Affording a small firm acquisition

These four components all work in concert to make buying the business more affordable and easier to fund.

Let’s face it. There are thousands of small architecture, engineering, and allied consulting firms out there with aging owners who are ready to retire. The bigger firm buyers aren’t interested in them. They are too small and it’s not worth their time to find them, buy them, and integrate them into their businesses. But acquiring these companies and giving their owners a way to get out is a big opportunity for you to grow your own AEC firm. That is why buying another firm is included in the strategic plans for many growing AEC firms today.

Yet, my experience is that most potential smaller and mid-size firm buyers think they cannot afford to buy another company. A typical $2 million revenue AEC business might be “worth” $1.5 million. The $8 million-$10 million revenue AEC firm buyer doesn’t have that kind of cash sitting in their account. So as far as their principals are concerned, buying another firm is just out of consideration until they can “save up” a bunch of cash.

But it shouldn’t be. No one writes a check for the entire purchase price of a company up front. I want to show you just one example of how you could structure a deal that would allow you to buy a firm that you may not have considered before.

The way to do it is to get the seller(s) to finance the deal for you. A typical deal structure that has not only worked on dozens of transactions we have helped our clients with but one I have also used myself several times involves four components. And it is critical to understand how your knowledge of these will affect your ability to make an offer and put a deal together that would benefit everyone.

Those four components include a cash down payment for "book value” of the business, an amortizing interest-bearing note, an annual payment based on a percentage of revenue from the selling firm’s clients for two to three years post-sale, and consulting agreements for selling firm principals. These all work in concert to make buying the business more affordable and easier to fund.

Here is a specific example of how to buy a $2 million firm:

1. Book value down payment. The book value down payment is essentially cash for cash and accounts receivable. It’s like moving money from one account to another. In the example above, a $2 million annual revenue firm would probably have a book value in the range of $300K-$500K. So you use $300K-$500K of your cash for a day or two (or draw on your own line of credit) for your down payment. But once you own the business you get $300K-$500K in short-term liquid assets to pay yourself back that money immediately.
2. Amortizing note. The note in this case could be another $300K-$500K, and let’s say that will be paid out over three years. For this example, it is $400K paid in three annual payments, or $153K a year at 7 percent interest. That money comes from profits this selling business will make. Hopefully a $2 million revenue firm with lower overhead (because you will be reducing professional liability, legal, marketing, accounting, etc. expenses post-acquisition) should be able to generate at least 15 percent margin post acquisition. That’s $300K a year assuming absolutely no growth. That leaves you about another $150K a year left over.
3. Earnout not based on profit, but instead revenue from existing clients. The next component is a percentage of revenue from existing clients at the time of the sale. Let’s say in this case that is $1.6 million a year for three years from these clients (80 percent repeat business). A 5 percent payment based on revenue would be another $80K per year for the sellers. I like percentage of revenue from existing clients versus percentage of profit in earnouts for many reasons. There won’t be any arguments over profit. There won’t be any barriers to moving work and people around. Work could be done by the buyer for the seller’s clients and they would still get their 5 percent. It’s cleaner and encourages integration and cooperation between the two companies versus keeping the sellers out to the side.
4. Employment agreements for selling firm owners. Many think these employment agreements aren’t part of the sale consideration but they are. Let’s say in our example there are two owners. One wants out immediately and the other wants to work for another three years but phase out over that time. So you agree to pay the one who wants out $100K a year for three years to not show up, and the other one gets $200K a year for three years but really would have averaged $100K a year based on the hours he or she will work. The total is $600K going toward the purchase price.

Add all these numbers up: $300K down payment, plus $400K note payment, plus $240K “bonus” payment, plus $600K in employment agreements, and you now have a $1.54 million offer to buy this $2 million revenue company. And you have been able to essentially finance 100 percent of the deal and pay for it over time. And hopefully, you will not only make it more profitable than it was but grow it, too. You could multiply the numbers in my example by 10 for a $20 million deal if you wanted to. The concept remains the same.

You might ask yourself why a seller would take a deal like this? There are many reasons! The sellers can’t just quit and shut down. They want to protect their employees and long-term clients. And they cannot get any money out of their business any other way. Their book value isn’t liquid. They may have personal debts to pay off. They may be ill. There may be any number of reasons they want to exit. By financing the deal they could save money on their taxes because it isn’t all coming at once. The percentage of revenue payments are a bonus. The employment agreements allow them to retire immediately or slow down gradually and still make some money. This deal structure also allows the buyers to expense out most of their acquisition costs.

Of course, you always need to consult experienced and specialized accountants and legal advisors to put this all together. It may not be quite as simple as I have portrayed it above. We are lucky there are some really great experts who work with companies in our industry who help engineer deals like this.

I plan on sharing more of my experience in buying and selling AEC firms in future columns here. I’m tired of all of the standard advice I read from non-industry specialized financial jockeys. And it’s time for some new creativity to shed some light on this super-important subject for all of us who own these businesses.

Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.

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