The truth about building value in your firm

Many owners fail to understand how much value they can create in their companies if they make the right decisions.

Every entrepreneurial architect, engineer, planner, or land surveyor who is an owner in their own design/consulting business knows they can make one of these companies profitable. But the majority – in my experience – fail to understand how much value they can create in their companies IF they make the right decisions.

Part of the reason for this failure to understand the real opportunity one of these companies represents is the the fact that most firms’ principals have spent their entire careers in one or two firms, and odds are those companies were run in such a way that ownership was viewed as an “income club.” In other words, the only value of the ownership is that you can make more through your share of the profits. The ownership may have been given to them or sold to them with payments tied to bonuses. And then when they move on they basically give it to the next person down the line, selling it for a fraction of its real value and getting paid overtime.

Another reason for this failure to understand the real value of their businesses is the accountants they get their advice from. When minimizing tax obligations is combined with the “income club” culture, there is a double-dose of keep the value low. Not to mention the mentality that book value internal valuation methodologies are always preferred by ultra-conservative accountants and financial managers who worry about the firm’s ability to buy back ownership stakes from departing owners as they leave or retire.

Over the last 40 years working inside and outside A/E firms as a consultant or board member, I have witnessed not only the conscious decision to make a firm more valuable, but the outcomes of most all of those efforts over that time. And I have seen many firm owners build incredible wealth in their ownership stakes that they may not have originally thought possible. What a learning process this has been!

So how can you really build value in your business – value that far exceeds what you can extract from your company each year? Here are my observations:

1. Develop and share a plan for growth. It starts right here. If top management doesn’t publicly state they want to grow and have a plan for it and they won’t lay out specific goals and share them with everyone, good luck making it happen.
2. High revenue growth rate. Your growth trajectory has more impact on your value than any multiple of EBIT no matter what anyone tells you. High growth rate – especially if the firm has good cash flow and any profits – is the best recipe for value creation.
3. High productivity/high margins. Any firm in this business with better than normal labor multipliers and higher than normal staff productivity (utilization) will have higher value than those whose key performance metrics look like the bulk of other firms in this business. Those high multipliers indicate that the marketplace values what they do. And those high productivity numbers show that the culture is healthy.
4. Be willing to reinvest in the firm. That means retaining some earnings versus paying it all out through bonus to minimize tax obligations. And it also means investing in things such as IT, recruiting, training, and marketing, so the firm can support and manage its growth.
5. Brand name/top of the market position. Any business that is in the top five firms for what it does in a particular market will be more valuable than the other firms. Having a brand that is recognized and highly thought of is one of the key elements of value creation in this industry.
6. Backlog. The bigger the backlog under contract, the more certain the future revenue stream is. That increases value.
7. Lack of client concentration risk. Firms that have too many of their eggs in one basket – meaning too much of their business coming from a single client – will not get the same value as an equivalent company whose business is spread out over a whole lot of clients. Not saying the firm needs to be in a zillion markets – just that spreading risk out over a lot of clients increases value.
8. Management depth. Everyone in the firm needs to know who their second in command is and who will take over for them if they leave or get sick. Having those “number twos” in place, and then having number twos for number twos will undoubtedly increase the value of the business because it will be more likely able to weather any turnover-related problems.
9. High quality staff. The better your people are – and we all know what that means – the higher your value will be compared to other similar firms. Recruitment and training, like marketing, are what I like to call “off balance sheet investments” that can yield huge dividends.
10. Clean books – preferably audited. Comprehensive and accurate financials again reduce the risk of the business and anything that accomplishes that goal will increase the value of the business. And even if it saves you on taxes, get all of your personal vacation homes and other luxuries that don’t do anything for the company off the books.
11. Codified processes for everything. I’m talking about good recruiting processes, RFP response systems, PM systems, good document storage systems, a well-developed intranet, and a decentralized and up-to-date CRM (client relationship management) system are all critical to building value in your business. These things take time and money to develop and are critical to your ability to scale your business as it grows.

So how are you faring on these 11 points? Are you doing what you need to be doing to build your value? And if not, why not?

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