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KP Unpacked
Join serial entrepreneur KP Reddy for conversations and discussions around innovation, technology trends, and AI for startup founders, innovation catalysts & investors focused on the built environment (and beyond!)
KP Unpacked
Transforming AEC Firms into Private Equity Magnets
We're baaaaack! In this episode, KP dives into how AEC firms can step up their game to attract private equity investors. He takes a closer look at what financial sophistication really means for the industry, exploring lessons AEC firms can take from the medical world’s shift to commoditized services and predictable revenue models.
KP breaks down key strategies like succession planning, ownership transitions, and why leaning into operational efficiency can make firms stand out. He also gets into the big questions about monetizing data and creating business models that make financial sense for architecture.
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Speaker 2:All right, welcome back to KP Ready Unpacked. This is our opportunity or my opportunity, really to sit down with KP Ready and ask him, as he was thinking about it, as he was writing a recent LinkedIn post what was it that inspired that post? What was he thinking about as he created that particular post? And, kp, there was one that you posted on LinkedIn it's about a week ago as we record this but you were talking about AEC executives and private equity and everything that's thinking about growth in the industry. So let me just read the post and then we can go back and unpack this. It says I really enjoy the conversations that I have with AEC executives.
Speaker 2:Today I was having a conversation with the CEO of an engineering firm. I was giving my views of private equity and how. Ceo of an engineering firm, I was giving my views of private equity and how, for many firms that sell to the private equity, they may be doing so for a liquid event and that they don't see their firm growing. Essentially, they're selling their interest in the firm and then likely allocating to the public markets. It could mean that, on a risk-adjusted basis, they have more confidence in the stock market than their own company. And you go on after that to kind of unpack your ideas around that.
Speaker 2:So, first of all, from my point of view, as I look around maybe more the AE market because that's more my background I see a lot of this. I see a lot of private equity coming in. I see owners transitioning out this. I see a lot of private equity coming in. I see owners transitioning out, so to speak. There's a session plan turning into hey, let's talk to private equity, but you're out there talking all across the ENR 500, all across the AEC world, and obviously this came from a specific conversation with the CEO of an engineering firm. So when you had this conversation, maybe what's the context of that conversation? And then, do you think about the hybrid approach that you described? What's going on there?
Speaker 3:Yeah, I think one of the things our industry is going through is there's not a lot of sophistication in finance, right, these are maybe owner created firms or employee owned firms. These aren't, these aren't folks from high finance, right, that really look at the numbers in a way that, like a person who's in finance really looks at it. And I think the example I brought up was, you know, the idea of, like, you look at a medical practice and you see, you see what's happening there, right? So you have a medical practice. Your limitation to a medical practice is the doctor. Right, the doctor can see only so many patients. Everybody wants to see, you know, Dr Ready. Everybody's got to see Dr Ready. Everybody's got to see Dr Ready.
Speaker 3:Like that's who they have a relationship with, even though a nurse might take your blood pressure and weigh you and a PA might come and swab the back of your throat, whatever, but at the end of the day, it's a boutique relationship with a physician, and that's why you've seen the advent of executive medicine, right.
Speaker 3:So you know you have a doctor, that's your doctor and you see that doctor. You know that's the deal, but I'll pay a premium for that, right. So those are the premium boutique services. But if you look at most doctor's offices, so much of it is like the sniffles business doctor's offices, so much of it is like the sniffles business, the sprained ankle business, right. And so what the medical industry has figured out is if I keep my physician practice separate and I spin out or create urgent care centers, urgent care centers don't require doctors, you can have nurses and PAs. So that limitation of a physician, of that boutique person, doesn't matter, right? So the urgent care centers are never you know ready's physician group, it's, you know, urgent well, or like they're all branded, like they're heavily brand oriented and heavily technology oriented. So what the industry has done is like let's bifurcate kind of the high value out and then take the low value, highly repetitive, very predictable business, and put it over here.
Speaker 3:And so urgent care is almost like a retail business, more than a physician's business. And what private equity wants is they want highly predictable revenue and cash flow. They don't like the ups and downs. It's essentially an annuity business, in other words, they have a guaranteed income every month after month, with some modest growth. The problem with things that are of high value is they tend to be high margin, but they also tend to be high risk and not that predictable. So when I look at what the AEC firms are doing, when they talk about innovation, right, for example, the high value things they want to do private equity doesn't actually want those. Private equity wants timesheets, utilization. They want the commodity business. They may say otherwise oh yeah, no, we really value your innovation. They don't value your innovation, right.
Speaker 3:And so what you look at, what's happening in private equity, is the firms that are being sold. Some of them are circumstances, right, ownership, succession, planning, issues. However, one would argue that the businesses that are most attractive to private equity are the ones that are most commoditized. So, like you talk about in your advisory practice and your content, you're always talking about commoditization. So, like you talk about, you know, in your advisory practice and your content. You're always talking about commoditization, right. So one could say you know, become highly commoditized and you're a great candidate for private equity.
Speaker 3:The thing that I kind of is a little bit of a little bit irksome for me is when people like, oh, we're value and we're this and we're not a commodity, and then they sell the private equity. It's like a lie, right. It's like they're lying to themselves. If you are a great candidate for private equity, you are therefore a commodity business full stop, and I think these people know this because they're selling it. I'm talking to civil engineering friends that are walking away with $50 million selling their firms. They didn't even know what $50 million ever looked like.
Speaker 3:They're civil engineers like me, and then they're taking that money and what are they doing? They're taking liquidity out of their business and then they're putting in the stock market, in real estate, right? So what they figured out is having ownership in a private company. There's no liquidity, so there's a risk there, right, and the growth probably isn't there. When you have an S&P 500 that's now up 23% this year, their profits aren't growing 23%. Their balance sheet's not growing 23% in a year, right? So what it is, it's a reallocation. You have to think about it as a reallocation of capital to the low risk, low return, very predictable world of private equity, and I think that's the issue right. I think that's where people aren't really tuning in.
Speaker 2:You're talking about repeatability, the repetitive things, the commoditization, the predictable things. Yeah, I remember a few years ago when a lot of the technology and data and AI quote unquote AI started to come onto the scene. There's a lot of talk about data and the value of data, and in our mastermind groups, we're talking about data all the time. As we're recording this, I'm getting ready to jump on a plane to come down to you and we're going to host our one day mastermind event tomorrow. Ready to jump on a plane to come down to you and we're going to host our one day mastermind event tomorrow. There's going to be a lot of discussion of emerging technology and data, etc. Uh, amongst other things.
Speaker 2:But is there anything to the idea that we're headed to a point again in terms of of valve, in terms of the through the lens lens of the private equity, the value and the predictability, the value and the commoditization? Is there anything to the idea that the data that these firms are collecting let's see, maybe it's performance data. Whatever it is Is that also a value proposition for the private equity or is that outside of this conversation?
Speaker 3:Private equity. I don't care about that, Not unless it means you can squeeze more margin and more profitability, right.
Speaker 3:Which means, you know, in our industry, most of these private equity guys and gals, they're only in for five years, so their goal is to grow by acquisition, which is just piling on more commodities, right? Think of it as buying power, right? It's not value add, it is buy more commodities. And if you buy more commodity firms, you only need one CFO, you only need one CEO, right? So you squeeze your, your, your GNA and overheads, you're squeezing the crap out of that. You're turning out more cash, right, that's all they care about. You know, it's put a quarter in, get a cookie out. That's all they care about. They're not trying to do anything, anything different, which is fine. That's a business model. It's not a negative, right? And so, if you think about that, they need to be out in five years. So let's say, you have some data, you're on a path to be a data business. If you can't monetize it ie, I'm going to invest $5 million in my data business and you can't generate profits that exceed within five years. The answer is no. It's a short-term game, and I don't think without, realistically, millions of dollars of investment to build a data business. Let's forget about whether there's a market for it and just putting that aside, we know we're not starting a data business with 10 bucks. It's a dedicated team. It's probably $5 million a year in spend. So you're going to spend, let's say, $15 million over three years just to get going, which means you need to deliver like $100 million.
Speaker 3:I sold my BIM company, my BIM tech company. I sold it to a Reprographics company and everyone on my team made like $200,000 a year because they're all technology people. Right, we're in the Bay Area. Even then, everybody was making a lot of money. Well, reprographics firm the people in those little print shops are making like minimum wage, right? They're printing companies and a great financial crisis happened and the COO was, like you understand, on every blueprint that we print, we make and profit a nickel. So when you go off and you hire these people making all this money, do you know how many sheets of paper we have to print to make up for it, right?
Speaker 3:So if you think about $5 million of spend to invest in innovation, right? How many billable hours does the firm have to create to offset that? It's a lot and you're not going to get that payback necessarily in five years and there's too much risk to it. So the private equity people are like no, let's not do that, let's just do more of the same. I think the worst job right now for me. Everybody has their preferences.
Speaker 3:I would hate to be a chief innovation officer for a private equity backed company, because all of your innovation is going to be cost mentality. How do we use ai to reduce the number of people? How do we which is fine, there's a market for that. It's just not what I want to do with my life. Right, I want to invest money and create value add, and so it's the same thing. Why private equity and a lot of the firms? When they look at the venture capital side of the business, they can't understand. Like KP, you write $2 million checks to 10 companies each, so you deploy $20 million against 10 firms and you only expect one to survive and pay back everything. They can't even fathom it.
Speaker 3:The private equity people can't fathom it. No, yeah, or a lot of this, firms, firm executives can't understand my support.
Speaker 2:Sure, sure yeah, yeah, I mean coming coming from. I mean, as you said, the advisory work that I do is a lot of it is is centered around the idea of decommoditization. So you know, what you're talking about is sort of the opposite of where I would go in the decommoditization theory. But the reason, or and the reason that I've focused so heavily on decommoditization over the years, is that mentality right. They don't understand firm leaders don't necessarily understand how to create value that's not commoditized and, as you're talking about it, you know, private equity, that's a business model. Going in that direction is a business model. So if we look at this, and maybe in two different directions, if I'm a firm leader and, for whatever reason, I decide that I want to go down the private equity road, what do I need to prepare myself for that?
Speaker 3:You need to be operationally excellent. You need to have a great brand. You need to be so operate. If you're an architecture firm, it's not about great architecture, it's about operations. So you should be able to acquire let's say you're a 100-person architecture firm. You should be able to easily acquire a 25-person architecture firm, bolt them in, plug them in, integrate marketing, integrate ops, integrate accounting all the operational stuff. Kind of ignore the fact that they're an architecture firm. It's a staffing business, right. Treat it as a staffing business, right. So you're going to go through both them on and try to reduce as many operational costs as possible to keep your EBITDA going right, to keep your cashflow at least at pace, if not better, right, because you should be. So the question is, if you're a 100-person architecture firm and you look at your overheads, you look at your fixed overheads accounting, it, whatever can you hire a 25-person company?
Speaker 3:acquire them and get rid of all their fixed overheads, because that's the goal. So it's all about being operationally excellent. In fact, I would argue, if you're advising a firm, this is the idea of having the end in mind. If you talk to a 100-person firm and you're advising them, they said, hey, we want to sell to private equity. Your strategy should be the re-commoditization of the business.
Speaker 3:In other words hey, all those value add things that you're doing, nobody cares. It's about getting as many architects on staff, it's about churning as many billable hours as possible, keeping your costs low and generating and going after K through 12. You can't go after that new stadium because that's not a commodity, Because a private equity guy says, how many stadiums do you work on a year? And you're like, well, we get one every five years. Well, that's not predictable. Whereas if you say, oh, we do 20 school K through 12 a year and we're on the budget for this new SPLOST for the next five years ding ding ding, they're very excited.
Speaker 3:Don't do award winning, don't do any of those things. It's firehouses, firehouses, schools, maybe a few airports in there, right, things that are very programmatic and predictable is what people want to see.
Speaker 2:private equity wants to see on the regular. Yeah, so if you flip the script on that you say, okay, I don't, I'm not interested in going the private equity route, different business model, you know, I'm interested in the decommoditization rather than the re-commoditization. What does a firm leader need to do in that case?
Speaker 3:I mean it starts with having a plan Like what is the exit strategy? Right, what is the exit strategy? Because you know mortality is a. It applies to all of us, regardless of how much money we have, even though the Silicon Valley people are trying to live forever, but mortality is mortality. So I think you have to think about the culture you want to build based on the exit strategy. If your exit strategy is not to sell the private equity, then who are you selling to? Are your kids going to inherit it? Maybe Some businesses? You see that in the construction world a good bit and the professional service is a lot less because, that requires you forcing your kids to get engineering degrees or whatnot.
Speaker 3:They can't be an English major and be the head of an architecture firm. It's very tough. They have to kind of grow up in the business. Or is it going to be employee-owned? And if it's employee-owned, it has to be more about a culture. But I'll say the challenge with employee-owned companies you have to build a culture that attracts young people and indoctrinates them into wanting to be owners and not employees, because otherwise you run into the problem that we've seen with a lot of firms that their Gen Z and millennials were never interested in being partners and now, as the senior people are aging out, they don't have anyone to sell their stock to Right. In many ways, employee ownership's a massive Ponzi scheme.
Speaker 2:The ESOPs Right. They're kind of Ponzi scheme, the ESOPs Right.
Speaker 3:They're kind of Ponzi scheme. I mean, they're not illegal, but they're definitely a pyramid scheme in a way. Right, it's like in order for me to get my money out, I have to sell my shares to the next person, yeah, which means I have to convince the next person that it's worth something.
Speaker 2:So it's a new spin on ESOPs fables, except I think it's worth something. So it's a new spin on Aesop's Fables, except I think it's spelled differently. All right, well, to bring it back around, you started out this post on LinkedIn and you said you had this conversation with an AEC exec, a CEO of an engineering firm, and you're talking about private equity. And so this whole conversation, as we've been unpacking that LinkedIn post, we've been basically picking your brain on what is private equity? What is private equity interested in? Again, a business model. You know, I know that there are people that will listen to this or watch this and say, yeah, that that's, that's not why I'm in it. Fine, right, not your business model, but we've been talking about the business model of private equity, investing in AEC firms and maybe the re-commoditization, which is a little bit of a different spin than I'm usually focused on. So this is really interesting. Any closing thoughts on?
Speaker 3:Yeah, I think you have to look at your strategy and say when I look at my business, start to draw hard lines between what is value at high value versus what is a commodity and treat them as such. In this urgent care example I keep using this because of experience I had advising a group and it was so interesting they sold 20 urgent cares. They kept the real estate and signed 20-year leases with the private equity firm to rent the space because they didn't care about the real estate. And then they took that money and they plowed that into these med spa businesses that are not very predictable. They're high value. You know it's amazing what people. The margin on Botox is very high and they reallocated capital into the hype.
Speaker 3:So I think if you look at your business as pieces and parts right, and you say this is a commodity, this is value add, and put them in their appropriate buckets and operate them that way, them in their appropriate buckets and operate them that way, then if a private equity event happens, maybe you're selling your K through 12 studio off to private equity and guess what? They don't care about keeping you as the architect right. It's not important as long as there's registered architects to do the work right, so you might sell off your K through 12, take that money and maybe you're into stadium. You know stadiums and you want to keep a 10 person firm and only do stadiums do one stadium every five years. Plow that money into your stadium practice and then the founders stick around. They can only work on the high value product projects, right. There's this idea that you know you can split the baby is my point, but it takes a very finance and analytical approach to how you operate them.
Speaker 2:Yeah, I think that's a really great point. First of all, Most of the AEC world is not that financially sophisticated and may not understand or may not see that opportunity to split the baby as you said. Split it, take the repeatable part and then reinvest in the other.
Speaker 3:Yeah, when I was in engineering, we had a big geotechnical group so we had our own drill rigs. Drill rigs are high cap, capital expense, high commodity, high commodity, right, it's people drilling holes in the ground. It's it's not rocket science, right? Um, we ended up carving that up. We ran it as a separate business. In fact, we did drilling for other engineering firms and then we ended up selling it to a drilling company, right, we? It was a commodity, for we didn't need drill rigs as an engineer firm. Why do we have drill rigs? You've seen that with surveying, right. It used to be in civil engineering. Surveying was part of civil engineering, and then surveying started to get commoditized, and so that was the advent of surveying companies.
Speaker 2:So it's not like there's not precedence is all I'm saying. Yeah, yeah, yeah, that makes sense, and those are examples that I'm sure many people in the industry can identify with. So, as someone who's listening to this, a CEO of an engineering firm, an architecture firm, an AE construction firm, whatever it is that they're leading, whatever their organization is, who do they need to talk to, how do they learn more about the strategies and who do they get to help them with these strategies?
Speaker 3:I mean, I think we're well-equipped to help people, you know, depending on scale. And I think it is like the details of how you look at this stuff. I think it was, I think it's either Renzo Piano or Duda Payne. One of them does not do, they don't do CDs. They got into that business. They're like our value add is just design. We're not going to do door details. So, like there's other commodity firms, like we'll send that off to Genzer, right. Like the bottleneck of production and deadlines. That's not what, who we are, let's sell that business off and just outsource it, right. So I think you know those are the type of things that I think you and I think you and I talk about a lot having, um, you know, being the old guys in this industry.
Speaker 3:Um, you're six months older, so you're the old guy, but uh, but generally I think we've seen enough cycles and I think, since we've kind of got we're industry adjacent now a little bit, I think we see it. We just have that bird's eye view and we're like what the hell are these people doing? Like we just see it right, they don't see it, they don't see it.
Speaker 2:So I think a lot of it is just getting that third, that bird's eye view of what, what the hell you're building yeah, I think that is uh, I think that's a really good point and actually you know, as you say, that I'm thinking again. I'm I'm headed to the airport here very, very shortly and I'll see you for dinner tonight and we'll do our one day mastermind event tomorrow and then the following day, which is Wednesday, as we record, this is our AEC Summit 2024. And a lot of the information that's going to be shared at Summit this year is from outside it's industry adjacent, certainly. It's absolutely applicable, certainly, but it's points of view from other industries from outside the AEC, in hopes that somebody will hear this and say, oh right, I see that and I can think of how that can be applied here in the industry. About our now industry adjacency is really important. It's like listen, there are other ways that this is being done in other areas that can actually be applied here in the AEC world 100%.
Speaker 2:Yeah, all right.
Speaker 3:Well, I'll see you later today.
Speaker 2:Absolutely. My name is Jeff Eccles, I'm Senior Advisor at KP Ready Company and, as always, I'm joined by KP Ready. He's the CEO and founder of Shadow Ventures and also the CEO, founder and namesake of KP Ready Co. We do this thing called KP Unpacked, so that I can ask KP hey, what were you thinking when you wrote that post on LinkedIn? I want to know more. And hopefully you've been sticking around. You've been, uh, you've been sticking around. You've been listening to, uh, these, these podcast episodes and also following along kp on linkedin. If you're not, you're missing out lots of great nuggets shared there. Uh, just find them on on linkedin kp letter k, letter p ready r-e-d-d-y on linkedin. Go follow him there and then you can have a preview of what we'll talk about on the next KP Ready Unpacked.
Speaker 2:Thanks, kp, thanks to everybody that's out there listening and we'll see you somewhere sometime soon. Thanks, everybody.
Speaker 1:Thanks for listening to another episode of KP Unpacked. You can connect with KP Ready today at kpreadyco that's K-P-R-E-D-D-Yco, and additionally follow him on LinkedIn at wwwlinkedincom. Slash I-N slash K-P-Ready. You next time.