So many firm owners in our industry could do even better for their people and themselves, and build real value, if they were more entrepreneurial.
When you look across our industry at the tens of thousands of AEC firms that make it up, it’s clear that most of these professional services firms are not what one could consider truly entrepreneurial enterprises. Not to say that the majority of these companies don’t provide a very valuable service to their clients, provide solid jobs for their people, and make a decent living for their principals, because they do. But at the same time, so many of these firm owners could do even better for their people and themselves, and build real value that could help their families for generations IF they were more entrepreneurial.
As someone who has worked in and around AEC firms for nearly 44 years now, it’s clear to me the reason why more firms in our “industry” don’t act more entrepreneurial than they do is multi-faceted – but ultimately, it really comes down to one thing. Their owners aren’t sold on the benefits of doing so. And if the owners aren’t sold, the employees certainly aren’t going to be able to make it happen. The thought change has to occur at the top.
I have stated before on these pages that the primary distinction of an entrepreneurial venture versus a small business lies in value creation. The entrepreneurial firm owner is thinking long-term and not trying to maximize their annual extractions from the company. Instead they want to build the company such that there is an even bigger pot of gold when they decide to get out.
There are several implications of that, including:
- The firm HAS to be committed to growth because growth rate greatly impacts value. I have written before about the fallacy of historic EBIT multiples when it comes to valuing rapidly growing companies in this industry and others. All you have to do is look at the public markets to see what happens when revenue for any business is growing rapidly. Value multiples of EBIT go out the window. We have seen rapidly growing AEC firms be worth as much as three times annual revenue in a few external transactions, which is mind-blowing in light of the historic industry multiples of 50 percent to 100 percent of net service revenue. It was only because of their growth rate!
- Growth in revenue has to be seen as more important than maximizing profitability. Any company can make a 20 percent or 30 percent profit or better in any given year if they want to – but at what price? Cut all overhead functions and it isn’t hard. But what happens later? Growth will plateau. Entrepreneurial firms figure out that by maximizing their growth rate they also end up being more profitable than their peers anyway because their revenue is always growing faster than their overhead. It’s a great paradox, but believe me it’s real!
- There has to be a valuation methodology for the company in place that ties internal transaction value to the real market value of the firm were it to be sold externally. You can’t transact internal shares or ownership interest based on book value or a multiple of book value or historic EBIT when the real value of the company is going to be assessed using projected EBIT based on a certain growth rate. This is fundamental. Otherwise, there is not a connection between doing the things that maximize value because the incentives encourage a much less aggressive strategy.
- In order to grow at a faster rate than the industry, the company has got to make greater investments in people, marketing, and systems. Acquisitions will also probably have to be part of the strategy and practice. Just because these things take money directly out of potential short-term profits doesn’t mean they aren’t worth doing. They must be done in spite of that fact.
- In order to sustain growth, the company has to be continuously innovating and improving all it does, and bringing out new service offerings that differentiate it from the dozens of competitors it inevitably has. Innovation and “new” has to be baked into the practice and culture of the firm on a daily basis. It must be part of the business planning process for each revenue-generating unit in the firm, and management has to see to it that it actually happens and isn’t just something that gets done if there isn’t any billable work to charge time to.
These five things are fundamental to the entrepreneurial firm. It takes unanimity of the owners who must all understand the hows and whys of entrepreneurial management principles. Don’t underestimate the power of having even a single unsupportive leader. The good news is we have some really smart people who own the firms in our industry. They can “get it” IF they understand the logic. So explain it. Sell it. Talk about it until they all get it. The benefits of doing so can be enormous.
Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.