Private equity firms that used to have no interest in AEC are now putting their money into companies in our industry.
I have always felt our industry was undervalued and have mentioned it several times in these pages over the years – and evidently, I was right. Private equity firms that used to have no interest in AEC firms are now putting their money into companies in our industry.
For those of you who don’t know the difference in venture capital versus private equity, venture capital firms invest in start-up companies. Private equity, on the other hand, invests in growing, established companies – and ones they think they can build through investment of additional capital and management expertise.
Why would private equity be interested in investing in firms in this business? I can tell you why:
- AEC firms generate a high return on invested capital. The typical firm in our business – if well-managed – can generate a 50 percent or higher annual return on equity. Some do even better than that. Now before you say, “Wait a minute – we only make a 15 percent profit. Nobody makes 50 percent,” read again. I said return on equity. How can that be? Let’s take the example of a company that does $10 million a year in net service revenue and makes a 15 percent profit of $1.5 million. If their book value or owner’s equity is $3 million or less (which it will be if they do a halfway decent job of billing and collecting their accounts receivable), they generated a 50 percent or higher return on equity. The calculation for return on equity is $1.5 million divided by $3 million. A 50 percent return on equity is hard for many industries to achieve, and the private equity people know that.
- AEC firms have trusted relationships with their clients that could be leveraged to sell something else. Because architects and engineers have a reputation for being highly ethical, our clients trust us. That trust could turn into opportunities to sell other, non-traditional services to those same clients. Insurance, risk management, management consulting, software as a service – I could go on. But if the private equity group has made investments in other B2B companies, their investment in an AEC firm could potentially benefit those companies as well.
- The AEC industry is ripe for consolidation. We are a huge, fragmented industry of more than 100,000 small companies. Many of these firms have aging owners and struggle with ownership transition schemes that work and will allow their owners to get their value out when they want to go. That creates an opportunity for someone who has the capital to buy them out. Not to mention the fact that many clients of these firms – especially larger ones – prefer one-stop shopping where they can deal with larger AEC firms that can meet all of their needs. That creates an opportunity for industry consolidation, and one in our case that has a very long runway ahead. Private equity loves these scenarios.
- AEC firms can successfully grow through acquisition. Over the years, buying and successfully integrating other AEC companies has become the norm rather than failing at it. Firms in our business are getting better every year at this. Private equity will seek out those companies that have proved they can successfully buy other firms in the same business because they can use these companies as growth platforms for further investments.
- The risk of spectacular failure is really low. Very few AEC firms go out of business entirely. Sure, some may have a bad year or two, and could be impacted by a recession with resulting lower growth and profitability – but complete failure is rare. That reduces the risk for the private equity buyer and they like that.
- The general public thinks we need to make more investments in public infrastructure. We have even passed a huge infrastructure bill at the federal level that will provide additional funding for years ahead. That means lots of money will be flowing to build and improve roads, bridges, airports, public transportation, water and sewage treatment, power generation and distribution, and much more. These are the kinds of projects that make up more than half the revenue of AEC firms. When you combine high demand with an industry-wide shortage of people who can do the work, you have a very good situation for those firms with capacity. Private equity firms can see this. There is a bright future ahead for our industry.
Hopefully by now you can see why private equity has discovered our industry. It’s going to present a whole new range of opportunities for those who are building companies in our business to cash in on their equity at some point, sooner or later. As someone who has worked with firm owners in this industry for 42 years and spent the last 18 years teaching entrepreneurship at the college level, I find this very exciting indeed!
Mark Zweig is Zweig Group’s chairman and founder. Contact him at firstname.lastname@example.org.