Sell or No-Sell: Design Firms Weigh Choices for Future Growth
Diane Cho, a founder of a small Baltimore architect, and her partner, cold-called Carl Elefante, incoming president of the American Institute of Architects, when they heard through the grapevine that the 140-person firm of which he was a principal wanted to open an office there.
With retirement looming for herself and two co-principals, Cho worried about the financial impact on younger managers and employees. “The decision to sell seemed like a way to address these concerns and create a path for both older and younger shareholders,” she says.
This experience was unlike Cho Benn Holback’s previous forays into merger-and-acquisition talks. After meeting with other potential buyers that were more focused on the bottom line than design, Cho says she immediately detected “culture clashes.” With Quinn Evans, “the chemistry was right … and the firms’ portfolios meshed in an unbelievable way,” she says. The deal was signed in May.
Ron Klemencic, chairman and CEO of Magnusson Klemencic Associates, sees a starkly different course for his 195-person structural-civil engineering firm. “We have no interest in selling or purchasing,” he says, adding that innovation “requires a strong culture and constant maintenance of that culture. Merging or selling means we will lose control and, ultimately, the culture we developed over more than 90 years.”
He observes, “Too much time and effort is devoted to trying to merge disparate cultures, agendas, markets and the like, taking top management attention away from clients and the work. We call it the march to mediocrity.”
Firms that share MKA’s view often attach adjectives such as “furiously” or “fiercely” to describe their independence.
To achieve next-step success, many industry architects and engineers must decide between a merger, a buyout or remaining independent—growing staff, markets and geographies organically or even by making their own acquisitions. As principals age and seek to recoup investments—with improving economics and new interested buyers such as private-equity investors pushing up firm valuations—M&As have grown in appeal and in size.
Deal numbers peaked in 2014 and 2015, say consultants that broker them and track trends, such as Morrissey-Goodale (se chart at top of story)
Larger design firms struggling with internal growth have relied on acquisitions, says Andrej Avelini, managing director of consultant EFCG. Among about 200 design firms it tracks, 2016 revenue growth averaged just 1.6% for those with $1 billion or more in revenue, he says. Deals include eye-popping “megamergers” fueled by public-ownership cash, such as AECOM’s $4-billion purchase of URS Corp. in 2014 and SNC-Lavalin Group’s soon-to-wrap $2.6-billion bid for U.K.-based Atkins Group.
Deals have slowed in the wake of oil-sector, election and other global economic uncertainties. But numbers are rebuilding, with action strongest among smaller firms. “Since 2010, the median size of a selling firm is 20 to 30 employees, typically generating $2 million to $4 million in annual revenue, with the median buyer around 300 employees,” says Steven Gido, partner in consultant Rusk O’Brien Gido + Partners. Colvin Matheson, managing director of Matheson Financial Advisors, says, “We have plenty of firms run by younger founders that, quite frankly, don’t need to sell, but they see it as an opportunity to accelerate growth.” The talent crunch is a newer M&A accelerator, says Jamie C. Kiser, Zweig Group consulting director, noting that a new key catalyst is staff additions, which historically have ranked as a low priority in its annual survey of deals. She says the “seasoned, experienced but still young and energetic [leadership] tier is an important one that is a gaping hole” in some firms.
Independents also are changing shape with less fanfare. “For all the headlines, this industry tends to quietly and steadily transition and perpetuate companies via internal methods, just like law and accounting firms: selling stock to a next generation of emerging owner-managers or implementing employee stock ownership plans,” Gido says.
Motivations for design-firm sellers are as varied as the firms themselves. “I had gotten to the point where I was tired of running a small business,” says Gregg Reese, president and sole owner of Summit Engineering Group, a niche transportation-sector designer acquired in 2015 by engineer Modjeski and Masters. “In the consulting field, it’s gotten more and more challenging every year to keep up. I love what I do, but it was wearing on me.”
Selling MEP engineer RDK was the best approach for three aging partners who owned 75% of the 185-employee company “while the economy was good and the firm is doing well,” says CEO Chris Cummings of its June 6 sale for $33 million to serial acquirer NV5 Global Inc. It reported $302 million in 2016 revenue. “It was better to do it now, when we could pick where we wanted to be,” he says. After conversations with various types of buyers, Cummings says NV 5 “was large enough to afford us, but we could still have impact.” He admits “some apprehension of the future” but sees new cross-selling opportunities for RDK staff.
Texas-based Bury had overtures from Canadian-based design firm Stantec, another long-time sector consolidator, for more than a decade when the 300-person firm agreed to an acquisition in 2016. “We weren’t a small company, but the resources that it takes to grow are tremendous. Stantec was persistent in its pursuit,” says James B. Knight, a former Bury executive vice president. He credits the new parent’s integration expertise for “a good process that allows us to see the positive future in front of us.”
That experience set up Stantec for even the experienced buyer’s most aggressive purchase: the $800-million acquisition—also last year—of giant MWH Global, which has a worldwide reach that includes construction. “Stantec tries to minimally change companies they acquire and incorporate the best parts,” says Texas-based MWH Vice President David Irvine. Stantec’s state footprint, which had been about a dozen staffers, now numbers about 700, he says.
Fresh from its epic $1.5-billion purchase of Parsons Brinckerhoff in 2014 and looking to boost its presence in the U.S. health-care market, Montreal-based WSP approached much smaller Dallas designer CCRD through its existing U.S. arm. At first, the 225-person firm was not interested, says former CEO Rick Rome. However, “our younger ownership wanted opportunities with a larger organization,” he notes.
The group is working on a 1.5-million-sq-ft hospital in China, a project it would not have been able to secure before the purchase. Integration into WSP, a 36,200-employee global giant, was initially a shock, says Rome. “Things got better as we were able to spread the message,” he says. The year-long transition included adjusting to the rigid structure of a publicly held parent. “It’s the thing we knew we needed, but it is sometimes frustrating,” says Rome, noting loss of “some autonomy and light-footedness.”
But with less focus on ownership details, “we are able to focus on what we do best—projects,” he says. “It’s allowed me to be a better engineer.”
While 900-employee Thornton Tomasetti was three times the size of Weidlinger Associates Inc. when the two structural engineers struck a merger deal in 2015, Raymond Daddazio, the latter’s CEO and now TT president, says the firms had much in common.
Weidlinger had planned to obtain venture capital funding to expand its software business but, as a smallish firm, could not get investors. Instead, TT is making the investment under the firms’ merger deal as part of a new arm called Thornton Tomasetti Weidlinger Innovation Incubator. To date, it has spun off five companies, says Daddazio.
Over the years, other suitors “could not get beyond valuing Weidlinger as a professional services firm,” he says. “Only TT had the clarity of mind to value the intellectual property.” Working for a larger firm took some adjustment, but, “for the most part, bigger is better,” says Daddazio.
The experience may have eased the now-larger TT’s purchase of tiny 18-person niche firm Swallow Acoustic Consultants, completed in January. “Everyone is very happy. There is so much opportunity,” says John Swallow, its founder and now a TT principal. “Swallow has access to markets all across America.”
Now 70, Swallow calls the TT buyout his “exit plan,” which will provide his employees with a formal pension plan for the first time. “It means a lot to me,” he says.
Agreeing to become a part of 1,700-person design firm HOK in 2014 may have seemed daunting for 200-employee 360 Architecture, but the deal was facilitated by long ties among the firm principals.
According to 360 former President Brad Schrock, HOK was well managed and profitable, while the intended parent considered 360 creative, entrepreneurial and aligned in a very specific niche. As a sports design specialist, observes Schrock, “we were a fresh market for HOK,” which had been out of that sector for several years. Bill Johnson, another former 360 owner, admits some clients were confused by the change. “We had a lot of explaining to do,” he says. Johnson advises industry peers that “you can never think about transitioning your practice soon enough.”
On June 30, Kalamazoo, Mich. parking consulting and structural engineering firm Carl Walker Inc. merged with West Palm Beach, Fla.-based design, planning and surveying firm WGI. Carl Walker president and CEO, Gary Cudney, who will serve as senior vice president of WGI, says the deal allows his firm to focus on core services while benefiting from WGI’s capabilities in marketing, business development, IT, HR, and recruiting. “The merger provides greater resources to navigate our ownership and leadership transitions that were to be upon us within a few years,” Cudney says.
The two firms are considering cross selling services such as parking consulting and transportation. “The parking industry is becoming more integrated with the overall transportation and planning sectors,” Cudney says, “joining a large and successful firm with these diversified services makes sound strategic sense.”
Robert Agbede, CEO of Chester Engineers, agreed in March to merge his Pittsburgh firm into Ontario-based Hatch Group, a deal that restores a U.S. water-sector presence in the Canadian firm since it dissolved a joint venture with Mott MacDonald last year.
“While Chester has done very well expanding our footprint in recent years, sustained incremental organic growth can be difficult for midsize engineering firms,” he says. “There comes a time when other options must be considered,” says Adbede, now Hatch vice chairman and former sole owner of what became the largest African-American-owned U.S. design firm.
“Chester’s long history in water and environmental engineering connects well with Hatch’s urban solutions, digital operations and P3 advisory capabilities,” says Agbede. The link now offers Chester’s 200 staffers employee ownership and provides a larger platform for Agbede, who grew the firm out of minority-business-enterprise status, to mentor other minority-owned design firms.
Designers that choose to stay independent say a shared commitment to preserve a firm’s legacy for future generations is a strong profit motivator. “We’re not driven by a fiscal model,” says transportation engineer VHB’s CEO Michael Carragher. “About 25% of employees own VHB, and as a generational company, our responsibility is to leave it in a better condition than we found it. We’ve been able to do this while still being profitable.”
Environmental engineer OBG is moving to grow itself as an acquisitor, having learned from past mistakes. “We made a smaller acquisition many years ago that did not deliver the results we expected,” says Senior Vice President Tim Barry, manager of its growth strategy. “In hindsight, there were strategic and cultural miscues.”
Buy-and-sell inquiries to the $125-million-revenue firm—what Barry terms the “industry effect”—now are analyzed in a new business process, called “Checking Our Progress and Adaptive Changes.”
That process enabled the so-far more successful purchase in early 2017 of Natural Resource Technology, a 75-person environmental engineer in Milwaukee. Firm President Laurie Parsons, now an OBG senior vice president, says NRT already was engaged in internal succession when OBG approached. “We took a measured amount of time getting to know” the intended parent. Managers who had joined NRT after other firms’ buyouts offered tips. “We listened and learned from these people,” she says.
But independents doing their own acquisitions can make mistakes. “There’s a belief you can purchase a firm and improve it because we’re all engineers,” says Gerry Salontai, an industry consultant and former CEO of engineer Kleinfelder. “That’s proved difficult.”
Target Engineers CEO Raj Rangaswamy says his firm chose private-equity investment to fuel its growth in a 2016 deal with Keystone Capital for a 65% share. For Target, a 160-person construction inspection firm, to grow at the same pace it has since 2000, “we needed financial strength,” he says, ruling out the options of an employee stock-ownership plan or a buyout.
Both mechanical engineers with MBAs, Rangaswamy and his partner own 30%, and other managers own the rest. P/E ownership “reduces our financial risk, and we still run our operations,” he says. “Whatever our culture was before, it’s the same now.”
With P/E firm involvement often just a few years and with high expectations for a return on investment, Rangaswamy understands peers’ reluctance to go this route.
But he claims his financial reporting to Keystone is little different than reporting to banks, and the P/E has been key in vetting prospects for an acquisition Target hopes to make in the next six months.
P/E firm interest in the AE sector has grown in recent years, “given its consistent growth track record, low capital needs and firms’ staying power,” says EFCG’s Avelini. But he admits deals have failed for firms with too much debt, a lack of “business acumen” or where investment was insufficient, forcing a search for a new partner.
Carollo Engineers isn’t shy about describing itself as fiercely independent—it’s actually a key part of the firm’s business plan. The California company, which reported $247 million in revenue last year, is a regular target of some of the largest industry acquisitors. But CEO B. Narayanan says not being one is a strategic advantage, as is its water sector-only focus.
Most of its larger competitors are diverse firms, serving multiple sectors. Being a privately held sector specialist “allows us to take a really long-term view of the water market [without] all the distractions,” says Narayanan. “Our clients don’t need to worry that if a market gets hot, they will be abandoned. Our employees know the same thing. That’s a strong strategic alignment.”
Narayanan says Carollo is focused on ownership transition, making sure it never gets “too top-heavy. That takes a lot of planning,” he says. Equally key is to ensure that the financial incentives “are aligned in a way that there’s never a reason for any group of firm owners to say we could make so much more if we sold,” he adds.
The firm also hammers home the value of independence to its owner groups, emphasizing that “the company is not ours to sell. No one wants to be the one who pulls that trigger,” Narayanan says.
Good bottom-line numbers help. When many water-sector designers saw single-digit growth, Carollo has grown by 15% to 20% annually. “Everything works when the company is successful … and people are happy,” he says. “We spend a lot of time worrying about that.”
California-based environmental-sector consultant Dudek also has devoted a lot of time to that challenge and to preserving a unique culture that CEO Frank Dudek says has generated a 13.5% average revenue growth over the past 30 years for the firm.
Says a staffer, “Board surfing is a big part of our employee culture, and Frank is a bodysurfer.” CEO Dudek says that, with an annual growth goal of just 10%, “we can maintain the high quality of services while maintaining our firm culture.”
Dudek says the firm’s “upside-down” organization has project managers and practice leaders functionally at the top, aided by company officers, support staff and board directors. “We’re careful in choosing outside board members who are not promoting build and sell,” he says. “We don’t know how this would work under another management philosophy and aren’t motivated to find out. I doubt we’d achieve the numbers we do with outside management.”
According to Dudek, “The right people to us are capable practice builders and PMs, not business managers or corporate organization chart-box fillers.” The firm’s goal has been “to repeatedly achieve upper-quartile profitability to fund investments, growth, benefits, retirements and operations,” says its CEO. The firm added to growth through small acquisitions. Says Dudek, “We’ll offer a fair price, but we’ll never be the high bidder in a competitive market.”
Fort Worth, Texas-based engineer Freese & Nichols also has spurned all M&A offers, which Chairman Robert Pence says averaged two to three a month in a recent year. With 2016 revenue of about $106 million, the firm considered selling itself in the 1990s, “when the industry was in a frenzy of consolidation,” he notes, adding that experts warned that midsize or smaller engineers risked being downsized. “We spent a year dancing with a large national firm, and the results were devastating,” says Pence. “It was our worst year financially, and staff was in turmoil the entire time.”
The inward focus since has included operational changes that earned Freese & Nichols a Malcolm Baldrige Quality award in 2010, the first and, so far, only engineer to win the prestigious U.S. Commerce Dept. recognition. He also cites profits “in the upper quartile, year over year.”
In tackling ownership transition, the firm limits the number of shares each shareholder can own and is adding new owners annually, “which will avoid future peaks,” says Pence. In a leadership competition that boosted 25-year veteran Brian Coltharp to CEO in January, all internal candidates remained at the firm—the same outcome that has occurred twice before in the past 15 years.
North Carolina design firm McAdams also relishes its independence, despite being approached by numerous “1,000-plus-person, super-regional” engineering firms seeking to buy it, says CEO Mike Munn. He says McAdams has “always declined even having discussions” with suitors.
The firm is in its seventh year under second-generation leaders who “enjoy and even thrive on running the business aspects. Munn says, adding that an M&A deal is not in the picture. “We know that what we have created is rare, and it fits us well,” he says.
Likewise, Idaho-based POWER Engineers Inc relishes the success independence has brought. “It’s important to understand that POWER does not have financial growth goals,” says new CEO Bret Moffett. “What we have instead are goals to grow opportunities for our people.”
He claims that focus “has led to excellent financial results” for the firm, which posted close to $400 million in 2016 revenue. “Looking back on our strategic plans for the past 10 years, nowhere does it state we’re building our firm up to sell it,” says Moffett.
Looking ahead, architect Cho says it will take continued effort to ensure that her firm and its new parent continue to mesh well. She says listening to younger employees and letting them step forward is crucial.
For independently-minded engineer MKA, CEO Klemencic says the path is clear. “With natural attrition and replenishment of the staff, a strong and stable practice is possible, ” he says.