Engineering Firm Financials

[jseng9]

I’m an entry level engineer at a medium sized structural engineering firm with about 12 principals. Before I spend 15-20 years trying to climb the ladder to an ownership position, I would really like to know what ownership typically looks like in private structural engineering firms.

I understand that the senior level staff get offered ownership positions if they are at the top of their game technically, have a good book of business (clients), and advance the firm both professionally and culturally. I’m sure there is a fair bit of politics involved as well.

However, what are the financials of ownership? How much does a prospective engineer need to invest in the firm, and how is that investment returned? Do principals get yearly returns on investment based on the shares they own and the profits made? And how does this fit in with profit sharing (at my firm the engineers are told that we get a percentage of the profits).

I've searched about this topic online and on the forum and the closest things I have found are articles on whether "it's worth it" for millennials to consider firm ownership or posts by people asking what you need to start up a firm (cash on hand to cover your first year, liability insurance, software licenses, etc. etc.). I really don’t know what it means to have ownership in the firm from a financial point of view so any information would be very helpful!

 

[BrianPetersen]

Be. Very. Careful.

I'm involved in this business, more on this later. First some basics.

A consulting firm, normally, is only "worth" as much as the people who work there ... or more specifically, the cash flow that those people bring in. When (not if) those people leave, count on a chunk of their cash flow leaving. The client list is perhaps worth something ... but you're only as good as your last completed job. Companies like this normally have very minimal hard assets that are "worth something". Office space is usually rented, maybe the company owns a few laptops and printers and the like. Essentially the company is worth nothing, it's just a cash flow generator.

In a previous life, I worked at a consulting firm where the owner got the idea that people would work harder and be less likely to leave if they had a stake in the company. I crunched the numbers that were presented to me, and a group of the employees to whom this offer was expected to be presented to (smaller company than yours) met to discuss it (obviously without the owner present). The unanimous opinion was "nope".

I ended up leaving that firm. I now work at another engineering firm which is even smaller than that. Owner has a different attitude and isn't interested in raising cash and selling the company. We just want to pay the bills and have less stress. I am fine with that. We operate as if the company is worth nothing. We don't go into debt, we don't finance stuff beyond current corporate credit card accounts. Maybe we're not destined to become a major multinational consulting firm. We also can't go bankrupt because we have no debts. I am totally fine with this, and it will allow me to smoothly blend into semi-retirement and part-time work in the not too distant future.

Maybe some financial wizard would consider my existence at this company to be "worth" some multiple of the cash flow that I historically bring in. You can rest assured that if I were hypothetically offered some such number as some part of a deal involving said financial wizard buying the company, I will be exiting stage right and buying a property someplace where it doesn't have winter, and never working again!

Perhaps it's different if the company in question becomes huge. But being huge brings its own share of headaches which none of us want any part of.

All I'm saying is ... be very careful.

 

[Agent666]

I've been at two places which offered shareholding with completely different models. Every place will be different, many will be secretive about the exact details of profits etc, as clients like to think they are getting value for money rather than finding out they are being fleeced.

Place 1 - Large multinational multi-disciplinary consultancy (~3000 staff internationally)
This place had a long history of employee ownership and were 100% employee owned since its inception (maybe 100 years ago). Once employees reached 'Senior engineer' status they were offered the option to purchase a limited number of shares (about $10k worth), every few years more were offered with the option to buy or not. Great return on investment, think along the lines of double your money every two years or so based on share splits and dividends based on distribution of some portion of the profit. I left about 2 years after investing in the shares. But one thing was certain for certain people it became a blessing and a curse, on one hand great dividends to boost the slightly lower than average pay, on the other hand some people definitely had the golden handcuffs on and despite all the bad stuff going on around them (this was during the GFC) they felt obliged to stay due to the returns and money they invested (when compared to the alternatives of starting on a salary somewhere else, or being jobless). I did feel that the model felt like they looked after the shareholders more than the staff just on a salary, in fact things like reduced bonuses for staff were commonplace even after making record profits through the GFC, but shareholders reaped the rewards of the record profit, not the staff that helped achieve them.


Place 2 - Small structural only consultancy (~40 staff nationally)
This place was moving into a shareholding model, and had been talking about it before I even joined. After several years there, and with one of the founder reaching retirement they had a valuation undertaken, had assets of ~$200k from memory, but they valued it at $6M for many of the reasons Brain noted. They offered something like 5% of one of multiple sub-companies for I think about $200k to selected people, the way I believe the profit share worked was it would take about 6 years to break even from the initial investment. I think only one person took up the initial offer and he wasn't exactly the cream of the crop material. The whole process was very secretive, there was no announcement or anything of the shareholding. People sort of deduced the fact that this person was a shareholder via other means quite a while later. Buying in basically meant you had no management rights though, so you sort of had zero influence in improving the company as a whole. Seemed like it was a knee jerk reaction by the second founder to the fact that the first was retiring and he needed help to run the business and hadn't really done any succession planning. I left shortly after as I couldn't stand some of the direction things were going and the fact that if I was to buy in I'd want things to go in a different direction and embrace changes, really couldn't see myself wanting to be there if it took 6 years to break even either. I think in the background they were looking to sell the entire thing and just get out of it with $6M. The motivation of the company should factor into any decision making. I felt like if they sold it, half the staff would simply walk out of the place as they had nothing invested, nor did they want to invest.

 

[jseng9]

Hi Brian, Agent 666. Thanks to both of you for the insight. This is helpful advice.

 

[GeoEnvGuy]

However, what are the financials of ownership?
Every firm is different from what I gather you are in an employee share ownership plan firm with 12 principals it is unlikely anyone owns more than 30% of the company individually but two to 3 older principals may have a 50% stake in the company with newer shareholders splitting up the remainder. Depending on the way its structured shares are valued based on EBIBT, book value, revenue or some combination. A study in geotechnical business polled 112 firms and found that shares valued according to the book value of the company have a median of 1.5 x book value with some firms less than 1 and some more than 3 times.

How much does a prospective engineer need to invest in the firm, and how is that investment returned?
Depends on if shares become available to buy by exiting shareholders or if they are willing to dilute the shares, if you were to buy 5% of the company you could be spending median 1.5 times the book value to achieve that level.

Do principals get yearly returns on investment based on the shares they own and the profits made?
Working principals get a salary then profits are then allocated to shareholders, reinvested, Christmas bonuses, or saved in the bank. This is typically determined by the accountant providing options and the share holders voting. If your new as a shareholder the allocation of profits (if any that year) is usually the same every year.

And how does this fit in with profit sharing (at my firm the engineers are told that we get a percentage of the profits).
Example if your firm made $100 profit they can allocate $20 to the bank, $40 to reinvesting in strategic goals and $40 distributed to the shareholders, this would give a 10% shareholder $4 that year. If the principals allocate a mass share plan to employees such as making a thousand or hundred thousand shares available to employees with the caveat of being 10% of the company if you owned all of this class of share a 0.1% ownership holder who bought 1 of 1,000 or 100 of 100,000 shares would get four cents.

The first stage of site investigation is desktop and it informs the engineer of the anticipated subsurface conditions. By precluding the site investigation the design engineer cannot accept any responsibility for providing a safe and economical design.

 

[KoachCSR]

I've had some limited experience in this arena, as well - two very different companies with two very different models.

First company - Privately owned by a group of owners, which managed their own respective clients or regions - The model for this company was that when an owner retired, his or her stake was bought out by a pre-approved successor (pre-approved by the remaining owners, that is). In reality, those owners who had been around for a while ended up with shares that became quite large and it became common for two or three new owners to buy-out a retiring one. I witnessed this model begin to dilute the ownership as a result during my tenure there, and the quality of executive leadership was noticeably affected.

My current company - ESOP - My current company is employee-owned through an ESOP which is heavily regulated by federal law. There's a significant level of checks and balances in place to keep everything above board and open. I would highly recommend a properly managed ESOP company to anyone.

 

[canwesteng]

Agent666.... Does firm 1 happen to start with an H by chance?

 

[cvg]

I would highly caution buying into an ESOP for a privately owned company. I was a casualty of an ESOP implosion at a previous company. Luckily I had not purchased the stock, but the company had to shut down entirely because of it.

you need to know 1) who is on the board and 2)the contractual details about cash payouts to stockholders (when they quit or retire) as a "run on the bank" can crash the stock price and take down the company entirely.

 

[Agent666]

Canwesteng, no sorry.

 

[glass99]

cvg: what happened with your "run on the bank"? Did everyone want to sell their stock at the same time? What precipitated that?

 

[cvg]

summary
51 / 49 merger between company A and B
corporate mgmt takeover by controlling stockholders in company B
management from A were fired/demoted/retired/unhappy and left
company A stockholders demanded stock buyback when they left
ESOP allowed for immediate buyback
company / stockholders ran out of money
stock price went to 2 cents
disgruntled employees of A quit and formed company C
company AB shut doors

 

[WinelandV]

Holy buckets, cvg!

Now for the obvious question: No one in the management of companies A or B saw this coming? I mean... if you're going to take over, surely you might think those being taken over might not want to stay, maybe?

 

[BrianPetersen]

Makes me like our business model even more. (see post #2 in this thread ...)

We're worth nothing. And we're good with that. Someone wants to buy us out? I take the money and run and never work again.

 

[cvg]

it was nearly a 50-50 merger, nobody viewed it as a "takeover" in the beginning. However, there must have been some back office drama that I was not aware of. the last straw was when the president of company A was fired and president of company B moved in to the corner office. that tended to ?iss off a lot of the loyal A employees.

 

[Rabbit12]

cvg, I just left an ESOP company and I can sort of see your scenario coming with that company.

The staff breakdown is quite a few employees in the 15-20 year+ range and a lot of employees less than 5 years. The middle group is a lot smaller because they treat their employees more or less like crap by controlling costs to an annoying amount. I'm talking expecting free meetings over lunch if they buy a $5 sandwich, mandating most employees are 100% billable, not providing coffee, etc. They also lay people off the minute they aren't billable. That leads to an amazing amount of turnover in the lower end of service time.

I'm curious what will happen when most of the senior level employees retire and the company is on the hook to pay them all out. FWIW, the company is in the oil and gas industry and the stock price rose by double digits every year I was there, even during the oil price crash in 2015. They would literally do just about anything to protect the share price for the old guys.

 

[KoachCSR]

cvg - yours is certainly a valid warning and the reason I prefaced my glowing recommendation of an ESOP with the phrase "properly managed."

Rabbit12 - the federal law governing ESOPs provides stipulations that payouts to employees when they leave the company can be "metered", so to speak, to prevent a cash drain on operating capital. The law is intended to provide a safety net to prevent the type of situation you're describing - though it remains in the company's best interest to pay off the retirees expeditiously, as they will carry the "debt" of the pending payouts into their valuation for the next year if it's not resolved.