Engineering Firm Valuation: Multiplier, Methods & FAQs
The engineering firm valuation process is nuanced and complex, with many factors affecting the final value. So, what valuation methods should you use? Can you calculate the value of the firm yourself?
In this article, you'll learn the typical multiplier for engineering firms and how to value your firm for the highest possible return on your investment over the years.
You'll also learn how we can help you with your engineering firm valuation to maximize your exit value and save you the hassle of going through the detailed M&A process alone, which can be devastating if it goes wrong.
Let's get right into it!
TL;DR - How to Value an Engineering Firm
You can value your engineering firm in different ways, including applying financial multipliers and an industry-specific rule of thumb.
For example, you can apply an industry-typical multiple to financial metrics such as the SDE, EBITDA, and revenue.
The typical multiplier for engineering firms is 3x—5x the seller's discretionary earnings (SDE), and this multiple is even higher for fast-growing firms with a substantial market share or position.
Suppose you prefer using the net or effective labor multiplier option. In that case, the typical valuation multiple for a high-performance engineering firm is 3.0 or higher, and some companies can go up to 3.5 to 4.0 or more.
We will discuss these figures further in the following sections.
If you are already scratching your head over this and can't wait to sell your company without balding yourself, consider hiring M&A advisors to help you determine your company’s value using different methods.
Connect with us today, and we'll help you hire the best M&A team for your exit.
Factors Affecting the Valuation of Engineering Firms
Some of the key factors that affect how much your engineering firm values include:
1. Niche Market and Market Share
The value and valuation of your engineering company depend heavily on the type of market you serve and the share of that market you command.
For example, according to First Page Sage, chemical consultant firms typically command higher multiples of 6.5 to 9.1 based on their EBITDA ranges. On the other hand, environmental engineering firms attract lower multiples between 4.1 and 6.8, depending on their EBITDA ranges.
2. Location of Operation
Since different states have different business growth rates, engineering firms in the same market line value at different levels.
Similarly, if you operate in an area highly populated by your target customers, you will receive more constant business, which means your firm's value will increase.
3. Quality of Your Workforce
Engineering firms rely heavily on specialized and highly skilled employees who are highly efficient and offer excellent project management.
For example, your firm is more valuable if your employees have professional licenses and certifications from accredited industry bodies.
4. Diverse Income Streams
Suppose your engineering firm offers services like testing, logistics, transportation, designing, consulting and advisory, planning, and physical execution of projects to diversify its income sources. In that case, you may score a higher valuation.
5. Eco-friendliness/Environmental Responsibility
There's a growing concern about preventing, causing, and managing environmental damage. If your firm is eco-friendly and on good terms with its community, it has a chance of a higher valuation.
6. Key Partnerships
Your engineering company exists amongst other companies or businesses. Cultivating partnerships with key industry players such as local, national, and international governments raises your firm's value.
7. Equipment and Technology
You are worth more if you have up-to-date, high-end equipment and technologies because they increase work safety and operational efficiency.
8. Public vs. Private Company Status
It is much more challenging to determine the value of a private company since, to some extent, there's no “market" that determines the price of its shares.
On the contrary, a public company selling its stock on the stock market has a market for its shares, which determines the price of each share.
Preparing Your Engineering Firm for Valuation
You need to prepare your engineering firm to achieve the best possible valuation through strategies such as:
1. Optimizing Finances
Increase revenues through more sales or diversifying income streams while reducing costs to increase profitability. If the firm is more profitable, it can attract more potential buyers.
Additionally, ensure the firm's financial records for the last 3-5 years are accurate and updated. Prospective buyers will want to see that your company is financially healthy and compliant.
2. Optimizing Operational Efficiency
To increase profitability, you'll want to streamline major processes and take cost-saving measures. For instance, you can automate manual administration tasks using digital software.
Alternative construction and design solutions, such as eco-friendly technologies, can also make the firm more efficient.
3. Reviewing All Assets and Liabilities
Even as you present updated balance sheets, identify all your company's tangible assets, such as real estate, vehicles, and equipment.
If you have intangible assets, such as brand reputation and intellectual property, consider them as well.
You should also determine the amount of liabilities, such as debt and accounts payable.
4. Conducting Company and Market Research
Research and understand the history, weaknesses, risks, strengths, and the firm's growth potential.
You can also analyze market conditions for buyers, trends, and competition.
Understanding these makes it easier to explain your valuation to potential buyers.
5. Preparing a Business Plan
If you don't already have one, make a detailed business plan showing your business goals, vision, and strategy. If you already have a plan, update it to reflect your firm's current planning reality.
The plan will help align the valuation with your business's goals and attract more serious buyers who have a similar vision.
6. Reviewing Agreements and Contracts
Evaluate existing agreements and contracts with suppliers and employees for potential issues that could impact the firm's value.
For example, you should ensure they are transferable to the new owner.
How to Value an Engineering Firm
You can value your engineering company in different ways:
1. Valuing an Engineering Firm by SDE Multiple
Value of the company = SDE x Multiple
For example, if the multiple is 3.0, and the SDE is $800,000
Value of the company = $800,000 X 3.0 = $2,400,000
2. Valuing an Engineering Firm by Revenue Multiplier
Value of the firm = Multiple x Total annual revenue (total sales income in the last year)
For example, if the revenue is $5,000,000 and the multiple is 1.5
Value of the firm = $5,000,000 x 1.5 = $7,500,000
3. Valuing an Engineering Firm by EBITDA Multiple
Value of firm = EBITDA x Multiple
For example, if the EBITDA is $9,500,000 and the multiple is 4.1X
Value of the business = $9,500,000 x 4.1 = $38,950,000
At Exitwise, we understand these numbers can be intimidating, and you need all the help you can get to understand these calculations.
We can help you hire and manage an awesome team of M&A experts, including accountants, corporate attorneys, investment bankers, and wealth managers, who can smoothen the valuation process and complete it relatively swiftly.
In the meantime, you can use our handy valuation calculator to understand your firm's purchase price better.
What is the Typical Multiplier for Engineering Firms?
As mentioned, the typical multiplier for engineering firms against the seller's discretionary earnings (SDE) is 3x—5x.
However, the SDE multiple isn't the only way to determine the value of a business. You can also use the EBITDA, revenue, and labor multiples according to the following data from First Page Sage.
EBITDA: The typical EBITDA multiplier for engineering businesses is 4.1x—9.1x, depending on the firm's EBITDA range.
EBITDA multiples are typically lowest in environmental engineering firms (4.1x—6.8x) and highest in chemical consultancy services (6.5x—9.1x).
Revenue: The typical revenue multiple for engineering companies is 1.5x—2.8x, depending on how much revenue the firm makes and the type of engineering it does.
The lowest revenue multiples are seen in environmental engineering firms, typically between 1.6x and 2.1x.
It's important to note that the EBITDA multiples method is much more common than the revenue multiple procedure.
The EBITDA method shows a company's return on investment and is more reliable for its insights into potential future incomes.
Labor Multiplier for Engineering Services
The labor multiplier or net multiplier is a common valuation strategy for engineering firms, and it typically ranges between 2.75 and 3.25.
It is the ratio of a firm’s net operating revenue (income) to its total direct labor and indicates its profitability.
Labor multiplier = Net operating revenue/Total direct labor, where;
Net operating revenue is income minus the operating expenses, but before you deduct the taxes and interests.
Total direct labor is the cost of all the personnel involved in production but not those in support services, maintenance, and administration.
Labor multiples are crucial in the engineering sector because labor is usually the biggest cost for service-based firms and is considered an investment.
According to Deltek’s 43rd Architecture & Engineering Study, firms with a net multiplier of 3 (the median) and above are high-performance companies. Some even attain between 3.5 and 4.0 net multiples.
Engineering Firm Valuation Rule of Thumb
There are many schools of thought regarding engineering firm valuations. According to Deltek, the most common rule of thumb is that engineering businesses are valued at 45% to 60% of their yearly net revenue.
But it’s important to note that since most of these rules of thumb ignore each firm's singularity and uniqueness, you should only use them as a starting point and check other, more detailed valuation procedures.
Importance of Accurate Engineering Firm Valuation
Here are the top benefits of valuing your engineering company accurately:
Strategic Planning and Value Improvement: A proper valuation helps you understand your company's worth and identify areas for maximizing business value and growth.
Setting Best Sale Price: If you overprice the firm, it could scare away potential buyers. If you underprice it, you will be leaving money on the table. With accurate valuation, you don’t have to worry about either.
Attracting the Right Buyers: Prospective buyers will be more confident and trusting if they see that you understand your business well and can justify your valuation report and asking price.
Risk Mitigation: The valuation can reveal risks and challenges that could discourage potential buyers. You can address these before the sale deal.
Partner with Exitwise for a Higher-Value Exit
Valuing engineering firms can be complicated for business owners and their internal teams.
At Exitwise, we can connect you with the best M&A experts in the engineering industry to help you value your firm accurately.
These experts include finance accountants, investment bankers, and M&A lawyers. Besides helping you value your company, the experts can also help you sell your firm under the best possible terms.
Reach out to our team today so we can help you build the M&A team of your dreams for a detailed valuation and optimal exit.
Frequently Asked Questions (FAQs)
Below are some common questions about this topic.
How Long Does the Engineering Firm's Valuation Process Typically Take?
A basic valuation can take a few days, while a detailed one can take several weeks or months.
The duration can vary significantly depending on your company's size and complexity, your preparedness for the process, and the complexity or depth of the valuation.
What Financial Documents Are Needed for an Engineering Firm Valuation?
You'll need the following documents to provide a comprehensive overview of your firm's financial health:
Profit and loss statement to show revenue, expenditure, net income, and profitability.
Balance sheets to show assets, equity, and liabilities to understand net worth and financial position.
Tax returns and records to confirm the accuracy of financial statements and show compliance.
Cash flow statements to track cash moving in and out to show liquidity and operational efficiency.
How Do Multipliers Vary Across Different Types of Engineering Firms?
As we have seen, multipliers vary across different types of engineering firms depending on the discipline.
For instance, currently, environmental firms typically have the lowest multipliers for EBITDA and revenue ranges. You ask why. You'll be surprised that not many people are passionate about solving our planet’s health problems.
Chemical consultant firms and civil and structural engineering companies have very high valuation multipliers. The main reason is that they are evergreen, always-in-demand firms.
How Do Industry Trends Impact Valuation Multipliers for Engineering Companies?
Industry trends that raise the valuation multiples for engineering companies include robotics and automation, augmented reality, artificial intelligence, the adaptation of the Internet of Things, and invisible governance.
For example, artificial intelligence is all the rage now, and engineering firms that adopt AI to increase efficiency and cut costs can experience a significant rise in value.
What Is the Difference Between Revenue and EBITDA Multipliers for Engineering Firms?
Revenue multipliers are a simple way to determine the value of an engineering firm, though this simplistic nature makes them a less preferred method.
On the other hand, the EBITDA method is more common because it considers a firm's return on investment and sheds light more clearly on the future earnings to expect.
With revenue multipliers, you must look at the firm's revenue streams to track its cash inflow patterns. For example, cash inflow from recurring revenue can help you forecast revenue with high certainty.
While EBITDA measures a firm's cash flow, it considers other aspects, such as equity and debt.
EBITDA also helps an outside buyer see your firm's profitability, plus its ability to repay its outstanding liabilities (including principal and interest) in any given year.
How Can Engineering Firms Increase Their Valuation Multiplier?
As a business owner, you can employ different methods to increase your firm's valuation multiplier, including adding more revenue.
For instance, here are some measures you can take to increase your company's revenues:
Leverage low-hanging fruits in your existing market
Adjust your rates or billing structure to pay off all costs and leave enough space for an ample profit margin.
Another crucial way to increase your firm's multiplier is to embrace industry trends. For instance, you can ride the Internet of Things wave by increasing your online presence.
Additionally, a firm with a good website reaches a broader audience, gains more trust or credibility, and receives more referrals, all of which raise its value.
What Are Common Pitfalls in Applying Multipliers to Engineering Firm Valuations?
The main pitfall to using multipliers in engineering firm valuations is failing to recognize that every firm has unique individual characteristics.
Even though the multipliers account for different crucial factors, they are a blanket phenomenon that may disfavor a certain firm.
For instance, the multipliers may not correctly capture intangibles, which are critical since engineering firms usually have fewer tangible assets but rather tie up most of their value in personnel, goodwill, management, and client relations. Some intangibles like goodwill may be overlooked.
Additionally, valuation multiples do not guarantee excellent performance or outcomes, and your buyer may entertain second thoughts on the purchase even when the valuation shows potential for massive growth and profits.
Finally, valuation multiples change based on other vital factors, such as the state of the industry and the general national economic outlook, meaning you have to keep determining your multiples. Repeated valuations can be expensive and time-consuming.
Conclusion
Mastering engineering firm valuation multiples and methods is critical to profitability so you can get the maximum value when it's time to sell the company.
Since your buyer will also go through the valuation process and come up with a figure, it’s essential to schedule a call with our M&A advisor to find out how we can help you build the right M&A team to fetch the best possible profitability.
