The business of architecture is considered a professional service. As far as business valuers are aware of, the majority of the architects do not treat their work as a business asset to be bought or sold.
The fair market value of an architecture company is largely dependent on its cash flow that allows for a good sum of remuneration to its employees and owners. Since there are hardly any tangible assets in a architecture professional services firm, goodwill becomes particularly significant in the business valuation process.
Goodwill in Architecture Company
Goodwill is the balance of the going concern value of a business minus the total value of its tangible and intangible assets. To simply put, goodwill is the latest financial value of the business’s expected future cash flow.
So when the future cash flow depends entirely on the reputation and abilities of a person or a team of people, then goodwill becomes a personal item that bears no commercially transferable value. A classic risk of such goodwill is the departure of clients with the person.
In reality, the goodwill in most architecture companies also includes the abilities of other architects and experts, and when customers do not depart with a leaving member then this goodwill is a considerable driver of the business value and bears a commercial value.
What Situations Warrant a Need for a Business Valuation:
1. When a member enters or exit the company
In such cases, there is a need to value the ownership interest according to the partnership or shareholder agreement.
2. When there is a merger of two companies
Each company will have to be valued as it is to distribute the proportionate ownership interests of the involved parties.
3. When a group ownership is considering full divestiture
This requires the knowledge of the fair market value of the business prior to tending to proposals.
Business Enterprise Value
Though each of the circumstances above is special in their own terms, they still use the same method of business valuation.
This method involves capitalizing the business’s normalized cash flow that is before the owners’ bonuses, using a rate of return that tallies with the latest market conditions and the operating and risk factors unique to the business. Hence the calculations can be considered as a multiple of the normalized Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) before the owners’ bonuses.
The end-product is termed the Business Enterprise Value (BEV), which informs the overall value of a business and the assets that drive its operations like the capital assets and a viable level of working capital.
Based on our research, a study was done overseas on real transactions of architecture firms discovered that most of them include the sales of non-controlling interest, which usually happens when a member joins or exits the business (circumstance 1 mentioned above), and the ownership of interest has to be valued. For such cases, the multiples of EBITDA and service revenue are expected to be equal to the BEV. This may be otherwise for cases with extenuating circumstances like abnormal cost structure.
The study also observed transactions with controlling interest acquisitions, and discovered that the BEV and EBITDA multiples increased by roughly 1.0 times. For architecture companies, the BEV is then roughly 4.24 times of EBITDA. Owners of non-controlling interests do not have the privilege of being part of the major decisions for the company, such as the business strategic direction, the sum of bonuses and dividends and the timing of payment, and the selling of their own interest in the open market.
Fair Market Value and Marketability
The business valuation of an architecture company also considers the drivers of the fair market value and marketability. These drivers are essentially the company’s growth rate, ability of its management and the relative efficiencies.
Upon observing the common Key Performance Indicators (KPIs) of a substantial number of comparable professional service businesses, the study discovered that on average businesses are sold at prices different from the fair market value. This is due to the following reasons:
- Deal terms like the non-cash considerations or earn-outs
- Different level of negotiation skills between the buyer and the seller
- Different level of drive and energy to complete the transaction
- Special purchaser premiums where the buyer pays a higher price out of special reasons
Whatever the method of business valuation, as long as all the involved parties agree to keep the entire affair fair and objective, negotiations can happen to safeguard everyone’s interest.
Every partnership has its unique influences and stressors to evoke changes. Past records have shown that succession concerns are one of the most common drivers of change.
One can start with engaging a professional valuer to perform a business valuation as seeking an expert opinion on the fair market value of a business is the first step. It might be surprising to learn that the business may actually be worth more than its perceived value.
Contact us for a non obligatory review of your company’s valuation.