Engineering Influence from ACEC

The Role of the Activist Engineer in Society

Engineering Influence welcomed Mike McMeekin, Executive Director of the Engineering Change Lab and Darshan Karwat, Assistant Professor, School for the Future of Innovation in Society, Arizona State University to discuss the evolving role of the engineer in society and the emergence of the activist engineer.  
Background:
Engineering Change Lab - USA (ECL-USA) is a new non-profit that is focused on the future of engineering. ECL-USA’s mission is to be a catalyst for change within the engineering community, helping it contribute at the highest possible level in addressing the challenges of the 21st Century.
ECL-USA has now held nine summits over the last three years. Each summit is a deep dive into an issue that will impact the future of engineering. The summits include a combination of learning from thought leaders, or provocateurs, along with small group and large group exercises and discussion.
“Society and technology are entangled together” according to Thomas P. Hughes, the great historian of technology. Engineers and the engineering community, as creators and stewards of technology, are inextricably woven into this knot. ECL-USA’s recent virtual summit included an exploration of this complex entanglement and the role that engineers, and the engineering community can play in an emergent future to help society anticipate and adapt to these entanglements.
One of the provocateurs for this session was Darshan Karwat, Assistant Professor, School for the Future of Innovation in Society, Arizona State University. Darshan Karwat’s work is centered around the concept of Activist Engineering. According to Karwat, an activist engineer is one who is willing to step back from their work and examine the question, “What is the real problem, and does this problem require an engineering solution?”

Strategic Considerations of a Contributory ESOP

 
Chris Staloch and Joe Skorczewski of Chartwell visit the Engineering Influence podcast to discuss how to use an ESOP to drive company performance. 
 
Host:
Welcome to the ACC engineering influence podcast brought to you by the ACEC Life/Health Trust. Today, I am joined by Chris Staloch and Joe Skorczewski from the Chartwell Financial Advisory. Chris is a managing director with Chartwell and has been with the firm for over 23 years. He has spent the past 12 years leading Chartwell's architecture and engineering practice. Joe is a director at Chartwell and has been working with Chris in the practice for most of his 15 years at the firm. We've invited Joe and Chris to speak with us today about some of the emerging trends with regard to ownership and compensation in A/E firms.
Host:
To start, what is the state of the current market? What are engineering firms looking for?
Staloch:
After some initial panic, when COVID first broke out, we actually saw a pretty quick return to what we would call normalcy. We actually managed to close a couple of transactions back in April, much to our initial surprise. We're seeing companies come to us looking for not only traditional third party sales transactions, but also new ESOP formations and a fair amount of just consulting around helping them think through their ownership, advisory issues. We see a number of companies that are currently struggling with how do they infuse enough capital into their organizations as companies transition out some of their previous ownership.
Host:
Are there any specific issues that you see as commonplace in the projects that you're working on?
Staloch:
One of the things that has become a recurring theme for us is that the companies that are privately held have this constant issue of having to transition the ownership of the business. And that's true whether the company is formed as an ESOP or whether they just have broad-based ownership in their organizations. And so what is happening right now is given the demographics of society. we're having a lot of people who are retiring from companies and the amount of capital that is available to come back into the organization through investments by other employees to replace those shareholders who are leaving is oftentimes not significant enough to make it worthwhile and to actually effect those transactions in a manner that you would hope to see on a recurring and regular basis.
Skorczewski:
I have a story to add. There's a client of ours who recently came to us. They do a fun Friday--this was pre-pandemic--morning trivia question. Everybody goes to the chalkboard and answers a question. And the question was if you won a million dollars, what would you do with it? And the answers were: A, I would go buy a boat; B, I would put it in savings; or C, I would pay off my student loans or other debts. And 80% of the firm answered C. The owner of the firm came to me and he said, "Joe, who am I going to sell my company to? My employees do not have the personal balance sheets to buy me out. So what should I do?"
Staloch:
That really speaks to the significant shift in the way the ownership has transitioned in businesses today. We've heard stories from our clients and older folks in these firms, who've talked about how they came to their ownership in the business. And they went out and got a second mortgage on their house and did things of that nature to be able to buy into an organization. Today we're not seeing people having the willingness to do that. Or in many cases, really even having the capability of doing that because of the amount of student debt that they're saddled with when they're coming out of school. For a lot of people, it might take them 10 years to pay off that student debt. They don't have the financial resources available to them to actually invest in these firms. So that presents a quandary for firms.
Host:
What are some of the considerations that companies should take when they're thinking about compensation and ownership questions then?
Staloch:
One of the things that we have seen is companies really trying to understand how they align their compensation programs with what they're trying to accomplish from an ownership perspective. Too many times, there's a disconnect between those things. Oftentimes they're thought about in a sort of vacuum. You have a firm that puts together this great compensation program, but it doesn't necessarily get them to where they need to be from an ownership perspective. And by that, I mean, oftentimes you'll see companies utilize stock as part of their compensation programs, either in the form of a long-term incentive program or as part of their annual bonus structure. But if there are not enough dollars or stock being utilized in those programs to actually effect the transitions of the older folks in the organization, that's not going to really work from a sustainable ownership perspective, if indeed the goal is to maintain the ownership of that company as a privately held organization inside the existing construct.
Host:
So what are some of the tools that firms can use to address these issues?
Staloch:
There's a variety of things out there. Oftentimes we see people think about programs such as stock appreciation rights, utilizing stock options, or Phantom stock. Things of those natures that generally are some sort of what we call synthetic equity. So they're equity-like instruments, but they're not actual equity in the organization. And so people will use those as part of their compensation programs, usually in the form of some sort of long-term incentive program. The other component that we often see companies look at is just going to stock bonuses or setting up programs where a portion of the cash bonus that the company is providing to their employees is expected to be utilized as part of the repurchase, or I should say, the purchase of stock in the organization.
Staloch:
There's an interesting psychological element that we hear people talk about, and management teams have different philosophies on this front. Sometimes they'll utilize stock bonuses as part of the program and they feel like they're, quote-unquote, giving stock to their employees. But if they cut them a check for their bonus, and then the employees need to make a decision to actually turn around and write a check back to the company, to buy stock in the organization, that there's a different sort of mentality behind that for the employees. There's more of a feeling of having skin in the game in that regard. So, so that's something that we see frequently as well.
Skorczewski:
One unique tool that we've seen come back to life is deferred compensation. And again, I'll walk through a particular story. As has been well-documented, the talent war in this industry is real. And further, there's a specific gap of these 10-to-15 year folks, project managers, future leaders of the firms. There's a shortage of them actually dating back to the recession of 2008. Many owners of firms don't want to reach down too far to provide ownership to a 30-year-old, for example, but they really want to retain that individual. But that individual is in high demand, and they don't want to lose them. What we've seen happen in that case is there's can be some sort of deferred compensation plan put into place where you might award that individual, a series of bonuses, $10,000, $20,000, whatever the number is that vest over a period of years, say three or five years. The presumption is that at the end of three or five years, that person would then be in a better position. And like Chris said that award would vest, that person would get paid, and that person would turn around and purchase stock in the company. So it's a way to extend a little bit deeper down into the organization, which can be useful depending on the demographics of your specific firm.
Staloch:
Two other elements of this to add to the discussion. One of the other tools that we've seen companies utilize is their 401K. What they'll do in some instances is create a stock fund inside the 401K of their own company stock that they allow their employees to invest in, or utilize stock in the company as part of their matching contribution to the employees' dollars to get more shares into circulation in the organization. Frequently we're seeing companies look at that as a creative solution. And then the other element that is becoming more common is a contributory ESOP? The idea behind that is that would use the stock of the corporation to make contributions into a retirement plan for the employees. It works very similar to what I mentioned on the 401k front, but it's really in the form of an ESOP and gives the company certain tax benefits that you do not necessarily have with other forms of compensation that are provided to employees.
Host:
ESOPs are usually thought of within the context of transitioning ownership in a company. Can you explain the difference between a traditional ESOP and a Contributory ESOP
Skorczewski:
An example of a traditional ESOP that most have come to learn and know in the industry space is the ESOP can be any percentage of the company, but traditionally, some pretty big milestones are 30 percent ESOP, 51 percent ESOP, and 100 percent ESOP. I'll walk through an example that's been very prevalent in the industry. You have a company that's a C Corp, let's call it a $30 million company. You might have four or five shareholders getting to retirement age and they might own about 30 percent of the shares. In that situation, the company would set up an ESOP. Next, the company would go to a bank, get a loan for $10 million, which is about 30% of the overall value. Then the company would loan that $10 million to the ESOP and the ESOP would go ahead and purchase those shares directly from the departing shareholders. There is, in that situation, an internal loan that's created between the company and the ESOP, and those shares are essentially collateralized and then released over a period of time, let's say 10 or 20 years. That would be the traditional ESOP, a leveraged transaction, which is a significant event in a company's history.
Skorczewski:
Now let's compare that to a contributory ESOP. What occurs in that situation is the company goes and sets up an ESOP, but rather than entering into a transaction, the company simply issues newly issued shares, let's say 3 percent of qualified payroll, and deposits those shares into the ESOP. Over 10 years, uh, you might get to the same spot, where the ESOP would own 3 percent in year one, 6 percent in year two, 9 percent in year three, etc. Over that period, all of those shares are allocated and you essentially arrive at a similar spot. You just get there in a different way.
Staloch:
And I'll just add to that, that one of the reasons that companies tend to think about utilizing a contributory ESOP, as opposed to a traditional ESOP structure, is that in the concept that Joe just described, you are reducing the fiduciary exposure significantly for the trustee overseeing the plan. Because now the trustee is not necessarily making a decision to purchase stock in the company. They're just accepting a contribution of shares into the plan each year. And so the amount of risk that's associated with that type of a model is substantially less than what it would be under a traditional ESOP construct.
Host:
Are there other benefits or reasons why owners and sellers would choose to go with a contributory ESOP versus a traditional ESOP?
Staloch:
Some companies, particularly as we sit here today, are looking for ways to incentivize the employees to go above and beyond and really drive growth in the organization. A contributory ESOP is a way to provide ownership to the employees and start to build that kind of ownership culture without providing direct ownership in the business, which carries its own complexities that go along with that.
Skorczewski:
In addition, as you compare those two examples. In the contributory ESOP, there's a small amount of capital that's invested in the company, but it's not a $10 million transaction. It's a small contribution of shares. So it doesn't impact the balance sheet in a way that a traditional leveraged transaction would. We've seen it work really well with very long runways, meaning folks that are maybe 50 or in their lower fifties who might have 15 years to retirement. They might feel it is just too early for them to sell. Maybe the next 10 years are going to be really good and they may not want to exit or liquidate their holdings so soon. In a contributory ESOP model, the percent ownership changes slowly over time. So you're not timing the market, so to speak, with a particular transaction on a particular date. It's more of a thought-out interval, a process over 10 years. So if you have good years in front of you, or particularly in the environment that we're in today, if the value is low, you might not want to sell today. But a contributory ESOP would put a market in place, communicate to the employees and the company where we're trying to take this entity over time, and provide clarity to all the stakeholders in the firm.
Host:
Finally, what are some of the challenges of utilizing an ESOP in this manner?
Skorczewski:
On the flip side, if we're dipping our toe into the water, we're creating a lot of flexibility for our departing shareholders, but it takes some time to create meaningful balances into folks' retirement accounts. It will not be an overnight success, and communicating to your employees that they own the company while contributing $575 to their retirement account that they're going to have access to in 40 years isn't a big bang out of the gate. But that's okay. It takes time. And that's not the intent. Over the course of a generation, over the course of a decade, you will start to accumulate shares in your account. The value of that will grow. And over time as you communicate that it will work, it can work very well. But the small dollar amounts right out of the gate are sometimes contradictory to someone feeling like they're an employee-owner.
Skorczewski:
In addition, a lot of folks would rather have a dollar in their pocket today than a dollar in their retirement accounts. So knowing and communicating around that would be important. And, and there are some explicit costs of trustees and valuation firms and third party administration. So, just from a dollars-and-cents perspective, you'd want to make sure that you are committed to going down this path. Otherwise, if you do this for a few years and then revert to something else, you'd have spent some fees that could have been gone elsewhere.
Host:
Great. Well, that's, it's been an illuminating discussion into contributory ESOPs. I appreciate you taking the time.
 

Looking into the Future of the Office Market

Carl Shilling, a principal at Stantec, joins the Engineering Influence podcast, to share his thoughts on the current state of the office market sector and how it may change going forward.
 
Host:
Welcome to the Engineering Influence podcast sponsored by the ACC Life/ Health Trust. One of the biggest business impacts of the COVID-19 pandemic has been the transition to working at home for many professional and office workers. In many downtowns and suburbs, offices are dark and empty. Not surprisingly. This situation has raised questions about the concept of the office. Many pundits have speculated that our traditional views on the office must change and that remote work will play an increasingly large role, maybe even a major role in the future. Others promote the benefits of the office, collaboration, teamwork, efficiency, and argue that once the pandemic has abated, we will return to the office. This is an important discussion for the engineering industry and for firms that work in the office space. To discuss these issues and more, we're here with Carl Shilling, a Stantec. He has a principal based in the firm's Butler, Pennsylvania office, and has more than two decades of experience focusing on the sustainability of the built environment. Carl, welcome.
Shilling:
Thanks for having me. I appreciate it.
Host:
So in the initial days and weeks of the pandemic, many companies shut down their offices, and employees began working virtually. Assuming that we eventually have a vaccine for the virus,. do you expect the virtual work environment to perpetuate, will we return to the old normal, or will we find something in between?
Shilling:
We, like many companies, vacated our offices and performed our business remotely. And I will admit, I did not expect it to work as well as it has. The technology has come through. We've been very successful in conducting our business virtually through, like the interview today, Zoom meetings, Team meetings, and others. They have worked very well, but as you're asking, as we're thinking ourselves: What do the next couple months mean? What does the next year mean? How are we going to conduct business in the future? Beyond our personal experience, we have also polled a lot of our clients--over 130 of them actually--to get their perception on what they think is going to happen in the future, so that we can position ourselves to design appropriate space. What we found is that although it's been successful, we're missing the human component. So we're hoping that beyond today, tomorrow that there's still going to be some interaction within the office, whether that's two days a week, three days a week. But people have learned that they can be effective from home, so what we used to be considered a luxury--being able to work from home--is now going to be considered the norm. So I think there's going to be an expectation that we still need the office space where we can go in and collaborate and understand our partners, their in-person reactions to real-life situations, but we also understand that we can be effective from home. And there are some advantages to being home with our spouses or wives or children and conducting business from there. So what we're expecting is that, yes, there's still going to be a demand for office space, but that workers probably won't be coming back five days a week 40 hours like they did prior to the coronavirus situation.
Host:
So, as an office designer, as an engineer, what does that mean in office design? Is this going to change it?
Shilling:
It will. One of the questions that's paramount is do you need the same amount of square footage or space to conduct business that you did prior to entering the pandemic? And what we're coming back with is that the dedicated office space that people are used to having, your cubicle, wherever you do your work, is probably going to change because typically it does not provide the right amount of separation or distancing from coworkers. But if we go into design and expect to be able to provide that, maybe the same amount of square footage works, but we have to reconfigure it so that it still promotes interaction between coworkers. We may need to spread out so fewer people are going to be in the office at any given time. Or it's going to take a larger square footage to accomplish the same thing.
Host:
In your conversations with your clients, what are their concerns?
Shilling:
It's kind of the same thing. How do I get my people into the office safely? How do they interact safely while they're there? We've all been out shopping in the meantime during the pandemic and you see one-way aisles. You see limitations of where we can't all go in at the same time. I think that's what we're going to see. You may go into the office, but you have to enter at multiple points so there isn't a large grouping of people at any one location. When you get into the office, there might be direction, it's probably not going to be arrows on the floor, but there's probably going to be within the design, elements to encourage people to not all go the same way or congregate in the same place.
Shilling:
You're probably going to see people spread out a little more than what you see in today's office, but there are still going to be spaces where you can interact with each other and do your work, There's probably also going to be additional technology within those spaces so that your coworkers and staff that aren't in the office at the time can log in or dial and be a part of the team, whether they're there personally or not.
Host:
You mentioned retail as one area that you can take some lessons from. This is a unique situation. So where have you looked for guidance to make design decisions on health and safety concerns?
Shilling:
I mentioned that we do multiple types of buildings and one of them is health care and doing that kind of design has given us a lot of direction on whether the virus is transmitted through the air or is it mainly a contact risk.
Shilling:
Those kinds of things really go across building types. It's not necessarily just indicative of the office environment. And so the first thing, the biggest risk, is proximity to your coworkers. Now we've heard about six- feet distancing. But given the particle size that you put off wearing a mask, does the mask stop it? As the particles dry, do they float longer than a couple of hours? So we're thinking about these issues between workers. We're thinking about how it is distributed by the air handling systems. There' are many aspects as to how do we keep people safe,
Host:
Focusing on HVAC, what changes do you expect to see in HVAC going forward?
Shilling:
The first thing is ventilation. There are three main bullet points and the first one is ventilation. The minimum that we have to think about is, do the systems within the building provide the minimum ventilation rates required by current code, whether that's the International Mechanical Code, whether that's ASHRAE 62, but a lot of office spaces, for energy efficiency reasons have reduced the amount of outside air, have chosen not to do it when they're not there in off-hours, but I think there's a general understanding out there now that we need to continually ventilate the spaces we're in. The benefit to the personnel outweighs the energy demand on the building.
Shilling:
Number two is filtration. Typical filtration for office environments is like a MERV-6 six, 25-30 percent. I think there's an understanding out there that can the particle sizes that we're dealing with be captured by a filter? It can. We're all wearing masks, right? So masks aren't really a very high particulate filter, but the virus lives in things that are larger, like water drops or things like that. The same thing applies to HVAC systems where if we put higher efficiency filters in, there is a benefit to the office environment. The parallel argument with that is I'm going to need more horsepower and fans to push the air through the higher efficiency filters. So there is an efficiency offset with putting in higher efficiency filters. I'm going to use more energy to do that.
Shilling:
Lastly, there are lots of products coming to market that we all trust, that we've been using, that have a benefit with combatting the virus, whether it is additional filtration, HEPA filtration, whether it's UV lighting, whether it's a technology like bipolar ionization. These are all things we need to have in our toolkit and our approach to making spaces safer that we can employ to respond to the demand that's out there.
Host:
In many office buildings, one choke point would be the elevator because you have to get people up upstairs and the elevator is by its nature, a confined space. What do you see happening with elevators?
Shilling:
I've seen a raft of things coming to light. And again, it's are you dealing with an existing situation or are you dealing with a new design? The most creative thing that I've heard reported to me, and it was experienced by one of our own employees visiting a client site was they entered an elevator. And it was an existing elevator. It was a small facility. The owner had attached a sponge to the wall and put a bunch of toothpicks in the sponge. And whenever you entered the elevator, you were to pick a toothpick and use that to push the button.
Shilling:
That was a very low dollar, very innovative solution to be as safe as they could with what they had. On the other end of the spectrum is we're designing new elevators. There are all kinds of new control technologies out there where instead of going to the elevator lobby and entering an elevator and pushing a conventional button, before you even get to the lobby, there's a panel where you can enter where you want to go. That panel then looks at where are the elevators in the building are, directs you to a specific one, and controls how many participants are in that elevator. That particular car delivers you to the floor without ever having to touch anything within the elevator itself. So there is a lot of technology coming out to address that situation. But we have a whole lot of existing elevators that we're going to have to be creative with. What are we going to do for those specific cases?
Host:
The economic forecasts for the office market are pretty bleak right now. What opportunities does Stantec see?
Shilling:
Again, communicating with our clients, there's a lot of waiting to see what happens. I will say that when I left the office back at the beginning of the year, I never expected that we would be gone this long. It has perpetuated far longer than I ever expected.
Shilling:
I think everybody's in a holding pattern to see where this is going. Is there going to be an additional infection rate here in the fall? As the weather gets colder and the humidity level drops, are we all going to be more susceptible to the virus? I think it's going to be another six months of what we're seeing, but I really think that there is a real desire for offices to open back up and for people to at least get back into the office in some way so that we can continue what we're doing. We're surviving just fine, but we are not thriving. We need to do additional things that we're not doing now, such as getting new people into the workforce. That isn't possible remotely like we're doing.
Host:
From an engineering perspective, is it going to more retrofit and renovation work in the office market in the short to mid-term?
Shilling:
I do. Yes. We're going to have to take a look at the existing systems. We're going to assess them. Are they bringing in any outside air or the right amount of outside air? We're going to look at whether all areas of the office have air distribution. Are there any dead spots?. I think we're going to look at whether existing air handling units can support additional filtration beyond where they're at right now. And then I think we're going to be looking at, can we apply things like UV lighting to sterilize the airflow? Can we employ things like bipolar ionization within the airstream to sterilize the airstream? Ionized hydrogen peroxide has onto the market that can be independent of the air handling system. There are devices that we can just hang on the wall to deliver these ions to the space, to clean the surfaces, to sterilize the air. There are many, many things out there that I think we can apply without spending a lot of money to make the space safer on a broader scale.
Host:
There's been a lot of talk that one of the impacts of the pandemic will be that the downtown business districts will shrink and the offices will move to the suburbs where there's less density. What is Stantec's view on that?
Shilling:
We're not seeing that. We're seeing that companies are still going to make the decision on where they want to locate their offices based upon serving their clients and where it makes the most sense for their office to be. I think what you're going to see is the opportunity for employees to choose whether to go into the office more or less independent of where the office happens to be located.
Shilling:
We are not seeing companies changing their business approach. Some of them are hub and spoke where the hub is within the city and the spokes are into the suburbs. Some, some companies choose to do work in the suburbs. That's where their clients are and where they interact. I don't think the specific office location is necessarily going to change. I think it's going to be focused on the ability to give their workforce the opportunity to say, "I'm going to be there all the time," or "I'm not going to be there all the time." And part of that is attracting new talent. The new generation of employees is going to demand the flexibility to say, "I'm going to work from home" or "I'm going to come into the office." And I think that's where companies will find success, in not necessarily changing the office location, but changing what they're asking their employees to do.
Host:
Great. That gives us some good insight into the office market. I appreciate your taking the time to speak with us.
Shilling:
I appreciate it. Thank you for having me.
 

A Preview of the Fall 2020 Private Industry Brief

 
 
ACEC's Erin McLaughlin joined the podcast to discuss the newly released Fall 2020 special Private Industry Brief, which can be read here.  Erin will be presenting a detailed analysis of the brief during the upcoming 2020 ACEC Fall Conference later this month.  More information and registration details for the event can be found here.  

Government Affairs Update: A Preview of Upcoming Webinars on NEPA and DOD's CMMC regulations

Matt Reiffer and Dan Hilton from ACEC's advocacy team joined Engineering Influence to preview two upcoming webinars of importance to our member firms:
 
September 30, 2020 at 1:30: Changes to NEPA Implementing Regulations and the Potential Impact on A/E Firms and Clients
 
October 8, 2020 at 1:30: New Cybersecurity Requirements Create Significant Responsibilities and Liabilities For Federal Contractors: What you Need to Know to Ensure Compliance 

The Engineering Health Quote from the ACEC Life Health Trust

 
Engineering Influence welcomed back the ACEC Life Health Trust to talk about the new Engineering Health Quote service that helps small and midsize engineering firms save money and time when searching for health insurance.  Find out more here.
 
Also, the 2020 ACEC Fall Conference early bird registration ends September 30th.  Act today to save $100 on your registration for this first ever virtual event!  Learn more about the event program and register here.

The Ins and Outs of Choosing Insurance with the ACEC Life Health Trust

 
John Krebsbach with ACEC Life Health Trust joined the podcast to recap the August 26th webinar, Health Insurance 101 and discussed the many options offered by the Trust to help engineering firms take care of their employees.
Transcript
Host:
Welcome to another edition of Engineering Influence a podcast from the American council of engineering companies brought to you by the ACEC Life Health Trust. And today we are featuring the life health trust. I want to introduce John Krebsbach. He is the director of sales for the Trust. And recently the Trust just finished off our R3 sponsored webinars series. It was the final in a series of webinars that have been sponsored kind of as a service to members in response to COVID-19. And the webinar took place on August 26, then it's available online. We'll link to that in the show notes, but really the webinar focused on insurance plans and something which is I'm sure, a mystery to many people who are very busy running their firms, very busy, making sure that their employees are happy and may not have the direct exposure to what insurance plans are meet up above or why it's important, or how do you choose one. So having John on the show is great today, because he can kind of expand on what was discussed in the webinar a little bit, but also give some good information about insurance plans. So John, thank you and welcome to the show.
John Krebsbach:
Hey Jeff, thanks so much. Appreciate you and ACEC National having me today. You know, I, I'm always really excited to have opportunities like this, Jeff, to provide the value of the ACEC Life Health Trust to all ACEC member firms and prospect firms. But thanks for having me today. My name is John Krebsbach. I'm the national director of sales for the ACEC Life Health Trust, a little background I've been with the trust for just over two years and prior actually spent over 10 years at United Healthcare. And most of my time at United Healthcare, believe it or not was working with the trust. So I've I've been around the program for quite some time.
Host:
Yeah. And the Trust has been around for quite some time as well. I know a lot of our members are familiar with it, but for those who aren't, I mean really it's a 55 year anniversary this year for the Trust. And can you go a little bit more into kind of what the trust is focused on, what the mission is and why it's so important and tailored for the engineering consulting industry?
John Krebsbach:
Yeah, absolutely. And thanks for, thanks for calling that out. Like you said on May 1st, actually May 1st of this year, the ACEC Life Health Trust celebrated 55 years of supporting ACEC member firms. And we're, we're extremely privileged to continue that role. It's, it's clearly stated in our mission, which, which we feel is very simple. You know, we're the ACEC Life Health Trust is here to provide healthcare benefits, solutions, and services to support the business objectives of ACEC member firms and the health and wellbeing of their firms, employees and family members. You know, I think you could argue the ACEC Life Health Trust, Jeff, is one of the biggest benefits of being an ACEC member.
John Krebsbach:
You know, I also, we believe our vision along with our mission, our mission is very compelling, you know, with, so well, I'm sure we'll get into it here. With all of our programs, medical, ancillary value added services, we, we really feel we can establish the consulting engineering industry as one of the healthiest industries across the U.S.
Host:
And you the trust, I mean recently right as the pandemic was kind of hitting its peak did something for its members, which was very beneficial. And that was that $10 million loyalty credit. What was that?
John Krebsbach:
Yeah, that's something that myself and rest of the associates at the Life Health Trust are very proud of, you know, this, this is an example in my opinion, Jeff, that just screams our mission in really being there for our member firms. So, you know, back earlier this year, when, when everything was going on the board of trustees Pat Fayen, president of the ACEC Life Health Trust approved, like you said, over $10 million in a loyalty credit that was given back to all of our member firms as a one-time invoice credit on August 1st. So we're, we're very excited to have the opportunity to give back to our member firms in that loyalty credit. And again, a piece that really lives by our mission of being here and giving back to our member firms.
Host:
Well, that's great, John, and I know that the trust has done a great job trying to keep members informed about different aspects of insurance and the services that the trust provides. And you've done a number of webinars for ACEC in the past. And of course the one that just happened recently on the 26th of August was how to buy insurance 101. Go a little bit into what was covered in that webinar, you know, for our members that that is available online on acec.org and the education area of the site, you can go back and see that on on demand, but what was, what was the main focus there and the big takeaways?
John Krebsbach:
Yeah, you're right. It was really how to buy insurance one-on-one piece. You know, insurance costs are among the top three expenses that a business takes on each year. And you know, what, what may have seemed simple in the past, Jeff with limited options has now become at times confusing as far as what plans and programs are available out there for each state, for these businesses. So the webinar from last week, which you referenced, allowed us the opportunity to break down the steps, to really understand how to purchase the right specific insurance plan for your firm.
Host:
And one of the things that I know was covered was, was what makes up an insurance plan. And I I'm guilty of this. I, you know, don't pay as much attention to this as, as I probably should. And I don't really spend time thinking about how plans and premiums are calculated and really what goes into them. Can you go a little bit into how those plans are and the premiums are constructed?
John Krebsbach:
Yes, absolutely. You know, you're looking at roughly four categories when it comes to insurance premiums, you know, those, those four different buckets that we're looking at are you know, we look at the expected medical and pharmacy claims for a specific firm. There are obviously administrative expenses which include taxes and fees. You have a profit risk margin, which is really looking at the amount of risk which I can kind of get into here a little later of how much the employer wants to pay. And then at the end of the day, it's really trying to figure out the premium, what is the per member per month pricing? You know, I think it's, there's a huge benefit. Jeff looking at the ACEC Life Health Trust in that we have multiple plans and programs available to ACEC member firms. You know, we're not just locked within one specific plan design.
John Krebsbach:
So we really have the ability to quote fully insured through United Healthcare. We have our, which was talked about last week on last week's webinar, the select level funding program, which utilizes Meritain the TPA and Aetna as the network on the ACEC select level funding plan. This plan is available in 33 of the 50 States. And then we have our, our advantage plan, which is available to firms that are typically over 100 employees in size and are currently self-funded or looking to move self-funded. So, you know, now all these programs aren't necessarily available in all states. But like I said, Jeff, there, there are many states where you could technically request a proposal for all three of these programs, which again, I think is just a huge benefit of the life health trust,
Host:
That scalability, right? It's that ability to be able to go and say, you know, how big is your firm? What are your needs? You know what exactly absolutely. You know, what's the level of covers that you want to have and how you want to structure that you guys can really focus in and design a plan that meets the needs of the firm.
John Krebsbach:
Absolutely.
Speaker 2:
So as it goes with, with insurance, I mean, I know you mentioned like, you know, the fully insured or the fully, the fully insured versus self-funded what are the big differences between those two?
John Krebsbach:
Right. So, you know, I look at what let's look at all three fully insured, level funded, self-funded. And again, I really encourage the listeners to refer back to last week's webinar because that really gets into the, into the weeds on each three of these funding types. But you know, for today's opportunity, Jeff, you know, I like to look at it from on a scale, you know, low risk to high risk, you know, fully insured is really non non-refundable premium, right? The, the insurance company assumes all the risks there. So there's low risk and low reward. Then you move into, as you get further on you know, the scale to higher risk, you know, you look at level funding, it's kind of right in the middle where the employer assumes some of the risks. And then self-funded is obviously the opposite of fully insured from a it's more of a high risk, high reward set up.
Host:
Now John, I know during the webinar the focus was put on the trust select plan and you went into some detail about what that plan offers for our listeners. Can you go into a little bit about about what was discussed about that?
John Krebsbach:
The select level funding plan, you know, you're looking at a handful of key, key advantages you know, really attentive to service. We have a dedicated customer service and account management team that's available to answer any the firm and broker questions to meet their specific needs. Like I mentioned earlier, it's the select level of funding plan utilizes Meritain as the TPA and, and it's on the Aetna network. So it's a very broad national network. The Aetna choice POS 2 is, is the specific network, Jeff that that's on. So thousands of hospitals as well, as more than 75,000 pharmacies nationwide when it comes to that broad national network. And then when you're, when you're looking at, you know, specific plan design options, we have over 80 plans in that product portfolio that are your traditional PPL plans. And then we have over 30 of our, of the plans within that product portfolio that are our more high deductible health plan options for health savings, qualified health savings account type plans.
John Krebsbach:
And, you know, lastly, again, just as far as availability goes the ACEC select level funding plan is available in 33 of the 50 States. And for listeners feel free to go to ACECLifeHealthTrust.com where you can find really those key advantages that I just listed off and an availability map of where that is available. And again, like I mentioned on last week's webinar, when it comes to the 33 of 50 States, that just means that your, your site - your headquarter location needs to be in one of those 33 States. But if you find that your firm has offices standard across the country, that may land in one of the non 33 of 50 States, you can, the, the entire firm can still take advantage of that ACEC select level funding plan.
Host:
Hmm, that's important to note, I also noted that, that on the webinar it was discussed that there is, you know, risk protection for firms with the select plan that the firm kind of decides on what they want to set their premiums to be. And that means that they don't have that risk of paying at the end of the year. Right. So if the claims come in or the firm actually gets that money back, they're not on the hook for that.
John Krebsbach:
Absolutely. That's and that's a fantastic point and one to call out because we don't typically see that, Jeff, in the open market with other arrangements. So yes, our ACEC Select Level Funding Plan essentially has two options. We can look at an aggregate only where all of the group claims roll up to one aggregate account. The second option, which is just an enhancement here recently is the individual stop loss where we can put in based on state ruling, state regulations, anywhere between 10,000 and 50,000 individual stop loss. And really how I look at it is you're just, you're buying that extra protection for your group. So you know, anything that is left over in that surplus in that claims fund at the end of the contract period, whether it's with either option yes, that that firm gets that entire amount back. The ACEC Life Health Trust does not keep that money. So really an amazing opportunity for firms to keep their costs down and in and enjoy that savings. And like I said, you typically don't see that amongst other arrangements across the country where you'll see a, a share of that cost 50/50, 70/30. So again, the firms get that entire amount back.
Host:
So, that's good to know number one, number two is, you know, with the variety of options that plan and the others present for members. I mean, it's kind of a, it's a lot of options to choose from. If I'm a firm CEO or, you know, if I'm in operations at a firm and I'm trying to out, okay, how do I navigate this? Can you go on a little bit into how the trust works with firms to kind of identify what they would need to select a plan that adequately not only covers the employees that they have, but also creates an environment where they can attract talent and, and retain the talent that they have?
Speaker 2:
Yeah, absolutely. I mean, we're, we're very open to all groups reaching out to us. You know, a lot of our business, we work through broker channels. So, you know, for listeners please feel free to reach out to us directly for any questions that you have around the plans and programs that we have. You can work through your broker and we're more than happy to connect with your broker again, on the programs and plans to really sit down, look at, look at maybe what, what you, as, as a firm are currently on where you want to go into the future. You know, we can, again, to my point earlier, it's, it's a huge value of the ACEC Life Health Trust to be able to look at different funding options and not just be locked into one. And again, if you're in any one of those unique States, we, we may have the opportunity to look at multiple options for you and you know, find out which one's the best fit and put our best foot forward.
Host:
And with 55 years of history behind you, I imagine that you have that institutional knowledge of what works best and what states and how similar firms similar sizes kind of navigate this. So I imagine you have a lot of historical information to be able to assist clients with making the right decisions.
John Krebsbach:
Absolutely, absolutely. We can absolutely look at you know, again, based on a firm size what firms of that size are typically electing within the trust. Yes, we can look back at that and really help paint a clear picture for these, for these firms.
Host:
I know, we went into the kinds of different plans that are out there and available with the levels of risk levels of coverage. But I know that the trust also offers a number of value added services with all the plan that they offer. What are some of those additional services that, that clients can take advantage of to plus up their plans?
John Krebsbach:
Yeah, Jeff, you know, this, this goes back to our vision, you know, in my opinion of really establishing that consulting engineering industry is the healthiest industry across the U.S. So, you know, with that, our member health and wellness is such a high priority, which is why we invest in and also offer, like you had said our value added services. So again, it's, this is not a, a stop to look at the health insurance plans, but you know, real quick, we have partnerships with United Healthcare and guardian when it comes to the ancillary benefits. So we're talking dental, vision, life, disability and then our value added services. These are again, very important. Our designed wellness program is our specific wellness program designed by engineers for engineers. There are three different levels of design wellness all of our ACEC Select Level Funding firms that move over will be automatically put into our basic program.
John Krebsbach:
And really Jeff, what it is, is based on the group's participation engagement, they can work, work their way up the ladder, if you will and receive different incentives for both employees and spouses. And then, you know, one of the other value added services, which I would argue has been a very hot topic of conversation is our design virtual care program. You know, a statistic that I think the audience will not be surprised with is telemedicine has the utilization has doubled since the pandemic started. So again, a very important very valuable added service that we provide with everyone that, you know, is maybe a little weary going into the doctor with everything that's going on. This is a service that includes 24 seven, three 65 tele-visits and then just recently we've added some enhancements. We have a behavioral health service back care dermatology and expert medical services that are embedded into the design virtual care program. And then we also have a design advocate service, kind of a patient advocacy tool, and then benefit solver, which is an enrollment and eligibility software solution. So for the HR audience out there, that's a program that could really take a huge burden off their plates.
Host:
That sounds like something, you know, especially, I just recently had my first ever video conference doctor's appointment where it was just strange, almost like a zoom call with the doctor, but, you know, every week, you know, so dispersed and working remotely, you know, having access, if you're a smaller firm and you have a program that allows you to have your employees engage in telemedicine that's a big benefit because that's the kind of thing that, you know, the big, you know, bigger firms definitely have. And the same with the enrollment eligibility software, that, that that's something that will speed the process for HR managers at, at smaller midsize firms. So those are, those are all value adds that I can see actually that, you know, adding value to an engineering firm.
John Krebsbach:
Absolutely. I mean, the, the, the trust, you know, one of our values is innovation and we are constantly looking at new upcoming value added services that are, that are going to bring value to our ACEC member firms. Again, back to emission, we are, we are here to serve the ACEC member from population, their employees and families. So we will, we will continue to look at new, up and coming latest and greatest services that we can bring into our portfolio to continue to add that value a lot like the design virtual care program and the others.
Host:
Absolutely. That webinar is up online for everybody to look at it goes into much more detail that was took place on the 26th. And it's again, it's the title of that is How to Buy Insurance 101. Really encourage all of our members and listeners to take a look at that webinar and get a little bit more of a deep understanding of the offerings that the trust provides member firms, especially when it comes to selecting coverage and selecting a plan. John, you know, for, for our conversation here, you know, kind of just going over these broadly, is there anything that we missed that you want to make sure that our members know?
John Krebsbach:
No, I don't think so. Jeff, you know, I think just the one thing I would ask is, you know, first off for the audience, you know, just that the ACEC Life Health Trust really values and appreciates the opportunity to serve those that are participating in the life health trust. You know, we have roughly 1,500 firms, Jeff that are taking advantage of the ACEC Life Health Trust. There's just shy of 4,000 firms across the country that are dues paying members. So we really appreciate that business. And for those that are not participating in the life health trust, it does not hurt to take at least a look. There are a lot of programs out here that, you know, we, we rolled through here today. And we'd, we'd love to earn the business and take a look at that benefit package.
Host:
Well, John, again, you know, our members are pretty aware of, you can be found on the web at www.aceclifehealthtrust.com. And for you in the sales department, where can people reach out and contact you?
John Krebsbach:
Yeah, my contact information email john@aceclifehealthtrust.com, or you can simply email sales, sales@aceclifehealthtrust.com. Everything that we discussed today, Jeff is on our website, www.aceclifehealthtrust.com, including contact info.
Host:
Well, that's great, John, thank you so much for coming on the show. This is really good information, especially these days with the focus being so much on health wellness, and just living in this remote work environment here you know, having a strong insurance plan is part and parcel with that. So really appreciate you being able to go a little bit more into what the trust provides its members. And thank you very much for coming on the show.
Host:
Thanks, Jeff. And thanks for everybody listening in. Hope you all stay safe and well, and we'll talk to you on the road.
Host:
And again, this has been Engineering Influence, a podcast from the American Council of Engineering Companies brought to you by the Life Health Trust. We'll see you next time.
 

Mick Morrissey of Morrissey Goodale Looks at the M&A Market from the Seller's Side

 
Mick Morrissey, managing partner of Morrissey Goodale, visits the Engineering Influence podcast to analyze the current state of the M&A market and offer insights and advice to engineering firm owners who may be contemplating selling their firms.
 
Sponsor Message:
The ACAC Life Health Trust is offering free insurance comparison quotes for all ACEC Engineering Influence listeners. During these uncertain times, every dollar counts. And we want all our listeners to take advantage of this special offer. Typically our firm medical plans offer your employees lower insurance costs, better coverage, and complementary health and wellness benefits above our competitors. Visit our website at acclifehealthtrust.com or call our sales team at (844) 247-0020.
Host:
Welcome to the ACEC Engineering Influence podcast brought to you by the ACEC Life Health Trust. The mergers and acquisitions market has been very strong in the engineering industry in recent years with Baby Boom generation owners, looking to sell their firms and buyers looking for strategic purchases. Not surprisingly the COVID-19 pandemic had an impact on the M&A market due both to the initial, rapid deceleration of the economy and now the uncertainty that pervades the market as it recovers. To find out where the M&A market stands right now and where it may be going, especially for owners who are looking to sell., we have invited Mick Morrissey, managing partner of Morrissey Goodale onto the podcast. Morrissey Goodale is a specialized management consulting firm that exclusively serves the AA and government contract consulting industries and is one of the go-to advisors for buyers and sellers.
Host:
Welcome, Mick. Thanks for joining us,
Morrissey:
Thanks for having me on great to be here. All of us at Morrissey Goodale are big fans of the podcast.
Host:
So the M&A market for engineering firms took a dip in the spring when the pandemic hit, but it has gradually worked its way back up right now. Year-over-year deals in the U.S. are off about 10%. What do you expect to see in the market over the coming months?
Morrissey:
Let me put some context on that. It's a great question. 2019 was a record year for deals in our industry, 317 deals, almost one per workday, a pretty torrid pace of activity and, really speaking to how fast our industry was consolidating. January and February of 2020 were ahead of that pace, then COVID hit and the M&A market froze in the spring, March through May deals were down about 50% year over year. We were back to 2017 levels. Things started heating up a little bit in June and July, but still way behind last year. And then boom, in August of this year, M&A just started right up again. And indeed, we're going to have one of the strongest August on record for deals in the United States. Based upon everything that we're seeing in terms of interest from buyers, based upon the fact that the consulting engineering industry and the engineering industry writ large has been remarkably resilient through this pandemic, and then given that we anticipate some sort of stimulus package benefiting the industry after the election, we would anticipate that we're going to see lots more M&A activity and an uptick in M&A activity as we head into the back end of the year here in Q3 and Q4. I wouldn't be surprised if we end up the year very similar to where we were in 2019, which was a record year for deals, or maybe 5% or so beneath that level.
Host:
You mentioned, that the engineering industry has not suffered as badly as many other industries did. A guy who owns a firm and is looking to sell, is now a good time to sell?
Morrissey:
It depends. It depends on what markets your firm is in. Buyers are looking for quality. They're looking for growth in the acquisitions that they make. They were before the pandemic and that's certainly where they're focused now. So if a firm is serving, for example, the federal market, or if a firm has particular expertise, let's say in warehouse and distribution centers, both of those markets are doing well in 2020 and are anticipated to do well into 2021. This could indeed be a very, very good time in terms of valuation and deal structure for a seller that serves those markets. On the other hand, if you're a firm that is seeing a decline in backlog or weakening in earnings, and oftentimes today, those are firms that are serving, for example, the retail market or the commercial markets, this may not be the best time to go to market. It may not be the best time to seek a buyer.
Host:
What about size? Is this a good time if you own a smaller engineering firm or a larger engineering firm? Does That have any impact on the decision?
Morrissey:
Well, it's a really interesting question, because the trend we're seeing in acquisitions for consulting engineers is that the median-size deal has continued to fall over the last several years. Now the median-size deal is something like 15 to 17 employees with somewhere between $2 and $3 million in revenues. And that's a direct result of it being so hard to find talent in this industry and that challenge hasn't gone away with respect to COVID. While there may be 9% to 10% unemployment nationally, that unemployment level is not being felt in our industry. By and large, quality people in our industry aren't getting hired at the same rate that they were before, although maybe it's a little different in terms of onboarding and hiring now with most of it being done remotely, or a lot have been done remotely, but still, talent is very hard to find and that's what's driving acquisitions of smaller firms in our industry.
Morrissey:
And that's why the median deal size continues to fall because small acquisitions are a way to get talent on board fast, instead of going through a three-month to six-month to one-year cycle of picking up the equivalent number of employees. So I'm not sure that that size is a determinant with respect to whether it's a good time or a bad time to sell. I do think though that size and we saw this pre-pandemic and we're seeing it still that size correlates with valuation. So the larger a firm is, the greater the probability that it will achieve a higher valuation when it sells than a smaller firm.
Morrissey:
If you look back a decade or so ago, right after the last recession, about one-quarter of all deals in the United States were being done by publicly traded firms, the Jacobs and AECOMs. The brand names. Since the Great Recession, the percentage of deals being done by the publicly traded firms has dwindled to about 5% of all of the deals. Over the same time period, private equity-backed firms and private equity recapitalizations of firms engineering firms in the ENR 500 have grown significantly to the point where now about a quarter of all the deals. Now, what does that mean with respect to size? Those private equity groups typically are looking to make acquisitions of firms that are generating at least $1 million in EBITDA and more commonly $3 to 5 million in EBITDA. And that speaks to firms that are generating about $10 million to $50 million in revenues, which would speak to the larger firms in the membership of ACEC.
Morrissey:
So, um, I think the market is fairly agnostic believe it or not with respect to size. I think there's a market for each size segment with different types of buyers. Again, I come back to the determinant, particularly in 2020: What is the outlook for the markets that the selling firm is serving? Are the selling firms are serving markets that are being impacted by the shift in what's happening in the larger economy? If the firms are serving commercial real estate, or they're serving bricks and mortar retail, or they're serving, for example, the cruise industry or the hospitality industry, those firms, by and large, are seeing some significant or moderate impact to their backlog into their earnings. And they're just not attractive to buyers right now because buyers are looking for quality. But for firms that are serving the federal market, which is still going strong, for firms that are subject-matter experts in particular facility types where there's great demand, such as warehouse and distribution centers being driven by the Targets and the Amazons of the world, those firms are seeing demand. And particularly for firms that have figured out how to incorporate technology and big data management, or have developed proprietary software applications to wrap into their traditional engineering business model, those firms are seeing demand.
Host:
So if I were the owner of a firm and I was not in warehouses or data centers, what would be my strategy to make myself appealing
Morrissey:
That depends on what sort of runway you've got. From our perspective at Morrissey Goodale, the industry has entered the first phase of a new reality, and most firms have got about a year we believe to figure out that new reality because we believe there's going to be a lot of pain in 2021 as state and local governments face some real holes in their budgets. That'll put real downward pressure on the market for engineering services and put downward pressure on pricing and fees. So, firms need to reposition themselves from our perspective over the balance of 2020 and beyond. If you have a backlog to do that, then the way for firms to make themselves more attractive over the next year or so is to get into the markets that are more attractive.
Morrissey:
They either do that by making key hires or making acquisitions to do so, or they need to figure out how to deploy technology. And that's either generating it internally, leasing it, or buying it off the shelf, and then customizing it to adjust their business model, to really improve their technology game. Neither of those strategies are immediate strategies that can happen in a three to six-month period, so firms need to start making those investments now. For firms that only have 30 to 90-days worth of backlog, to make themselves more attractive for a buyer, they need to really cut out all extraneous costs, need to get themselves profitable, need to connect with their clients, and need to get as much backlog as they can in place.
Morrissey:
Those are the things that they need to do to position themselves for a sale, but even in that situation, and even if they do find a buyer, firms that are serving clients or markets that are being challenged are going to find it hard to find a buyer. Again, I come back to buyers being focused on quality. They're focused on the long term. And so they're planning to allocate their M&A resources to, to quality firms.
Host:
What about selling to insiders? Is that market slow right now? Has it stopped or is it continuing?
Morrissey:
It's continuing, although we believe it's going to run into headwinds into 2020 and 2021. If you look at 9 to 10% unemployment in the nation, there's a greater chance that, somebody's spouse or partner has either been furloughed, um, or has lost their job. So, if you're a potential owner in an engineering firm and your partner has lost their job, your kid is graduating from college and can't get a job because of a 9% unemployment rate and is stuck at home with you, then it's harder to have that kitchen table conversation and say, "Hey, I need to invest a hundred thousand dollars in my company to support the ownership, transition plan," because the money just may not be there.
Morrissey:
This is what we saw in the last recession. Ownership transition plans broke down in the industry, and we saw a spike of M&A activity 12 to 24 months after the recession as firms realized that they just weren't having the capital inflows from their employees and potential owners to support the plans while they were digging out from, uh, the wreckage of the recession. So we expect to see internal ownership transition plans be challenged again over the next 24 to 36 months as we come out of whatever we're in the middle of. And in particular, when we come out of the challenges after 2021, because again, we think that 2021 is going to be a real challenge for the industry.
Host:
So in this situation with, with the uncertainty, with the potential for a bad year coming up, how do you value a company? Are they the standard valuation techniques or is there some sort of percentage allocation for uncertainty?
Morrissey:
Yeah, that's a great question. And actually there should be some sort of percentage allocation for uncertainty, Valuation is one of those professions that has a hard time in pivoting to a new reality and it is pretty much stuck on the axiom that valuations of a firm are based upon forward-looking cash flows for the entity. In a time of great uncertainty, however, forward-looking cash flows become hard to forecast. Most firms in our industry have a hard time forecasting a year anyway and beyond a year becomes challenging. So when you look at valuations done in the industry, and you look at the projections that are used for those valuations, they make you scratch your head sometimes. And also when you consider that in the middle of the year, the publicly traded firms in our industry withdrew their guidance, meaning that they weren't going to provide estimates as to what was going to happen going forward.
Morrissey:
You can see how it makes it much harder for smaller privately held firms, which are the majority of the ACEC membership to do so. The way that valuation adjusts is, the valuation folks assign a higher discount rate, which just means they put more risk into the model, and that tends to drive down valuations. So that's sort of a theoretical perspective, but that's not necessarily what we have seen in the marketplace. My contention to our team was if deals are falling 50% in the spring, then let's figure out if valuations have also fallen 50%. And what we found was it wasn't the case. In the data set of deals that were done in the spring and the data set of deals that were done in the summer, the valuations are not that dissimilar from the valuations that we saw pre-pandemic, in January and February or in 2019.
Morrissey:
So what really happened was, instead of buyers beating up on sellers and looking for lower valuations as the pandemic played out, in the first stages, buyers just kind of withdrew. And so those valuations in theory went to zero, but in reality, they kind of stayed put, because many of those deals came back online in the summer. Also, when you're buying an engineering firm, the last thing you want to do is start with an evaluation and then if things change, try to beat up on the seller and say, "Things have changed, We're only going to buy it for 50% of what we said." That's just a lousy way to start a relationship and it really doesn't help integration.
Morrissey:
So what happened was the deals where buyers felt that there was quality, they stuck with those valuations through the deal-making process. Where there was uncertainty, about half of the deals in the U.S. stopped. They just stopped. Now the deals are coming back. What we've seen in the late summer, what we're seeing in August is those valuations are pretty much picking up where they left off prior to the pandemic. So, I urge everybody listening to the podcast to take these metrics with a grain of salt and don't apply them specifically to your individual firm, but what we saw at the high end and what we're still seeing at the high end, in the upper quartile, is multiples of EBITDA in and around the seven range, seven times trailing 12 months; EBITDA multiples in the medium range of about five or north of five; and multiples in the lower quartile of a little under four and a half. So we haven't seen the valuations change that much from a real-life perspective in the marketplace.
Host:
What do you think might happen to valuations if the market does struggle next year? Do you expect to see a gradual tailing off or do you think this trend will continue?
Morrissey:
So I think what we'll see is a bifurcation of the market, actually a continued bifurcation of the market. Quality firms--firms that have got really strong backlog, firms that have got something special about them, firms that serve attractive clientele, firms that are located in a great part of the world in terms of the outlook for engineering services, firms that have proprietary offerings that they have developed and where there is demand--those firms will continue to see strong demand and strong multiples and high multiples. Generic firms--firms that are vanilla firms that don't have anything special about them, firms that are followers rather than not leaders, firms that have to sell--they're either going to find lower multiples await them with not very attractive terms or they are going to find that there's no buyer for them. That's where I think we're headed and that's where that's the market that we're in now.
Morrissey:
In 2019, there were 317 deals. Not all of those firms were getting the higher multiple. Smaller firms tend to get the lower multiples. Smaller firms tend to have fewer options and may need to sell rather than choose to sell. And when you need to sell, when you have to sell that's when the deals that are in front of you generally are less attractive. And that gets to the interesting nature of selling your consulting engineering firm. The best time to sell is when the economy is doing well, when your market you're doing well, when your firm is doing well from a financial perspective, and to do it before you're 60, because then typically a buyer is going to lock you up for three years. And so at 63, which is still relatively young given all of the advances in healthcare and science, you've got two great decades ahead of you to decide if you want to work or consult or go and sail the Caribbean. Most owners don't figure that out. And most owners end up looking to sell when the economy is not good when their markets are not good, when their firm's financial performance is weak, and when they're 65 plus, and they have lost all of the leverage that they could have had in any negotiations,
Host:
That's a great lesson, right there, I'd say for people to listen to it because that seems to me to cut right to the heart of it. But just one more question and then we'll let you go. What kind of financial arrangements are you seeing as far as how the deals are structured?
Morrissey:
We're seeing the same basic packages as pre-pandemic. So cash, notes paid over one, two, or three years, stock, and earn-outs. Pre-pandemic we were seeing more cash, more notes, more stock, less earn-outs. Post pandemic, what we've seen is buyers moving more consideration to the earn-out component and moving it away from the guaranteed components of either cash or note payments over one, two, or three years. And that I think is just an acknowledgment that, the market is less certain for both buyers and sellers, and buyers are looking to hedge their bets with the amount of money that they guarantee in a deal.
Host:
Which, given the pandemic, sort of makes sense.
Morrissey:
Yeah, I think it does, but I also think, and this is what we saw again in the last recession, there's a whole bunch of received wisdom and conventional wisdom in our industry, and that has played out in the fact that M&A has declined over last year, which is not unusual. In general, when there's a recession or a pullback in the economy, M&A does decline, and indeed, M&A was down 19% in May and June year-over-year, but now it's back to just down 10% or so. But I think, when you dig into the details, once again more and more deals are being done by these private groups. So while employee-owned firms and ESOP firms have pulled back from the marketplace, the private equity firms are still buying because that's what they do. And if you consider a mantra of buy low and sell high, while the marketplace in general recognizes the pandemic and acts appropriately, and most of the ACEC membership acts conservatively, a number of these private equity groups, who are very, very skilled buyers, are seeing this as a buying opportunity and a way to position themselves ahead of the market recovery. And I think that's something for the membership and the listeners to be aware of.
Host:
It's a good place to end. I appreciate your taking the time to talk to us about the market. Thanks so much,
Morrissey:
Thanks for having me on, I really enjoyed it. Great to be with you.