A COMPLIMENTARY

RESEARCH BRIEF

HOW MUCH
IS YOUR FIRM
WORTH?

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This white paper is provided as a free resource for architecture and engineering firm
leaders. As such, it is meant to provide general insight and information on the topic of
business valuation.
The research and opinions contained in this white paper are not meant to serve as a
replacement for independent valuation analysis and due diligence. Accordingly, PSMJ
Resources is not responsible for any damages resulting from actions taken or not taken by
any individual or corporate entity. Consult with your business, tax, and legal advisors
before conducting any transactions relating to the equity of a business entity.
2013 PSMJ Resources, Inc.
All rights reserved. No part of this publication may be reproduced, distributed, or
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Should you have any questions or require any additional information on this topic, please
contact PSMJ Resources, Inc. at:
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How Much is Your Firm Worth?

TABLE OF CONTENTS
1.0 Introduction

2.0 Covering the Basics

3.0 PSMJs Approach to Valuation

4.0 Closing Thoughts

13

About PSMJ Resources, Inc.

15

Additional Resources

16

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How Much is Your Firm Worth?

1.0 Introduction
Whether you are considering an external sale, an internal transition, or an equity
transaction for virtually any reason, there is one key question that you will need to answer.
That is how much is your A/E firm worth?
Of course, the reality is that your firm is worth what someone is willing to pay for it. In fact,
there are several different methods of valuation and, over the years, weve seen dozens of
individual formulas. But, the basic purpose of these methods and formulas is to come up
with an amount that a buyer with a reasonable knowledge of all relevant facts will be
willing to pay for the ownership he/she is buying.
Beyond the wide range of internal and external factors that well describe in this white
paper, the ultimate value of an architecture or engineering firm will often be driven by
some important realities. For some, these realities just serve to create further confusion in
what can seem like a rather confusing and murky mix of art and science that is business
valuation. But, before we get into the details, one must understand that value is dictated
by:
Similar completed transactions. A value from a few years ago may not be valid
today. Much like broader economic cycles, over time, there are tides that rise and
sink all ships. Even if nothing has changed within the firm, external factors can
influence value.
Purpose of the value. One answer to how much is your firm worth? is It
depends why youre asking. Generally speaking, internal share transfers to up-andcoming principals will carry a lower valuation than an external sale to a strategic
buyer.
In the sections of this white paper that follow, we begin to provide an understanding of
what goes into valuing your A/E firm and how you can begin to get your arms around what
your firm might be worth.
You might not be able to instantly pin a number on the value of your firm after reading this
white paper. But, you will gain a better understanding of how to arrive at a value and what
information you will need to estimate the value of your firm.

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2.0 Covering the Basics

When we talk about the value of a firm, there are a range of standards of value (e.g. fair
market value, fair value, book value, etc.). Most often, in the context of ownership
transitions or mergers & acquisitions, the appropriate standard is fair market value. Fair
market value is defined by the United States Department of Treasury as ...the price at
which the property would change hands between a willing buyer and willing seller, neither
being under any compulsion to buy or sell, and both parties having reasonable knowledge
of relevant facts
Of course, with a publicly-traded firm, fair market value is determined every day in a free
and open stock market. Want to know what AECOM or URS is worth? Just go to any one of
a number of equity trading or financial information and youll have it at your fingertips. If
only it were this easy with your firm. You see, the vast majority of firms in the A/E industry
are closely-held with no free and open market. This makes it a bit more complicated to
assess the market for the stockbut, not impossible. In the absence of a free and open
market, we use various methodologies and techniques to arrive at a valuation.
First, lets be clear on this. Remember how we said at the outset that the purpose of the
valuation will play a role here? Factors such as sweat equity and marketability come into
play here. In other words, the actual value a seller can realize will depend on the nature of
the buyer. Generally speaking, obtain the highest realizable value by going public. Obtain
the lowest by closing the doors. Everything else is in between.
Keeping in mind that no two transactions are alike, following is a general indication of the
relative scale of transactions:
Valuation Expectation
Highest

Transaction Scenario
Public offering. A public offering of equity brings the highest
realizable value for owners, but its only available to the largest
firms (200 to 250 employees).
Foreign sale. Foreign buyers usually look at return on
investment as an indication of profitability, as opposed to profit
margin on gross or net revenues. Since successful U.S. design
firms usually achieve very high return on equity, they can
command a high price with foreign buyers.
Domestic U.S. sale. Consolidation potential within the industry
is resulting in further horizontal integration. The increase in
design-build and other cross-discipline trends results in more
vertical integration. So the external market for design firms is
on the rise.

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Internal transition. The price is greatly influenced by the

firms philosophy of ownership.
One view: the important factor in ownership is stock
value. Incentive is based on growth and higher volume
or profits. A formula for share value includes significant
goodwill calculation.
The opposite view: ownership means the potential for
earnings while one is an owner. Owners dont hold
shares to see them increase significantly in value (so
little goodwill calculation is included), but to participate
in ownerships levels of distribution.

Lowest

Close the doors. The most you can expect to achieve is the
adjusted book value. Maximize your financial returns by
retaining all the profits of the firm until you retire. Selling at
book value is often the worst case and least desirable
scenario.

When thinking about valuation and different transaction scenarios, it is also critical to
recall the old negotiating saying of You name the price, Ill name the terms. In other
words, the actual total transaction price can be achieved in a number of ways:

Up-front payment.
Guaranteed payment over time.
Payments contingent on future profitability.
Long- or short-term employment agreements.
Non-compete payments.

Once the type of sale is understood, in the absence of a public market, many A/E firms will
look to formulas, rules-of-thumb, or a more comprehensive valuation analysis to assign a
value to their firm.
Common Valuation Techniques: A Problem for Design Firms
Across a broad range of industries, there are several commonly used valuation techniques
and rules-of-thumb. But, each has problems when applied to professional service/design
firms.
Comparable firm valuation. Tax agencies recognize this technique, and its
required in valuation reports for Employee Stock Ownership Plans. It assumes that
the value of one firm can be determined by examining the value of a similar firm.
While public companies can be compared, design firms are usually closely held and

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its difficult to obtain information about them. Comparing a private firm with a
publicly held company on the basis of price/earnings ratios, as is often done, can
lead to inflated valuation.
Multiple of book value. Design firms are not usually capital intensive. Their volume
of business is usually far greater than the owners investment. Also, book value
depends heavily on subjective factors like the owners personal philosophy about
leverage.
Multiple of revenue. This valuation, based on gross revenue or gross service
revenue (for example, one times gross), works for other professions where profit
margins are usually within a narrow range. But profit margins within the design
professions vary too much to make this a viable method.
Capitalization of earnings. This method applies a capitalization rate to profits to
arrive at value: a certain value is expected to be in place to deliver the level of profits
at the assumed capitalization rate. Here again, profit margins in the profession vary
so widely that its hard to devise one capitalization rate for the industry.
As you can see, each of these approaches brings its own set of problems and constraints.
So, absent a comprehensive valuation from an experienced consultant, is there a relatively
simple yet effective means for estimating the value of your firm? Yes, there is.

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3.0 PSMJs Approach to Valuation

As discussed in the previous section of this white paper, many valuation techniques and
rules-of-thumb have significant shortcomings for A/E firms. Through our decades of A/E
industry experience at PSMJ, we have developed one formula that is relatively easy to apply
and that can accurately and adequately capture both the tangible and intangible value
associated with an A/E firm:
PSMJ Valuation Formula: Adjusted Book Value + (X * Earnings)
As the figure above shows, PSMJs valuation formula starts with a firms adjusted book
value (as described below) to identify the tangible value tied to the firm. Our valuation
experts then apply a carefully-selected multiple to a representative level of earnings to
identify the intangible value tied to the firm. This multiple is based on a variety of factors
described later in this white paper.
When these two values (tangible and intangible) are added together, you arrive at an
estimated value of the firm.
Book Value
Accrual basis book value as it appears in financial statements may be adjusted in a
valuation to determine realizable book value. Adjustments might be made for such items as
the following.
Unrecorded values. These might include survey records, extensive library
materials, or proprietary software.
Appraisal assets. The actual value of assets may differ significantly from
accounting standards book value. For example, the appreciated value of real estate
may differ from the depreciated purchase price value. Old accounts receivable may
be worth less than their book value. Work in process has value.
Deferred taxes. Some firms balance sheets carry accrued federal income tax
liability associated with the difference between cash and accrual basis income. Since
operations and tax planning usually eliminate corporate income tax liability, a
valuation expert may eliminate this liability in determining value.
Unrecorded liabilities. These might include, for example, the potential loss after
insurance coverage on professional liability claims.
To facilitate financing an ownership transition, keep out of your book value and balance
sheet any assets or equity that are not related to the actual conduct of your primary
business.
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Earnings (Profits)
Earnings are defined as profits from operations before discretionary distributions and
expenses (tax avoidance financial transactions). These often include incentive bonuses,
ownership-based bonuses and contributions to profit-sharing plans. Its also appropriate to
evaluate compensation paid to owners and others to determine whether their pay is
commensurate with what they do for the firm.
Earnings are often averaged or weighted averaged over three to five years, so that one
years unusually high or low earnings doesnt inappropriately influence the firms value.
Volatility is not a good thing in a relatively illiquid equity. As such, the smoothing effect of
using a multi-year average is very important.
Once a representative earnings level is determined, PSMJs experienced valuation
specialists apply a multiple to the earnings figure. This is a somewhat subjective figure
influenced by such factors as:

Reliability of earnings.
Stability of earnings.
Earnings trends.
Significant risk factors (e.g. client or market concentration).
Institutionalized versus individual leadership and rainmaking.
National trends within specific markets.
Potential of increased profit achievement.

The multiple of earnings portion of value is equal to the concept of the intangible value or
goodwill.
What is Goodwill?
Goodwill is the difference between the value of the practice as a going concern, and the
book value of its net tangible assets. Its the business advantage the practice has in the
marketplace because of such factors as:

Reputation
Business connections
Previous work
Probability that it will retain old clients and get new ones in the future as in the past
Probability that the business advantage will continue to generate profits above
those required to earn a normal rate of return on assets.

Understanding the source of your goodwill helps put a value on it. Take an honest look at
your business and consider the following questions.

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Is the goodwill the result of many years of outstandingly ethical practice or

technically and economically outstanding work?
Is certain recent profit generating the illusion that goodwill is higher than results
would indicate in other years?
Are above-average profits included in goodwill calculations the result of being
innovative?
Is your success due mostly to government decisions that suddenly elevate the need
for your firms expertise?
Is your firms unusual success the result of special technical skills and
communication talents of one individual or group, so that this goodwill is not
transferable?
Is higher-than-average profit due to technical capability or to astute business
management?
PSMJs valuation experts use a multiple of earnings to put a valuation on goodwill.
Admittedly, the choice of multiple is subjective. It ultimately reflects an assessment of the
firms ability to pay for itself over a reasonable length of time, i.e., its earnings capacity.
Typically, the multiple applied to the firms earnings ranges from 0 to 5 based on all of
the factors described above.
What Goes into a Valuation?
In some cases, a general estimate of the firms value cannot be easily obtained. Or, perhaps
a formal appraisal is needed to support ESOP transactions or a marital dissolution. In these
cases, it may be necessary to retain a professional valuation consultant or business
appraiser.
To start, the appraiser will review your firms historical financial and operational
performance. He/she will examine trends over time and benchmark your firms
performance against industry norms.
To further their analysis, an appraiser will visit your offices interview key leaders and
managers to better understand the firms competitive position and future growth
prospects.
At a minimum, specific materials that an appraiser will likely request include:

Up to five years of historical financial statements.

Profit-sharing, pension fund and/or bonus distribution data.
Available calculations of project backlog.
Current project list.
Marketing brochures.
Current buy/sell agreement.

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Strategic plan documentation.

Current accounts receivable aging list.
Marketing plan documentation.
Current employee list.
Historical employee counts and turnover rates.
Information regarding ownership of any related corporations.
Past valuation reports.
Other documentation deemed relevant to the determination of the firms value.

If you take away one key concept from this white paper, it should be thisvalue is
subjective. In fact, two professional appraisers may interpret a firms risk profile and
growth prospects differently and, as such, arrive at a different estimate of value.
While prospective owners inside a firm may have a better understanding of its operations
and value than someone outside, any potential buyer should ask the same questions that an
outside buyer would ask:
Does the company have a track record of success?
Is there a good possibility to sustain and increase profits?
Additional questions that should be raised in the context of valuation include:
The market
Is its chosen segment of the market expanding or contracting?
Is the market segment easy to enter for new firms or firms from other geographical
areas?
What is the economic outlook for the firms services during the next five to ten
years?
Financial status
What is the asset value of the company if it were liquidated today?
Is the firm financially strong enough to suffer a few economic reverses without a
financial crisis?
What is the earnings record for the past five years?
Are previous earnings levels likely to continue?
Can any trend in earnings be detected, either up or down?
What percentage of the fees has been spent on business development?
Have excessive amounts been spent or has very little been spent in an effort to
increase earnings for a short period?
How much money is tied up in accounts receivable and how old are the accounts?
Is work-in-process realistic? At cost or billing rates?
What is the deferred tax liability?
Is goodwill shown on the balance sheet?
If so, how much and what proportion is it of the price asked for the shares?

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Does the practice have any current or long-term financial obligation to any person
or company? If so, for how much and for how long?
Does the firm have audited or unaudited financial statements?
Have salary increases been promised that will erase a significant portion of the
profit?
Ownership
What is the current distribution of stock?
What percent of shares are offered for sale?
What is the history of previous offers for sale, and sales?
Is voting or non-voting stock being offered?
Who has control of the company and will this change in the near future?
Staff

Will the key staff stay or leave the firm?

Have there been any recent terminations of key staff? Why?
Will the existing majority owner stay after the sale? If so, how long?
Is the second level of management and technical staff experienced?
Has there been a high turnover of staff?
What is the average length of service for key staff?

Legal Issues
How many lawsuits have been filed against the company?
How many judgments?
How many lawsuits are still pending?
Compared with Other Firms
How does the practice compare in size and service capability to the acknowledged
leaders in the market?
What is the ratio of professional to non-professional staff and does this compare
favorably with other similar firms?
How do salary levels compare with other firms in the same geographic area?

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4.0 Closing Thoughts

There are many factors that go into assigning a value to an A/E firm and the purpose of this
white paper is not to oversimplify the valuation process. Rather, the intent here is to
provide an overview of the mechanics and levers behind the valuation process and what
drives value for an A/E firm.
When entering into any discussion or analysis on valuation, there are some fundamental
principles that you need to keep in mind, such as:
Be as simple as possible. It is very common for an A/E firm to use a formula to
determine value. In some cases, value formulas can get very complicated. Many
include a point-in-time decision that puts a twist on the value. But, when designed
correctly, if something traumatic happens to your firm (a key person dies
unexpectedly, for example) a simple formula will minimize argument, speed
decision-making, and help deter legal challenges.
Keep your books on an accrual basis. Most of your value is in the assets on the
accrual side of the balance sheet (work in process, accounts receivable, signed
contracts, for example). If you dont have accrual information, youll have to create it
for the purpose of determining value.
Real value is determined only when theres an agreement. Until you have a
willing seller and a willing buyer, any valuation is only theoretical.
Taking this one step further, following are some concepts and factors you should not
include in your valuation:
How much you need to retire comfortably. Your retirement lifestyle has nothing to
do with the value of the firm.
Valuations more than two years old. Just because your firm was worth $400,000
five years ago, theres no guarantee that its worth that amount plus inflation now.
Value is subject to current market conditions and profitability, not to the cost of
living.
How much it would cost to replace the firm or build an equal one. Replacement
value is cost-driven; firm value is market-driven.
An offer from an outside buyer. Buyers have different reasons for acquiring a firm
(geography, services provided, staff, etc.) and different buyers have different
reasons for buying. Valuations should reflect the current buyers interests.
How profitable your firm should be. Valuation is based on proven performance.
How profitable you were ten years ago. Not only must profits be proven, they must
be proven currently
How much another firm sold for. Even if that firm is similar, each firm has to stand
on its own record.
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Book value. Accounting is not very good for valuation. Current market value (not
historical cost) of assets and expected future profits are the basis for valuation.
Rules of thumb. Guidelines such as multiples of book value, earnings multipliers,
dollars per staff, and others help assess the reasonableness of a proper valuation.
Theyre not tools to develop a fair valuation for a particular group of buyers.
We should also point out that determining what your firm may be worth doesnt just come
into play if there is an imminent transaction. Even if youre not planning to sell your firm
any time soon, you should have an up-to-date valuation, for several reasons:
Keep score. If you know the value of your ownership, youll know how well youre
doing in the marketplace.
Compare. How well are you doing compared with the publicly listed design firms?
Reality check. Have you established certain values in your planning sessions, and
are you keeping up with these values?
Update your buy/sell agreement. It should include proper valuation. And if its
more than five years old, it probably needs revision. Get an annual valuation and use
this as a reason to update your buy/sell agreement.
Be prepared. If someone offers to buy your firm for $500,000 today, you wont
know whether thats a good deal unless you have a proper valuation. Or if
something happens unexpectedly to you or a key employee, a valuation will save the
remaining owners an extra hassle.
Understand your personal wealth. Without a proper valuation, you dont know
where you stand in terms of estate tax or inheritance.
Stay current. Tax laws change; youll fully understand their implications only if
your valuation is up to date.

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ABOUT PSMJ RESOURCES, INC.

Established in 1974, PSMJ Resources, Inc. is the worlds leading authority on the effective
management of architecture, engineering, and construction firms. With offices in the
United States, the United Kingdom and Australia, PSMJ offers over 150 titles in book, audio,
and video format. We also publish three monthly periodicals and deliver hundreds of
seminars, roundtables, conferences, webinars, and in-house training sessions every year
for A/E/C professionals around the world. PSMJs sought-after consulting expertise covers
a range of critical business areas such as strategic planning, project management, valuation,
succession planning, and mergers and acquisitions.

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ADDITIONAL RESOURCES
If youd like to learn more about determining what your firm is worth, you can find additional
products and services (including the featured products detailed below) at www.psmj.com.

PSMJs Complete Guide to Ownership Transition

Dont put it off another day! Without a plan, every day that passes
brings you one day closer to an undesirable outcomean outcome
where key employees, clients, and firm value are lost. With The
Complete Guide to Ownership Transition, you know what you need
to do, what to steer clear of, and how to make success happen. More
than this, you have the tools, templates, and checklists that you need
to implement your ownership transition plan.
How to Sell an A/E Firm
How to Sell an A/E Firm leverages the rock-solid management and
professional experience of PSMJs M&A experts and brings clarity
and simplicity to what can be a very complex and overwhelming
process. There are dozens of books on mergers and acquisitions, but
only How to Sell an A/E Firm that combines the financial, legal and
human side of selling an A/E firm into one practical guide.
Essential Reference Guide: Buy/Sell Agreements
The buy/sell agreement is the most fundamental document
underlying the allocation and transfer of ownership in your firm.
Without it, you are putting yourself, other shareholders, your
employees, and even your clients at risk. This value-packed
reference guide gets right to the point with 46 real buy/sell
agreements from firms just like yours. Stockholder agreements,
partnership agreements, and divestiture/buy out agreementsthey
are all here.

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