Do you own a small engineering firm or are looking to acquire a consulting company? Here are some interesting industry statistics and company valuation tips that you may find useful:
Private engineering firms are a typical small professional service business. Of some 58,300 engineering firms classified under SIC code 8711 and NAICS 54133 in the US, fewer than 8% have more than 25 employees.
While the engineering consulting industry as a whole generates over $208B in annual revenues, the average engineering company does about $3.5M in gross revenues annually and employs a staff of 16 to 17. Revenue per employee is about $211,000.
Privately owned engineering companies cover a number of disciplines, the most common being:
- Civil and structural engineers
- Mechanical engineering and industrial automation
- Electrical engineers
- Environmental and chemical engineering consultants
- Information technology services and systems engineering
The market for engineering service businesses remains highly fragmented with the top 4 consulting firms accounting for about 15% of the industry revenue. Most engineering companies are locally owned and operated and address the needs of specific market niches in their target geographies.
Professional engineering license requirements tend to limit competition and contribute to relatively consistent billing rates and stable business earnings across the industry.
Valuation multiples for engineering companies
Smaller firms with gross annual sales under $10,000,000 are typically valued on their earnings, most often seller’s discretionary cash flow. Business sale price to gross revenues is the second most common formula multiple used in valuing an engineering company.
- Business sale price to net sales
- Business sale price to gross profit
- Business sale price to discretionary earnings
- Business sale price to EBITDA
Engineering company value – cash is king
Interestingly, the historic coefficient of variation for the business price to EBITDA valuation multiple is almost 4 times greater than the discretionary earnings based figures.
Why is this important? The smaller coefficient of variation tells us that the valuation multiples based on discretionary cash flow tend to cluster around the mean. You can estimate your engineering company’s fair market value with greater precision if you use such valuation multiples.
This points to the need to adjust your engineering company financial statements in order to establish the business earning power – typically based on the discretionary cash flow, not the accounting profit multiples.
Other business valuation methods for engineering firms
Depending upon your business valuation needs, you can resort to a number of standard business appraisal methods. For established engineering companies the value of business goodwill may be considerable. The Capitalized Excess Earnings business valuation method is an excellent choice for valuing such companies.
Equally important, you will need to separate the overall goodwill into the personal and business goodwill parts. While the personal goodwill is generated by the skilled employees, the business goodwill belongs to the company itself, and is highly transferable in case the business sells.
The Discounted Cash Flow business valuation method is the usual choice when valuing a young or rapidly growing engineering firm. This method is widely used by the venture capital industry and requires no introduction when talking to business appraisal professionals.
If you require a precise, defensible business valuation of your company, the discounted cash flow valuation should be on your list of priorities.
If you are valuing a smaller owner-operator managed engineering firm, consider using the Multiple of Discretionary Earnings method. The method offers a very intuitive link between the business earnings, key financial and operational performance factors and business value.