The Lowdown on Buying or Selling an Engineering Firm (in Austin, Texas and Beyond) – Part 3

Other M&A Contracts and Documents

Prior to signing the purchase agreement, a buyer and seller in an M&A deal often sign a letter of intent (LOI). The letter of intent lays out the key terms of the deal. It is usually non-binding, except for confidentiality and exclusivity (the seller agrees for some period of time – often 90 days). Still, it saves time to document the terms in an LOI and it usually fleshes out if a party if not really serious because, even the document is non-binding, it costs some money to negotiate if attorneys are involved and most people don’t want to sign a document if they don’t really intend to follow through and close a deal.

There are other important but ancillary documents that come up in the M&A process depending on the specifics of each deal. These ancillary documents include:

  • Bill of Sale
  • Bring-Down Certificate
  • Resolutions of Board/Managers and Shareholders/Members of Seller
  • Resolutions of Board/Managers and Shareholders/Members of Buyer

These ancillary documents are important to the merger or acquisition, although they aren’t usually the subject of heavy negotiation.

Assignments and Transfers of Contracts and Other Assets

One issue on which buyers and sellers of businesses and their M&A attorneys spend a lot of time involves the assignment of contracts. Remember all the “boilerplate” language included at the end of most contracts you’ve signed? Well, some of those contracts may have “anti-assignment” or “change of control” provisions, which can haunt the transaction and drive up costs as you work with other parties to get their approval for the merger or acquisition. One thing your corporate attorney (or someone else on your team) will do is review all your firm’s contracts and determine how to structure the deal to minimize your exposure to any existing agreements with anti-assignment or change of control provisions.

The general position in U.S. contract law is that contracts are freely assignable unless they say otherwise. U.S. courts like free trade. As with just about every area of the law, there are some exceptions, such as contracts involving professional or artistic skills (if our contract instead says I’ll pay you $100 to sing at my daughter’s wedding, your services are considered unique and personal and you can’t just assign away your obligation in that case). Nevertheless, the general rule is that contracts are freely assignable. So, if a contract (other than a personal services contract) does not have an anti-assignment or change of control provision, then you should be free to assign it to the buyer of your engineering firm without getting approval from the other party to the contract.

However, most commercial contracts say otherwise, i.e., they have restrictions on assignment. Often, though, the restriction is a prohibition on assignment that is only triggered in the case of an asset sale. If you sell the stock of your engineering firm, the contracts aren’t assigned at all. They stay in place with the company whose stock is being sold. All that is transferred is the actual stock – from the shareholders (or members in an LLC or partners in a limited partnership or another type of partnership) to the new buyer. The contract remains in place, untouched. Your stock changed hands, but no one assigned the contract.

The ideal way to handle anti-assignment provisions is to approach the seller’s counter parties (the other party to each contract) and ask them each to sign a Consent to Assignment. This takes time, though, and the counter parties tend to be slow to respond or may have zero interest in helping. If cost, time or counter party leverage plays against the parties approaching contract counter parties and obtaining consents to assignment, the buyer and seller will need to decide how to handle this issue. Your business attorney will be your ally during this process – and, indeed, the entire M&A process – so rely on their counsel.

Commercial leases and bank loans are particularly tough to assign. In a commercial lease, the landlord has a lot of leverage over the buyer. The buyer can’t easily go somewhere else. This represents an opportunity for the landlord to leverage the situation for its gain. With bank loans, the bank will be understandably concerned about the credit quality of the buyer. The bank did not underwrite the loan for the buyer – it was underwritten specifically for the seller. Moreover, assigning a commercial loan may trigger a “default” that results in repayment for all loaned money being due now.

I can only think of one deal I was involved in where the parties agreed to close the deal, knowing it violated a loan agreement. In all the other circumstances I can think of, the debt is paid off or the parties approached the bank before closing and the buyer was underwritten and the bank provided its consent. In that one case, it didn’t end well. The bank ultimately said, “No,” to taking on the buyer and the buyer was forced to scramble and come up with money to pay off the bank loan, which went into immediate default when the deal was closed. That was a business risk the buyer took. M&A deals are all about risk, but you want to be sure you fully understand where the risks lie and great advisors will help you do that.

Working Capital Targets and Work in Progress (WIP)

In stock purchases, where the purchaser acquires the stock (or other equity interests) of the seller (stepping directly into the shoes of the current owners of the seller stock), the purchaser usually takes over the accounts receivable and accounts payable of the selling engineering firm. This isn’t always the case in asset purchases. Sometimes, buyers don’t take over either the accounts receivable or accounts payable. Other times, buyers of engineering firms take over one and not the other. Buyers, of course, prefer to take over the accounts receivable, not the accounts payable.

When buyers agree to take over both accounts receivable and accounts payable, the parties will typically negotiate a target figure for working capital. Determining working capital — a way of measuring an engineering company’s efficiency — is simple. To get working capital and see how financially healthy the firm is in the short term, you just subtract current liabilities from current assets.

Because it isn’t usually feasible for a seller of an engineering consulting company to know exactly what the working capital is on the day of the closing, the seller usually delivers a preliminary balance sheet to the purchaser at or right before the closing. Over the next few weeks, the buyer will perform its own calculation of the actual working capital of the business on the day of closing. If actual working capital is less than the target figure, the seller pays the buyer a true-up payment. If actual working capital is more than the target, the purchaser pays the seller a true-up payment.

So, if you structure the deal as an asset purchase agreement, you will probably not have to deal as extensively with working capital. But if the deal for the engineering firm is structured as a stock purchase, working capital and working capital targets will more than likely pop up. It is important to have both experienced M&A attorneys and accountants who can help you with these provisions.

Your deal team will also help you with a semi-unique feature of engineering firm transactions. In engineering firms, an issue that doesn’t show up in most deals in other industries involves work in process (or work in progress). We’ll refer to both as WIP.

Because most engineering firms work on long-term projects with flat fees, they often have current projects in progress when a buyer swooped in to purchase the firm or the owner decides to sell. WIP becomes a consideration for the buyer who will want to understand where the project is relative to the fees that will be billed for the project. Is the project coming along on time and is it over or under budget? If the project is performed on a flat fee basis and the remaining work is much greater than the amount left to bill, either because the seller front-loaded the fees or mis priced the project and is having to put in more time than it will be paid for, the buyer will look to the seller for compensation. After all, no one wants to buy a business where there is a lot of work promised to customers but for which the customers no longer must pay. A similar issue pops up with gift cards in retail businesses – it’s the same basic principle. Buyers want to understand what they’ll owe to customers but for which they won’t be able to charge those customers.

Why Purchase an Existing Engineering Firm Rather Than Starting One?

To understand M&A, it’s important to understand the motivations of buyers and sellers. Sellers are generally looking to cash out and go do something else or realize joining a larger firm through a sale and acquisition may provide better opportunities to compete in the marketplace. Buyers, on the other hand, are generally interested in quickly gaining market share in existing markets or buying their way into new markets or new service lines. There are other motivations to do M&A deals, although these are common ones.

Buying an existing firm has its benefits. Buying may be quicker and give you an established clientele from the start. The name recognition may be another benefit, but only if the firm has a stellar reputation among engineering clients. But before acquiring an existing engineering company, buyers should conduct thorough due diligence to see whether it’s a good idea to buy and to understand why the current owner is selling. Owners may sell because the firm is not doing well financially, or the owners are exhausted and just want out. As part of the investigation, buyers should evaluate the reputation of the selling company. The Better Business Bureau serves as a trustworthy resource for potential buyers to see reviews of engineering firms and customer disputes. You may be able to solve tangible problems like poor project workflows, for example, but it can be hard to salvage a burned reputation. Nevertheless, an inefficiency may be the driver behind your interest in acquiring the firm so you can correct the inefficiency and improve financials, so even a damaged reputation is not a deal killer per se.

Buying a financially successful engineering firm comes at a premium. For a successful firm in the engineering industry, a buyer will pay a multiple of sales, not just the asset value. If a business isn’t financially successful, that doesn’t mean it isn’t worth buying. New management may be the solution to turning the place around, although tread cautiously. You want to be 100% sure it’s poor management and not a bad reputation or some other insurmountable issue. And, keep in mind that convincing employees or customers to stick with the firm once it changes ownership can be tough. You must communicate to them that management has changed and, even then, some won’t think it’s worth the risk versus going somewhere more “reputable.”

Licensing and Permitting

Whether the buyer of an engineering consulting firm in Texas is acquiring stock in the engineering firm or assets or merging companies, the purchaser wants to make sure that they are getting a legally compliant business. Part of legal compliance is ensuring proper licensing of the company and engineers working in it.

The website for the Texas Board of Professional Engineers lays out the requirements for working as an engineer in Texas clearly: “Under the Texas Engineering Practice Act, only duly licensed persons may legally perform, or offer to perform engineering services for the public. Furthermore, public works must be designed and constructed under the direct supervision of a licensed professional engineer. The terms ‘engineer’ or ‘professional engineer’ can only be used by persons who are currently licensed. Anyone who violates these parameters is subject to legal penalties.” You can read more about the requirements to become a professionally licensed engineer in Texas here.

If the buyer plans on hiring certain engineers as part of the merger or acquisition, then it will look for assurances that those engineers have all licenses in place and can practice in Texas. The key requirements for being a licensed engineer are:

  • Must have graduated from an approved curriculum in engineering or related science (B.S., M.S., or Ph.D.)
  • Depending on degree accreditation, must have a minimum of 4 or 8 years of creditable engineering experience referenced by a P.E. (Professional Engineer), and
  • Must have passed the Fundamentals of Engineering (FE) Examination

Again, this information is from TBPE’s website.

The second item of concern for buyers of engineering firms in Texas is the required permits. While the State of Texas does not require a general business license, regulatory agencies may have licensing and permitting requirements based on the type of business. For engineering firms, the State of Texas requires that “any entity offering engineering services to the public of Texas must register with the [TBPE].” The buyer will want to make sure that the new entity or merged firm meets the TBPE’s requirements for permits so that the firm can continue running as a profitable business.

To register an entity, an engineering firm must complete the form “Firm Application for Registration.” For information on engineering firm licensing requirements in other states, read this American Bar Association 50-state survey of engineering firm licensing requirements.

Ultimately, the buyer of an engineering consulting firm will want to make sure that the licenses and permits for the firm and its engineers are updated and in compliance with all applicable laws.

Other Considerations When Buying Engineering Firm  

I talked earlier about the weight of debt on the financials of any business. Instead of borrowing money, you can also take on investors and give them equity in your engineering consulting firm in Texas. But whenever you raise capital from investors, you must comply with federal and state securities laws. So, it’s time to call an attorney. Specifically, experienced corporate attorneys who can help you navigate these issues and how to structure the deal.

What if you want to have those investors play a more direct role in your engineering consulting firm? Well, then bringing them on as partners might be a good option. Having partners to share the workload and to commiserate on down days (these exist in any new venture – trust me!) is invaluable. For a few of my thoughts about structuring business partnerships, check out these articles:

Additional Resources for Growing an Engineering Firm in Austin, Texas

If you purchase an engineering firm in the Austin, Texas area with the intention of growing it (possibly to sell to a different purchaser), you can find a great list of resources here, although I list a few key ones below, as well.

Austin’s Small Business Program http://www.austintexas.gov/department/small-business-development-program
This site a great starting point for anyone starting a small business in Austin. Here, you’ll find classes, events, and more.

Locally Austin http://locallyaustin.org/
A tool for locally owned small businesses in the Austin community. It can serve as a great resource to research other businesses in your field and a place you should definitely list your business if you’re local to Austin.

Austin SCORE http://www.austinscore.org/
Receive mentoring and advice from local volunteers and fellow entrepreneurs.

BIG Austin http://bigaustin.org/
BiGAUSTIN is a Central Texas non-profit for entrepreneurial education, tailored business counseling and flexible loans

Texas Economic Development Corporation Resources https://texaswideopenforbusiness.com/resources/reports-directories
At the TxEDC, you’ll find loads more resources from economic reports by industry to legal requirements and tax structures.

Capital Factory https://capitalfactory.com/
Capital Factory is a hub for entrepreneurs in Austin. It’s a co-working space, incubator, and great source for education and networking opportunities.

Tech Ranch https://techranchaustin.com/
Tech Ranch is another supportive entrepreneurial community local to Austin. You can find a co-working, office space or programs to help grow your endeavor.

How does a Mergers and Acquisitions Lawyer Help?

While lawyers won’t usually help with the engineering firm’s client relations or business development, a business lawyer can help you navigate the path from owner of an engineering company in Texas to whatever your exit option might be – think retirement or your next endeavor. You should think of an experienced corporate attorney as the quarterback of your legal team.

As a corporate attorney, I help engineering companies raise capital (securities law), purchase existing engineering firms or other businesses (mergers and acquisitions law), sell engineering firms and handle a wide variety of other transaction and contract-related issues, including negotiating and drafting master service agreements. I do this in Austin, Houston, Dallas and other areas of Texas and the United States.

If you want a trusted advisor to jumpstart your new venture, call me at 512.888.9860. I am happy to discuss your plans for the engineering firm. As your business attorney, I can help you accomplish your goal of selling or buying an engineering consulting company.

If you haven’t already be sure and read:

The Lowdown on Buying or Selling an Engineering Firm (in Austin, Texas and Beyond) – Part 1

The Lowdown on Buying or Selling an Engineering Firm (in Austin, Texas and Beyond) – Part 2

 

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Author: Brett Cenkus

Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.

2020-11-30T17:35:32-06:00