By - Jeremiah Grant
Last Updated - October 8th, 2024 8:53 AM
Oct 08
Figuring out what your architecture and engineering firm is worth can be tricky. Every firm is unique. You might be planning to sell your share or buy into a new partnership. There are three main ways to value a firm: market-based, income-based, and asset-based. Each method has its own pros and cons.
Experts often mix these methods to get the most accurate firm value. Knowing how each approach works and what affects a firm’s worth helps you through the valuation process. This way, you can make sure the deal is fair for everyone.
Architectural firms, like many service-oriented businesses, require detailed analysis to accurately assess their value, drawing on approaches similar to those used for other professional services. This is commonly seen when valuing a consulting business as well.
The global architecture industry is forecasted to reach a market value of $313.8 billion by 2027, with significant growth in sustainable architecture expected at a compound annual growth rate (CAGR) of 7.5% from 2021 to 2028. In the U.S. alone, over 113,000 licensed architects contribute to the industry’s evolution, where sustainability remains a top priority for 72% of firms. The adoption of technologies like Building Information Modeling (BIM) is also accelerating, with 84% of firms planning to invest in it within the next year. Moreover, the global architectural, engineering, and construction (AEC) market is set to grow at a CAGR of 10.3%, reaching $24.36 billion by 2032, driven by advances in digitalization and public sector investments in infrastructure projects.
Find the Actual Worth of
Your Architecture Firm Today!
Be it opportunities for growth, investment, or exit, receive tailored insights for all with our specialized architecture firm valuations.
Valuing an architectural firm involves several methods. The main ones are the income approach, market approach, and asset-based approach. Each method has its own way of figuring out a firm’s value.
1. Income Approach
The Income Approach is based on the principle that the value of a business is fundamentally tied to its ability to generate future earnings. It looks at how much revenue a firm is expected to earn in the future and discounts those earnings to present value using specific financial models. The two most common models used in this approach are:
Capitalization of Cash Flow Method (CCF)
This method is ideal for firms with stable earnings that are not expected to grow or change drastically over time. It calculates the value by dividing the firm’s expected cash flow by a capitalization rate (a rate of return that accounts for the risk and time value of money).
Example: Imagine an architectural firm generates $500,000 in annual cash flow, and the capitalization rate for similar businesses in the industry is 10%. Using the CCF method, the firm’s value would be calculated as:
Firm Value = Annual Cash Flow/Capitalization Rate
= 500,000/0.10
= $5,000,000
This calculation indicates that the firm’s value would be approximately $5 million.
Discounted Cash Flow (DCF) Method
Unlike the CCF, this method is used when a firm’s earnings are expected to fluctuate over time. It estimates future cash flows and then discounts them to present value using a discount rate that reflects the risk associated with those earnings.
Example: Suppose an architectural firm expects cash flows of $400,000 in year one, $450,000 in year two, and $500,000 in year three, with a discount rate of 8%. The present value of these cash flows would be:
After calculating each term, you would add them together to determine the total present value of future earnings. This would give a more precise valuation considering the time value of money and the risk involved.
The Income Approach is often favored for its focus on profitability and its adaptability to different revenue scenarios. However, it relies heavily on accurate cash flow projections and the assumption that future earnings can be reasonably predicted.
2. Market Approach
The Market Approach values a firm based on comparisons to similar companies that have been recently sold or are publicly traded. It assumes that if similar firms are valued at a certain level, then the firm in question should have a similar valuation. This approach commonly uses valuation multiples, such as:
Price-to-Earnings (P/E) Ratio: This multiple compares the firm’s market value to its earnings. For example, if similar architectural firms are selling at a P/E ratio of 5x, and your firm has earnings of $300,000, the valuation might be:
Firm Value = Earnings × P/E Ratio = 300,000 × 5 = $1,500,000
Revenue Multiples: Another common metric is the multiple of revenue. For example, if comparable firms are valued at 1.2 times their annual revenue, and your firm’s revenue is $2 million, the valuation would be:
The Market Approach is straightforward and widely used, and in many industries, such as when appraising gyms, architecture firms and more, understanding market value relies heavily on comparable sales and market trends. If similar transactions are scarce, this method may not be as reliable.
3. Asset-Based Approach
The Asset-Based Approach calculates a firm’s value based on its net assets — tangible and intangible. This method adds up the value of the firm’s physical assets (like property, equipment, and inventory) and intangible assets (such as patents or trademarks) and subtracts liabilities.
Net Asset Value (NAV): This method looks at the difference between the firm’s total assets and total liabilities. It is particularly useful for firms that have substantial tangible assets or those that might be winding down.
Example: If an architectural firm has equipment worth $1 million, buildings valued at $2 million, and liabilities of $500,000, the NAV would be:
NAV = Total Assets − Total Liabilities = (1,000,000 + 2,000,000) − 500,000 = $2,500,000
This means the firm’s value based on its assets alone would be $2.5 million.
Note: An architecture firm that owns a valuable property in a prime location might find its asset-based valuation higher than one based on income or market comparisons. If the real estate itself is worth significantly more than the firm’s operational profits, potential buyers might consider the property as the primary asset.
The asset-based approach is often less emphasized in valuation due to the complexity of measuring intangible assets, a challenge common in sectors beyond just architecture like in the case of a hair salon appraisal.
Each valuation method offers unique insights into the worth of an architectural firm. The Income Approach focuses on profitability and future earnings, making it ideal for firms with stable revenue streams. The Market Approach leverages comparable sales to determine a fair market price, which is effective when similar transaction data is available. The Asset-Based Approach provides a baseline value based on tangible and intangible assets, useful primarily for firms with significant physical assets or those planning to liquidate.
In practice, a comprehensive valuation often involves a blend of these approaches to provide a more accurate and balanced view of a firm’s worth. Understanding these methodologies helps owners, investors, and potential buyers make informed decisions and negotiate better deals, ensuring that the architectural firm’s true value is realized in the marketplace.
Factors Influencing Firm Value
When valuing an architecture firm, look beyond the usual methods. Key factors like client concentration and the role of “key personnel” play a big part in its business valuation, affecting a firm’s market position as you could also witness when getting a law firm valued.
Client Concentration
High revenue from one client can hurt your firm’s value and marketability. Buyers see it as risky, fearing loss of a big client could cause big financial issues. To boost your firm’s value, aim to spread out your clients and projects.
Key Personnel
A “key man” – an employee vital to your firm’s success – can affect your firm’s value. Losing this person could lead to big financial and operational problems. Buyers will lower your firm’s value if they think there’s a chance of losing such an important employee.
Knowing how these factors influence your firm’s value helps you prepare for a better valuation. This is crucial whether you’re selling or just want to increase your business’s worth.
How to Value an Architectural Firm?
Finding the fair market value (FMV) of an architectural firm takes a detailed look at different methods and factors. To get a true picture of a firm’s worth, use the Income Approach, Market Approach, and Asset-Based Approach together (as discussed earlier).
The Income Approach looks at the firm’s past and future earnings, like revenue and profits. It calculates the present value of what the firm will make in the future. This is key to figuring out its total value.
The Market Approach compares the firm to others in the industry. By looking at what similar firms sell for and their valuation ratios, you can understand the market’s view of value. Then, you can apply this to your firm.
The Asset-Based Approach values the firm’s physical and intangible assets, like equipment and patents. This is especially useful for firms with lots of assets or those focused on assets.
Other things also affect a firm’s value, such as:
Client Concentration: How much the firm depends on a few big clients and what happens if they leave or change.
Key Personnel: The value of the firm’s leaders, designers, and other key team members.
Using a mix of these methods and considering these factors gives you a full and accurate view of the firm’s worth. This is important for owners, investors, and others who need to know the firm’s true value. They use this info for planning, succession, or when making big decisions.
Valuation Multiples for Architecture Firms
There are three main ways to value a business: income, market, and asset-based methods. But, industry experts often use valuation multiples for a quick look at an architecture firm’s worth. These multiples make it easier to value a business by focusing on key financial numbers.
Top Valuation Multiples
The top valuation multiples for architecture firms are:
Business selling price to gross revenues or net sales
Enterprise value (EV) to EBITDA
Business sale price to EBIT
These multiples are trusted because they show a smaller range of possible values. They make it simple to estimate a firm’s value by looking at its financial performance.
Example Valuation Using Multiples
Let’s say an architecture firm has $600,000 in net sales and $200,000 in EBITDA. Using a 0.5x multiple for net sales and a 2x multiple for EBITDA, we can estimate its value. This puts the firm’s value at about $348,414.
Net sales: $600,000
EBITDA: $200,000
Valuation multiple for net sales: 0.5x
Valuation multiple for EBITDA: 2x
Estimated value: (Net sales x 0.5) + (EBITDA x 2) = $300,000 + $48,414 = $348,414
Valuation multiples offer a handy way to quickly figure out an architecture firm’s value. They work alongside more detailed methods to give a full picture.
The Importance of Professional Valuation
Getting a professional valuation for your architecture firm is key. It’s important if you’re thinking of selling, planning for the future, or just want to know what your firm is worth. Without a professional check, owners might accept low offers without knowing the true value of their business.
On the other side, sellers might think their firm is worth more than it really is, scaring off buyers. A detailed valuation by an expert gives a clear view of what your firm is worth. It highlights what makes your firm valuable and helps with both short-term and long-term planning.
The benefits of getting an architecture firm valued include:
Setting a fair and defendable asking price for the business
Finding ways to improve the firm’s operations to increase its value
Understanding the firm’s financial health and performance clearly
Helping with succession planning and a smooth ownership change
Strengthening your position when talking to potential buyers or investors
Professional valuation is very important for architecture firms. Knowing the real value of your business helps you make smart choices. It helps you get the most out of your investment and sets your firm up for success in the future.
Find the Actual Worth of
Your Architecture Firm Today!
Be it opportunities for growth, investment, or exit, receive tailored insights for all with our specialized architecture firm valuations.
When selling an architecture firm, you might sell to an outside party or someone already working with you. Each buyer type has its own set of considerations.
External Buyer Due Diligence
An external buyer will do a lot of research before buying your firm. They’ll look at your financial statements, tax returns, and details on contracts and customers. They’ll also want to know about your company culture and how it matches their goals.
This due diligence is key for external buyers. They need to know everything about your firm to make a smart choice. It helps them figure out a fair price and check if the deal is right for them.
An internal buyer, like an employee or partner, already knows your firm well. In this case, you should have a clear plan for passing on responsibilities smoothly. Whether the buyer is outside or inside, the deal’s terms matter a lot. Both sides need to plan carefully for a successful sale.
Conclusion
Figuring out what an architecture firm is worth is hard. It takes a lot of knowledge about different ways to value, the industry, and the market. By using the Income Approach, Market Approach, and Asset-Based Approach, experts can give a full and trustworthy look at a firm’s value. They also look at things like how many clients a firm has and who the important people are.
Getting a professional valuation is key for owners of architecture firms. They might be selling, planning for the future, or just want to know their business’s market value. Knowing the value of their firm helps owners make smart choices, negotiate better, and set their business up for success. It’s important to know how to value architecture firms, understand what affects their value, and see the benefits of getting professional valuations.
In case you need some expert hands in getting your firm valued, feel free to reach out to our team at Arrowfish Consulting. We’d be happy to provide a free consultation and see if we are a good fit and could help you out.
Jeremiah Grant
Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.
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