Do you own an engineering business or are looking to acquire a consulting company? Then you should consider getting a valuation of your engineering firm.
First, here are some interesting industry statistics and company valuation tips:
Private engineering firms are a typical professional service business. Moreover, there are some 58,300 engineering firms classified under SIC code 8711 and NAICS 54133 in the US. But fewer than 8% have more than 25 employees.
The engineering consulting industry as a whole generates over $208B in annual revenues. Yet the average engineering company does about $3.5M in gross revenues annually and employs a staff of 17. And revenue per employee is about $211,000.
Privately owned engineering companies fall under a range of disciplines. Here are the most common ones:
- 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 services is highly fragmented. The top 4 consulting firms account for about 15% of the industry revenue. Most engineering companies are locally owned and operated. They address the needs of specific market niches in their target geographies.
Professional engineering license requirements tend to limit competition. They also contribute to relatively consistent billing rates and stable business earnings across the industry.
Multiples for engineering firm valuation
Professional appraisers value smaller firms with gross annual sales under $10,000,000 on their earnings. You will often hear about the seller’s discretionary cash flow, also known as seller’s discretionary earnings (SDE). The pros use the business sale price to gross revenues as the second most common multiple.
- Business sale price to net sales
- Sale price to gross profit
- Price to discretionary earnings
- Price to EBITDA
Engineering company value – cash is king
Interestingly, the historic coefficient of variation for the business selling price to EBITDA valuation multiple is almost 4 times greater than the discretionary earnings based figures.
Why is this important? Because the smaller coefficient of variation tells us that the valuation multiples based on discretionary cash flow tend to fall closer to the mean. So the skinny bell curve means you can estimate your engineering company’s fair market value better with this multiple.
This points to the need to adjust your engineering company’s financial statements. Because it helps you establish the business earning power – typically based on the cash flow, not the accounting profits.
Other business valuation methods for engineering firms
Depending upon your business valuation needs, you may decide to use specific appraisal methods.
What is your business goodwill?
Equally important, you may need to separate the overall goodwill into the personal and business goodwill parts. The personal goodwill belongs to the skilled employees and owners as individuals. On the other hand, the company itself creates business goodwill. And this is highly transferable in a business sale.
Valuing an engineering firm based on its cash flow
Consider using the Discounted Cash Flow method when valuing a young or rapidly growing engineering firm. For instance, the venture capital industry and business appraisal professionals prefer to use this method.
Do you need a precise, defensible business valuation of your company? Then the discounted cash flow valuation should be on your list of priorities.
Does the firm earn highly stable and predictable income year after year? You would do well to consider the Capitalized Earnings method in your analysis.
Earnings multiple valuation
Valuing a smaller owner-operator managed engineering firm? Consider using the Multiple of Discretionary Earnings method. Most importantly, the method offers a very intuitive link between the business earnings, key financial and operational performance factors and business value.