when we do. So, there's a lot of good reason why the impartiality of what we can bring to the process, I think, is very important.

[00:12:51] Becky Carlson: Yeah. 

[00:12:52] Jeff Adams: I imagine you don't have very many people come up and say, Hey, I'd like to get a valuation and I don't really think we're doing very well, and you know, don't look really good, and don't think I'm gonna be very valuable. Right? They're usually coming and saying, No, I think I'm worth more than what they probably are? Or, what do you assume? 

[00:13:11] Tracey Eaves: Well, you know, I will say that, from the perspective of valuations, you know, we're doing valuations for a myriad of reasons, but sometimes we will have clients, uh, I've had this happen several times, where I've had clients, and it somewhat tends to be maybe more on the architecture side of the equation, where they've had a very massive project that they've worked on that really helped to bolster their revenue stream.

But they're also understanding that is not something that is going to be sustainable for them to continue to grow from that starting point forward. So sometimes I will have clients come and say, look, we had this very major project, it lasted a couple of years. We know that we're gonna be down for the next two. And so we need to understand how does that ultimately play on our value indication.

 And a lot of it too is, coming at it from the perspective perhaps of internal share transactions rather than an M&A transaction. But sometimes it's also just about the longer term look at the corporate planning process for people who aren't perhaps thinking about selling in the market, but they're not quite ready yet and they wanna understand how the decision-making process that they are investing in today is ultimately gonna have an effect on, perhaps what they could see in a transaction in another couple of years.

[00:14:38] Becky Carlson: Yeah, absolutely. Yeah. It's almost a mini due diligence process for them.

[00:14:44] Tracey Eaves: Yeah.

[00:14:44] Becky Carlson: You're getting ready to sell, the valuation will really inform you of what you're doing well and what your risks are. So I think that example of the project risk is really a good one. What phase are you in a lot of your projects? I mean, we know profitable phases are usually at the beginning of projects, and if you're looking at a couple years of great net income, but you're walking into a CA phase on five of your six top projects, you know, the next years aren't gonna be that great, and you may not even be aware of that. So that's part of, I think, the valuation process is looking at that company-specific risk, especially in this case, the project risk and how buyers would look at you.

[00:15:33] Tracey Eaves: Sure. 

[00:15:33] Jeff Adams: Yeah. So a lot of different things to consider during a valuation and how really to determine what is it worth today, is what I'm hearing there. What are some of the valuation methods used and you know, maybe more broadly speaking, but then what do you see typically used in the AEC industry? 

[00:15:52] Becky Carlson: Mm-hmm. 

[00:15:53] Tracey Eaves: Well, I mean, from the perspective of a appraisal itself, just in general, you know, we are trained to look at and consider three different approaches to value, much like a real estate appraiser.

So there will always be the consideration of an income approach, and what is the appropriate methodology within an income approach. There will be a market approach consideration, the appropriate methodology there, and an asset approach, and that methodology. Typically in professional services, the asset approach is much less viable just simply because a lot of the value that is wrapped into these firms, is on that intangible side that we don't see on the balance sheet.

So it is, at least in my practice, Becky, I don't know about you, but, at least in my practice, the asset approach is something that I typically just don't consider for professional services firms unless we have a firm that is perhaps maybe a little bit more asset intensive with heavy equipment or a lot of equipment investment or perhaps they own some real estate or some other investment inside of the corporate entity.

And then, it's worth a consideration. But I would say most of the time, the valuation is gonna be driven on an income approach, methodology, and a market approach when the data is available. Becky, I don't know if you're in the same thought process. 

[00:17:16] Jeff Adams: Oh, before you say that too, Becky, uh, Tracey, I think you talking about the asset base there, just want to tie this back together for the audience .

That ties into what we were just talking about a while ago about the equity on your balance sheet, and book value.

[00:17:29] Tracey Eaves: Right.

[00:17:29] Jeff Adams: That's really what we're talking about. And being that we're not, the AECs typically, or at least the AE is not typically an asset-intensive industry, some might have some vehicles, things like that. Get on the edge construction side, you start having equipment. Now it gets to be more asset-intensive, but, professional services, as you said is not very asset intensive. And as a result, what a firm's worth tends to rely more on its cash flows and market than it does on what the book value would say that it's worth or the assets would say they're worth.

[00:18:02] Tracey Eaves: Yep. 

[00:18:03] Becky Carlson: Right. There's always those one-offs. You know, we have a client down in Louisiana who buys his own equipment instead of renting it, does a lot of drilling, exploring, surveying. That is a one-off. In that case, if you believe the assets are worth more, you may want to consider that, but ideally, those assets are generating cash flow that's supporting the company.

And so those income approaches, methods are really, I think, always used. At least I do. Always an income approach. The market approaches, that's really, preferable I think for M&A. The big problem with that is, what are these firms actually selling for? Privately held firms do not advertise their sale price.

So we are constantly working with, do we have great data? I mean, we're blessed to have Jeff and Tracey supply the touches they have, and we need to try to compare our firm against those. But that's really what that market approach or market method means, is if I could buy a firm like mine for five times EBITDA, then this one is worth five times EBITDA, but it's trying to get them to be similar so you can use a similar multiple. That is the challenge. 

[00:19:31] Tracey Eaves: Yeah. Market data is a challenge. I agree with you, Becky. You know, it's one of those items that does have some scarcity to it. Yeah. even though we also have access to databases that the appraisal community uses, sometimes the relevancy is just not there, and there's not enough to properly represent the total market.

 It just too few data points. The other thing I will say with the market approach methodology is sometimes the historical financial performance of the firm is not indicative of its future. Right? And we also have to be thinking about that. That is where, experience number one comes into play.

Two, it's also about having a really good and quality management interview process with management, that we do. So that we have a deeper understanding after having had a chance to look at an initial analysis process. But sometimes that is the case, and particularly with firms that know that perhaps they're about to win a very large contract that is going to be that next step up. And I see that particularly with, smaller firms they've rocked along and they've been in the two to three to $4 million range, and all of a sudden they get an opportunity that comes along that really is going to increase their revenue stream and then come back and do a valuation of them two or three years later, and they've been able to sustain that.

So it's fun. It's really fun to be able to work with firms that do take those steps up. But sometimes that is the case, is that they just take a step up and they get in a different market or they get into a different client base, and it's a sustainable revenue stream going forward.

So if you had that situation, a market approach methodology, because it's always backwards-looking, sometimes is not appropriate in those cases. But again, I think Becky would agree, that is the decision of the appraiser and using our judgment as to what we feel like is reflective of the market and how an investor would look at a firm and how they would not.

[00:21:40] Jeff Adams: You know, speaking of market, I think about market multiples, right? We hear that all the time. I mean, you go to different M&A conferences, they talk about multiples. Tracey, you and I intentionally did not talk about multiples at the M&A next conference 'cause sometimes they're misleading, right?

 How do you, as valuation experts, handle market multiples? There's a lot that goes into it. I tell people all the time, right? That's a byproduct. That's not a driver. Yeah. How do you take that information and what's some of the complications maybe that you see with market multiples?

[00:22:13] Becky Carlson: Yeah, market multiples, they serve a purpose because they're really easy to compute. So if you think about what we mean by market multiple, it really is. What is the number that your earnings is multiplied by and that creates value. So when we say five times EBITDA, what we're saying is the value of the company is five times your earnings.

And very simple to understand, to compute. And many larger firms that are in this industry that are buying firms, they may start with a market multiple when they approach you and they'll say, Hey, I'm gonna offer you five times EBITDA. Oh, things look really good. I'm gonna change it to seven. And you know, that conversation starts from there.

But really what is in that EBITDA earnings before, interest, taxes, depreciation, amortization. That's what it means. What is that earnings made up of? What are the unique characteristics that maybe can be peeled back. That's really important to look at. What are the one-offs? On both sides, revenue and expenses.

And also it is a rule of thumb. So I do use rule of thumb in valuation. I look at all of our sources of data that are available in the general valuation community as well as industry specific sources. I always subscribe to all of our competitors data. I mean, before we were partnering with Zweig. I ordered their report every year. I couldn't wait for it because it was another source of data, another source of rules of thumb. And they do tell a story, but it's a simple story really. It's a little more complicated when you think about what goes into both of them. The multiple is really a return on investment. So like a five equates to 20% if you think about it.

Five, a hundred divided by five is 20%. So that means they are expecting a 20% return on their investment. And if you think about that, that is pretty high compared to the rest of the world. In privately held firms, it's not necessarily outrageous, but that's all it is. That multiple is really just a return on investment.

And what are the risks associated with that? 

[00:24:40] Jeff Adams: Yeah, I think on that market multiple too, the EBITDA side of it, Becky, that you brought up, you know, from an M&A perspective, that's somethingI hear people throw that out there, and my first question is, well, what is that EBITDA? In addition to the basic calculation from the financials, what adjustments have been made to it? What add-backs have been put into it? What normalization of compensation for executives has been put into it, or for owners?You don't really know. When you're dealing with all this data out there, they're self-reporting. You don't really know what they're doing.

At the end of the day, you're having to trust that people are getting it right, if you will. 

[00:25:21] Tracey Eaves: Yeah. 

[00:25:21] Jeff Adams: So that's always the danger. I tell people, Hey, when you think about EBITDA multiples, that's your guardrail, right? It keeps you between the ditches, but it doesn't tell you what lane you're in.

[00:25:31] Tracey Eaves: Yeah.

[00:25:32] Becky Carlson: And I will add to that, you know,I think we've all heard it, well, so and so I heard that they got a 10x or they got a nine or an 11 or whatever, and it all sounds so super sexy.

[00:25:43] Jeff Adams: Mm-hmm.

[00:25:44] Tracey Eaves: I think every business owner would go, I want one of those. Yeah. I mean, who wouldn't? But, my first response is always, sounds great, but you do not know what the deal terms were.

So it could have been that there was some unfavorable deal terms from the perspective of the seller. And the seller said, okay, I'm willing to accept this deal term. I'm not in love with it. I'm willing to accept it, but I've gotta have a higher price for you buyer to put some more risk back on me.

I have confidence that it can happen, but there are some things that are also out of my control. Market forces, economic forces, different things that could happen. So when you hear multiples in the market, you do not know what those deal terms were. 

[00:26:34] Jeff Adams: That's a great point, Tracey. 'cause there could be huge tax implications to the way a deal is structured, right?

And they might have accepted an asset purchase. You know, a seller might have accepted an asset purchase, which could have greater tax consequences on 'em, but the buyer was gonna give a higher purchase price to help offset part of that. 

[00:26:54] Becky Carlson: Absolutely. 

[00:26:54] Jeff Adams: So that's just one example. 

[00:26:57] Tracey Eaves: Sure. Or the other thing that you also have to think about is, what was the driving factors behind the strategic interest from the buyer's perspective? What was their strategic value, interest, and how much? If you took a firm and you put that firm in front of three or four or five different buyers in the market, and you said, okay, everybody, you all have this same information, you're all gonna look at it, and you're gonna come back with, end quotes, "offer".

 If you interviewed each one of those companies separately and said regardless of some of the mechanics of cash flows and different things, as the buyer, what are the strategic elements to this particular seller that is attractive to you, and how much influence did you allow those strategic elements to have?

I guarantee you, you would get five different answers. And so that is the other thing that we don't necessarily know from some of these transactions is because we don't have a lot of the data to understand, sometimes we have very little, so we don't have the data to understand all of the financial component pieces of it, in addition to perhaps what some of the strategic value element could be as well.

So, there's a lot going into that. And just coming back to what Becky said about, hey, you might start at a five multiple, but the reality is, is a firm that has a 35 or 40-day collection period on accounts receivable the same as a firm that has a 120-day collection period on accounts receivable? And the answer is no.

[00:28:46] Becky Carlson: Right.

[00:28:47] Tracey Eaves: And there's a lot of reasons why Becky and I both yelled no. A lot of it is, it's risk profile. It is the need to have working capital that supports that receivables collection period. There's a lot of different elements that go into that. It's probably part of the client profile.

It is probably also the fact that you've got perhaps a firm that is sitting in a primary position versus a firm that is doing a lot of subcontract type work that has a longer collection cycle. And so is their cashflow stream at more risk because they can't control like the other firm does. And the answer is probably yes.

So there's a lot that goes into that consideration. So when people are talking multiples in the industry, just keep in mind that there is so much noise in that data that it is, there is no direct comparison, period. 

[00:29:44] Jeff Adams: So, I think what I'm hearing in summary on that is, income is the preferred approach overall in the AEC industry with a little bit of reliance upon the market approach.

 And then, the asset approach kind of way down on the list in an M&A context generally anyhow. 

[00:30:03] Becky Carlson: Right.

[00:30:04] Tracey Eaves: Yeah.

[00:30:04] Becky Carlson: Unless you're a big C firm, right? But Construction Management company, if your people are your biggest asset, you're really gonna rely on income. And then yes, the market is still informative.

 I like what Tracey said about it being backwards-looking. What that means if people don't understand that, is it's looking at historical earnings. It's not looking at projections. So the income approach gives us another way where we can project the future and actually monetize that. Which we don't necessarily do in the market approach.

It's more of a stagnant approach.

[00:30:40] Tracey Eaves: Yeah. Yeah. 

[00:30:41] Jeff Adams: So people get valuations for multiple reasons. We mentioned M&A, we've mentioned internal stock trades, maybe there's trust, maybe there's an estate. 

[00:30:51] Tracey Eaves: Estate planning Yep. Estate settlement. 

[00:30:54] Jeff Adams: Yeah. An estate settlement, things of that nature.

[00:30:57] Tracey Eaves: Divorce cases.

[00:30:58] Jeff Adams: Well, how does the purpose for the valuation, impact your approach to valuation? Is there any change? Does it matter what the reason is for, or is your approach the same, or what does that look like? 

[00:31:12] Becky Carlson: Yeah, it does reflect what the standard of value is that we have to use. So Fair Market Value is a term that is used most often in this case, where we're valuing based on a hypothetical buyer, hypothetical seller, and neither one is under any compulsion to buy or sell. And I liken that too. If you go to an auto dealership and you wanna buy a car, you kind of know the price that's going to be there. Especially now with the internet, it's really hard to have a lot of differences, and you know, you don't have to buy from this company, but you wanna buy, and they wanna sell to you.

So it's kind of like that, that market price.

[00:31:55] Jeff Adams: Mm-hmm. 

[00:31:56] Becky Carlson: If you were talking about something where you know, a fairness opinion after the deal is done, an M&A deal, and the shareholders wanna know, did we pay a fair price, then that would be a Fair Value Assessment. It has a little bit of different connotation.

It could mean that there isn't a hypothetical buyer and seller. There's a defined buyer and seller. So the terms are a little bit different, and they inform us as evaluators what rules we need to follow. And I think we had also talked a little bit about the Strategic Value, which is a value above and beyond fair market, which is subject to interpretation, but you can think of it as kind of a control premium, where I'm gonna get a hundred percent control of this company. And I have been looking for a company who does healthcare in Austin for five years, and I finally found one that culturally I like, they have room, their utilization isn't off the charts, so I know that they have

[00:33:02] Jeff Adams: Checks all the boxes.

[00:33:03] Becky Carlson: Exactly. Then maybe I'm willing to pay above and beyond that Fair Market Value. 

[00:33:10] Tracey Eaves: And that's where some of these market multiples come into play, and Becky's right. You know, and the Strategic Value. So, I tend to think of Fair Market Value as the value to the universe of buyers that's out there in the market.

[00:33:24] Jeff Adams: Mm-hmm.

[00:33:24] Tracey Eaves: I think about Strategic Value, and there is definitionally, in the appraisal community that Strategic Value is the value to one identified buyer. 

[00:33:34] Unknown: Mm-hmm. 

[00:33:35] Tracey Eaves: And we're still making assumption about that identified buyer, but at least we know who that buyer may be. But the purpose of the valuation is, it helps to frame the scope of work that has to be done, and whether it's, internal share, transactions where we're gonna be valuing a minority interest, in the firm, or if we know that the valuation is going to be done for the purposes of a sale of the firm in the industry, then we're probably valuing at the total invested capital level rather than the equity level because we know that a seller has to deliver the firm debt-free.

And so depending upon what it is we're doing, there are mechanically some different things that we have to think about with regard to the scope of work. 

[00:34:23] Jeff Adams: Okay. So the approach is pretty much the same, it sounds like, but there's certain levers you have to look at and think about depending upon the unique circumstances.

[00:34:34] Tracey Eaves: Yes. 

[00:34:34] Jeff Adams: Let me ask this question try to tie that conversation to what we just heard, 'cause you brought up the Strategic Value versus the Fair Market Value, and then Becky, you mentioned this fairness opinion saying here's a known buyer and seller versus the "hypothetical" buyer. Is the fairness opinion, since it's dealing with a known buyer and seller, giving you something more like Strategic Value, or is there still a difference between.

[00:35:03] Becky Carlson: No, not necessarily. Yeah. It's really following a lot of the same rules, but the purpose is different. So yeah, there's different rules you need follow. Another example would be firms that have bought, and they have it on their books, that Goodwill component that we were talking about, which is the difference between the assets that you bought and the intangibles, goes to Goodwill. Well, some firms need to test that to make sure that it hasn't gone upside down, that their investment is still worth what they paid for it.

[00:35:36] Jeff Adams: Mm-hmm.

[00:35:37] Becky Carlson: So they'll do a valuation for goodwill impairment purposes, and that follows that Fair Value rule, but you use the same methods. It's not necessarily strategic, it's used just for other reasons as well. 

[00:35:51] Jeff Adams: And that's where the science part of it comes in. Right. So.

[00:35:54] Becky Carlson: Yeah. Yeah. Yeah. 

[00:35:55] Jeff Adams: What's the difference, while we're on that topic, what's the difference between what an offer price might be in an M&A scenario versus the Strategic Value? Are they pretty much the same or Fair Market Value? I mean, do you think of all that? How do those relate?

Because I know, I see buyers and sellers get that terminology confused all the time.

[00:36:21] Tracey Eaves: Well, again, going back to the scenario of if you put a deal in front of five buyers, they would all look at it very differently because they all have different strategic objectives. Their offer price is perhaps reflecting their assessment of the overall value based on their strategic initiative, which could be daylight and dark between buyer A and buyer B.

So, from a seller perspective, some of it's gonna come down to the objectives of the seller or sellers in the process, and what their collective goal is as a group of shareholders to sell the firm. But then, from the transactional perspective on the M&A side, you've gotta go a layer deeper than that and actually probably a couple layers deeper. You've gotta go another layer deeper from the perspective of not only what's the collective goal of the current shareholders, but then the next level would be what are the individual goals of the shareholders and what they need to achieve out of a transaction.

And then you go another layer deeper, and it is what are the goals, or what do we want for that next level of leadership, who may not necessarily be a shareholder upon the transaction date, but they are the people who helped drive revenue streams, grow the business, and all of that. And so, what is that group of people need from this transaction?

So when you start, as a seller, begin to think in the layers of the goals and how you have to match all that up. Then you begin looking at the deal terms that are offered by a particular buyer and say, does this meet the goals? And if it does or it doesn't, that is, in my mind, above the culture that Becky mentioned, those goals have to be achieved. Or I can pretty well tell you it's not gonna be a totally successful transaction. Post-close, post-integration, it's never going to be as robust as it could be because people are just like, eh, I'm okay, but I'm not like, happy we did this.

[00:38:34] Jeff Adams: Mm-hmm.

[00:38:34] Becky Carlson: Yeah.

[00:38:34] Tracey Eaves: So those things have to be achieved. When you look at offer prices, again, it's goes back to the multiples and deal terms.

It's the same thing. You can look at an offer price, and my goodness, if you looked at offer prices just at the top level, they could: number one, be all over the map; two, some of them are going to be incredibly attractive on their face, but if you don't look deeper and if you don't look at the deeper layer of what those deal terms are, it's gonna be very difficult to compare because you're just gonna have, again, a lot of strategic objectives of one buyer, is gonna look very different than the next.

[00:39:13] Becky Carlson: Yeah. 

[00:39:14] Jeff Adams: And we're definitely seeing that now, Tracey, I know you are too over at Zweig when you're representing sellers and you take 'em to market. We will see offer ranges wider than they've ever been and on both ends of the spectrum. 

[00:39:29] Becky Carlson: Yeah. I think, you both mentioned terms and the importance of terms, so that letter of intent puts a number down, but then, both of you know, the terms and how you will receive the funds is quite different.

[00:39:44] Tracey Eaves: Mm-hmm.

[00:39:45] Becky Carlson: I've seen the reverse where the number is actually lower, that first number, and then I've told people, well, they don't wanna buy your cash, so you have to take that offer and add your cash to it. That gets you closer to value. But then the terms, quite different, right? And how do you navigate that. I mean, I've talked to both of you about trying to compare different offers to present value in some way.

[00:40:17] Tracey Eaves: Yeah. Sometimes it is about a comparative to a present value number, but sometimes there are other elements in play that sellers value more than maybe the biggest number in the group of buyers that could be...

[00:40:35] Jeff Adams: mm-hmm.

[00:40:35] Tracey Eaves: I have a desire as a seller to be able to maintain, as a legacy, the name of the firm. 

[00:40:44] Becky Carlson: Mm-hmm. 

[00:40:44] Tracey Eaves: It's important to people. And so sometimes, those things can be as valuable to the seller or sellers as a number on a piece of paper that is gonna maybe result in cash somewhere down the road.

So. When we're talking about this from the M&A perspective and deal terms, it becomes a much deeper conversation than just looking at market value. And then you start looking at the terms, and then you've really gotta be thinking about the achievement of all of the other things that people are trying to achieve outta selling their firm.

[00:41:20] Jeff Adams: Yeah, to that point, Tracey, recently we've been seeing things with this talent shortage that we have in this industry so much. You know, it is quite common to see sellers say, I'll opt for the buyer that can solve my number one problem the fastest, and that's that I've got more work than I've got people to do the work.

Sure. And if you've got a geographic presence where they are such that you can get your people onto their projects.

Isn't that crazy? They'll take that over the price. 

[00:41:47] Becky Carlson: I know, I tell people, if you're selling, it's almost more attractive to have a 55 to 60% utilization than a 70 to 75 because buyers are looking for qualified, talented team members.

[00:42:03] Tracey Eaves: Mm-hmm.

[00:42:04] Becky Carlson: And that is more attractive.

[00:42:06] Tracey Eaves: Mm-hmm.

[00:42:06] Becky Carlson: Being a little underutilized, which I never thought I would say. 

[00:42:12] Tracey Eaves: We'll hold it against you, Becky. 

[00:42:15] Becky Carlson: It's good that you're not moving the median. 

[00:42:18] Jeff Adams: Well, I think this was good discussion though, 'cause it helps people understand the wide range, you know, what can happen in a valuation.

I mean, as valuation experts, when someone comes to you and says, give me a valuation. When you're dealing with an unknown entities, right? You don't know what purpose it's gonna be used for, and you're having to kind of just say the average, right? The law of averages kind of coming here.

It's gonna give you one valuation versus if you're sitting here dealing with a known buyer and a known seller, and you're able to know what the strategic synergies are of putting these two firms together, what the cultural synergies and likeness are between those two firms that really can drive the value in an M&A transaction.

I mean, we say beauty is in the eye of the beholder, and when you get the right beholder looking at you, the price follows because everything just lines up perfectly. 

[00:43:10] Tracey Eaves: It does. But something I would like to throw out there too, and particularly for any sellers who are listening to this.

If you think that you have a buyer and you're gonna take every strategic element and add it to your valuation as the seller that probably is gonna be a disappointing exercise for you from the perspective of actually achieving a transaction, because sellers, you have to remember, one of the reasons that the buyer is also looking to buy you is because they see upside potential in combining you with their other investments and other firms and all of those things.

So while you can take some of that into account, ultimately you are not gonna achieve every dollar for dollar, because then why would the buyer buy you? Because there's no upside potential for them on that front. So there's a lot again, this is so much deeper than just numbers on paper, and I think that's just one of the things that becomes very difficult to discern, is that in itself?

[00:44:14] Becky Carlson: Yeah. 

[00:44:16] Jeff Adams: We're getting short on time here. I just wanna kind of lead into one thing. What are some of the common misperceptions that you see in here when it comes to valuation and AEC? 

[00:44:28] Tracey Eaves: Well, something I do wanna throw on the table, and this relates to the last topic we were talking on, and that is the strategic buyer element, and achievement of people exiting firms.

But something that we at Zweig Group see, it's not every time, but there are certainly times that we see this too, is that sellers, you have to be thinking about your exit strategy and when you are going to sell your firm. We still have a lot of the baby boom generation that are shareholders, especially the smaller firms, sometimes you may have an ownership group that is approaching that retirement age category. And certainly buyers are going to be thinking about that from the perspective of what does the runway look like for the leadership group in the firm that is currently leading.

And then they're gonna be looking at the leadership group that is the next level. And those elements are also going to be very critical to the overall process. And Becky, I'm sure that you have, from time to time, looked at the ages of some of the ownership group, thinking about that from the risk profile perspective of particular companies that you're valuing.

And when there's not a depth of leadership and there's not much depth of the bench there and you've got an aging shareholder group or shareholder in a lot of cases, it adds some element of risk. 

[00:45:58] Becky Carlson: It does. And I,

[00:46:01] Tracey Eaves: Yeah.

[00:46:02] Becky Carlson: I just wanted to add to that. I think knowing that you as an owner will have to continue to work for a while. And I think sometimes a misconception is, well, I'm gonna sell my firm and tomorrow I'm going to the beach. No, you have to stay. And that's why I think if you are thinking about retiring in five to 10 years, you should be already planning, right?

[00:46:26] Tracey Eaves: Yeah. Yes. Absolutely.

[00:46:29] Becky Carlson: Because you'll have to continue.

[00:46:32] Jeff Adams: Mm-hmm.

[00:46:32] Tracey Eaves: Yeah. 

And if there is some reason that you cannot continue to work for a period of time, then you need to be prepared in your mind that while you might get offer and offer or offers, if you can't stay for a period of time, if particularly if you are in that lead category, buyers will tend to suppress value and offers because of that element.

So, it's definitely something that if you're thinking about it, if you're thinking about selling, you've also gotta think about what does that runway look like? So, that is definitely a misconception that you're gonna get to go to the beach the next day with a pocket full of money.

[00:47:11] Becky Carlson: And I think another misconception is the firms that maybe have a culture of rewarding employees and taking home a lot of the value during the time they own. So in other words, you reward your team well, you take yourself a large paycheck and distributions, and the company itself is not necessarily a shell, but the value of the company is distributed.

[00:47:40] Jeff Adams: Mm-hmm.

[00:47:42] Becky Carlson: And to think then that you will be able to sell it without add-backs is a misconception. For example, if you're an owner and you're paying yourself quite well, maybe you're paying yourself $500, $600,000 a year, you probably won't get that same salary. If you're selling, you're gonna have to fit into their structure.

So, what you need to think of is that you've been rewarding yourself along the way. 

[00:48:09] Jeff Adams: Mm-hmm. 

[00:48:09] Becky Carlson: And that there's no, shall we say, double dipping. So the value of the company, there are add-backs, but they're add-backs. So, thinking of your company from the eyes of a buyer, I think is the main goal of valuation.

As well as, looking at your industry metrics, your KPIs, your benchmarks, how do I compare to peers? A lot of times, we're so busy, I know we do this at Stambaugh Ness, we're so busy doing our business that it's like, well, we think we're great. How do we compare?

So I think that's a huge component of the valuation is it is an eye-opening experience so you can understand better what qualities you have that are valuable.

[00:48:55] Tracey Eaves: Yeah. I would say another misconception is probably the element of time itself. It takes time to go through the process, so it takes time to do a valuation. I hope that anybody who's listening today understands that this is not something that we're throwing into some kind of a software program and spitting out a number because there's way too many qualitative component pieces of this to be able to do that.

 It takes time to do the valuation. And then of course it takes time to bring a firm to market. It takes time to market that firm. It takes time to talk to buyers. It takes time to get to a term sheet. It takes time to get to an LOI.

[00:49:37] Jeff Adams: Mm-hmm.

[00:49:37] Tracey Eaves: It takes time for due diligence, and it takes time to close.

And so somebody who's in a super hurry, there's only so much compression that can be done in that process. There is a time element to this, and if you are thinking about selling, you probably ought to have in your mind that this is gonna be a good 12-month process at a minimum.

[00:50:04] Jeff Adams: One last thing I can think of is working capital. Talk about that a minute. When it comes to valuation and how's that considering working capital, and what are some misconceptions you see around that? 

[00:50:16] Becky Carlson: Yeah.

[00:50:17] Tracey Eaves: Becky. 

[00:50:19] Becky Carlson: I'll, I'll start. I'm sure Tracey has a lot of war stories about that, but working capital.

So what we mean by that is - that is really the funds that are available to the company to keep it going. So, typically, working capital is gonna be your accounts receivable, it's gonna be your work in progress. Simply subtracting your accounts payable gives you working capital. So that's the simplest way of looking at it.

[00:50:47] Jeff Adams: Mm-hmm.

[00:50:47] Becky Carlson: And that really is the money that the company needs to continue working, continue to pay the employees, collect, bill, and sustain itself. 

[00:50:59] Jeff Adams: Mm-hmm. 

[00:51:00] Becky Carlson: So that is always going to be a component of that offer. You will have to bring some working capital to the table. So sometimes people get caught up 'cause they think, well that should have value.

[00:51:15] Tracey Eaves: That's my value. 

[00:51:16] Becky Carlson: Yeah. I work really hard for that and... but it's more of a business concern. An ongoing business concern. So what does that mean? Well, it means you wanna keep it really clean. You want good working capital. There's gonna be a look-back period, but you wanna make sure that you have what you need, but not too much.

[00:51:37] Tracey Eaves: Mm-hmm.

[00:51:38] Becky Carlson: And that you don't have old work in progress, for example, that's never gonna be billed.

[00:51:42] Tracey Eaves: Yep.

[00:51:43] Becky Carlson: The risk, I think, is that a buyer will come along and they'll say, well, I don't want anything that's over 90 days because I don't believe you're actually going to be able to convert that, but I need your 12-month average.

So, you know, et cetera, et cetera. But 

[00:52:01] Jeff Adams: That's a great point, Becky. 

[00:52:04] Tracey Eaves: Yep. The receivables. Yeah. And you know, and talking about some of the old stuff like accounts receivable, you need to understand that, your accounts receivable collection cycle is going to also drive the amount of working capital that you're going to have to deliver at the time of the transaction. And so, if your working capital collection cycle is maybe what it is, just because you haven't ever had a very dedicated, and intentional process to collect receivables in a timely fashion, that's going to ultimately penalize you in a transaction.

So, if you are thinking about selling and you look at your receivables collection cycle and you go, we could probably tighten that up, man, you need to start today. Start tightening that up because you need to have a demonstrated track record of at least a year or two that what is the older data, is pre-intentional collection process, and the last couple of years are very intentional collection process, because that is going to also drive a lot of the discussion around what that working capital target's gonna look like in a transaction. 

[00:53:19] Becky Carlson: Mm-hmm. 

[00:53:21] Jeff Adams: Yeah. You know, I was gonna ask the question, how sellers can prepare themselves for sale with the goal of maximizing their valuation?

[00:53:27] Tracey Eaves: I think you just hit on a big one there, Tracey. Working capital can be a big number and for a sizable transaction, working capital can be millions of dollars... Yep.

[00:53:38] Jeff Adams: to be negotiated either way. And the better you manage your working capital, collecting your billing, billing as soon as you can, collecting your receivables as quickly as you can, can definitely help you drive a lower networking capital target, which is gonna mean more cash in your pocket when a deal closes.

[00:53:59] Becky Carlson: Right. 

[00:54:00] Tracey Eaves: Absolutely. And I would say that from the perspective of a transaction, one of the things that you don't wanna do is you don't want to decide that post LOI post-term sheet or post LOI with a working capital target number in it, that now you're gonna start cleaning up your accounts receivable and you're gonna start cleaning up your WIP. Because you start moving big chunks of financial element on your balance sheets post LOI, it really makes that working capital target discussion more difficult to come back to once that target has been set. So if you have WIP on your balance sheet, take care of your WIP, don't ignore it. We see too many times that that's one of those things that it's kind of easy to ignore. You know, it's like the little pile of papers on your desk that it's like, eh, I'll get to that one of these days.

It's not critical today, but your WIP is truly important because it's part of your working capital. So make sure it's cleaned up. Look at some industry guideline data to see is my day's WIP number within a reasonable target range of what the industry looks like. Same for accounts receivable. You need to be running that and look at that over a two - to three - to five-year period of time and say, is there consistency? Is there volatility? Is there something here that we need to clean up? Is there stuff that's hanging on? Because we just left it there because we think someday we may get paid. And the reality is, you need to move that out. If nothing else, put it in other assets, do something else with it, but get it out of your current asset profile, because that's what a buyer is looking at.

[00:55:46] Becky Carlson: Right. And talking about accounts payable. Do a pay when pay. Pay your subs when you're paid. Keeping an eye on that.

[00:55:55] Tracey Eaves: Yeah.

[00:55:55] Becky Carlson: And if you are going to market, you should know what you should have in working capital. And I think your point was well taken as well, that the time to talk about that is during that LOI phase, not three months later.

And when you say, oh, well, my working capital was overstated because blah, blah, blah.

[00:56:13] Tracey Eaves: Right.

[00:56:13] Becky Carlson: You should, know going into it and have those conversations sooner rather than later. 

[00:56:19] Tracey Eaves: And I will just come back and say. In my mind that is a great, all of what we just talked about with looking at some of the analysis of historical data.

All of that is gonna be looked at in a valuation.

[00:56:33] Becky Carlson: Right?

[00:56:33] Tracey Eaves: So Becky and I, whoever's doing that work, 

[00:56:36] Becky Carlson: Yes 

[00:56:36] Tracey Eaves: We are looking at that. We're asking the hard questions before you get to a buyer who's gonna ask you hard questions, right? We're asking you hard questions. We're identifying what we think are issues that you need, that you, as a seller and an owner, need to go look at and clean up before you ever even get to market.

So those are all things that a valuation would reveal. 

[00:56:59] Becky Carlson: Right? And it works for buyers as well. You know, we can do valuations and give you our opinion on the quality of what you're trying to invest in. Many quality of earnings, like we can tell you, this is the good stuff and this is the stuff that might cause you some headaches.

[00:57:20] Tracey Eaves: Yeah. 

[00:57:22] Jeff Adams: Well, Becky, I think it was you that alluded to it earlier, the partnership between Zweig and SN. And for those that don't know, we did enter into a strategic partnership, I think it was in April of this year. 

[00:57:33] Tracey Eaves: Mm-hmm. 

[00:57:33] Jeff Adams: And, this was a great opportunity for people to see that partnership at work.

Thank you so much for joining me today, and both of you sharing your insights and, your back and forth and talking through the different topics, was a real partnership. So, thank you so much for that. Glad you could be here. 

[00:57:49] Becky Carlson: Thank you. Enjoyed it. It was fun. Yeah. 

[00:57:53] Jeff Adams: Thank you so much, Becky and Tracey, for participating in today's podcast. And thank you for tuning in to AEC Unscripted Mergers and Acquisitions Edition. I'm Jeff Adams, and it's been a pleasure guiding you through M&A from the perspective of a couple of AEC-focused valuation experts.

Please remember to subscribe and leave us a review wherever you get your podcast. And until next time, keep pushing forward.