High Performance Ownership: employee owned Architecture, Engineering & Construction firms command higher valuations

By Trevor Gilmore

Zweig Group’s recently released 2019 Valuation Survey of AEC Firms highlights an important trend in employee ownership performance. Zweig focused on nationwide AEC firms – i.e. architecture, engineering & construction firms, of all sizes. From a valuation perspective, firms with employee stock ownership plans (ESOPs) performed better than non-ESOP firms in five of the six valuation ratios for the years 2016 through 2018. Some key highlights:

ESOP firms have a median value per employee of $89,000, compared with $69,136 for non-ESOP firms ( a 30% premium)
ESOP firms command higher median EBITDA multiple – 6.67x versus 3.51x for a non-ESOP firm (a whopping 90% premium)
ESOP firms outshined their non-ESOP counterparts in these three valuation metrics: value/net revenue, equity value/profit and equity value/book value ratios.
The only metric where non-ESOP firms outperformed ESOP firms was the value/backlog metric – which was .66 and .64, respectively. The difference is arguably immaterial.

Why do ESOP AEC firms command a higher valuation than their non-ESOP peers? Especially when you consider the future share repurchase burden? Two things come to mind: (1) efficiency/productivity gains and (2) the ESOP tax shield. The broad-based employee ownership under an ESOP will motivate a firm’s main asset, its staff, to work smarter. Working smarter usually equates to higher profits over time. The tax shield is a boon for cashflows – since most employee owned AEC firms are organized as S corporations, their income is passed through to the tax-exempt ESOP shareholder – which means the company is essentially exempt from federal tax. Increased cashflows can be used for acquisitions, growth, reinvestment, share repurchases, and so on.

*According to the Zweig Group, ESOP AEC firms command a higher valuation than their non-ESOP peers*

Are we thinking too binary here – is there a better AEC ownership structure out there beyond the ESOP vs. non-ESOP dialogue? The combination of broad-based equity and great tax efficiencies drive higher employee performance which in turn drive higher values makes a compelling case that an ESOP is the ideal structure.

Trevor Gilmore is the Chief Financial Officer of The Menke Group

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