As the demand for infrastructure assets continues to grow, infrastructure investors are increasingly looking beyond traditional core infrastructure assets and turning their attention to infrastructure services businesses. Among these, engineering and design firms that design, build and maintain critical infrastructure have emerged as particularly attractive targets. These firms offer many of the same appealing characteristics as traditional core infrastructure assets, such as stable and predictable revenue supported by long-term contracts, strong secular tailwinds and regulatory barriers to entry arising from state licensing requirements. However, these same regulatory barriers and the specific risks associated with engineering work create unique challenges that require careful navigation. Below are five key legal considerations for infrastructure investors evaluating opportunities in engineering and design firms.
- Corporate Practice of Engineering (CPOE) Laws. Some states regulate who can own and operate an engineering and/or architectural (or similar) design firm, often through corporate practice rules that require entities engaged in engineering or design to be either wholly or majority owned and controlled by licensed engineers or other licensed professionals depending on the firm’s specialty (for instance, architecture or land surveying). Acquiring 100% of any such firm without proper structuring can inadvertently trigger state licensure and compliance related violations, potentially resulting in (i) penalties or loss of the firm’s license, (ii) fines or licensure infractions against the professionals employed by the non-compliant firm or (iii) contractual limitations regarding the ability to legally provide engineering or design services in a certain state. A common solution is a dual-entity structure, where a state-law compliant professional entity (owned by licensed engineers) provides engineering and design services, while a separate management company (owned by the non-professional investor) provides non-professional management services and receives payment for such services through a management services arrangement. This structure must be carefully tailored to each state’s laws. Investors should work closely with legal counsel to map out the CPOE requirements, ensure qualified engineers are involved as required, and plan for contingencies if a key engineer departs. These types of issues can sometimes be discovered by the state when the firm applies to the state board of engineering for licensure.
- Contractual Risk Allocation and Insurance Adequacy. Engineering projects often involve significant financial and safety risks, including the potential for latent defects that may not be discovered until years after a project is completed. Investors should review all standard form and major customer contracts, focusing on (i) whether liability is capped and, if so, how (e.g., fixed dollar amounts, multiples of fees or insurance limits) and (ii) whether there are any exclusions that could undermine the effectiveness of these caps, such as carve-outs for third party claims. At the same time, investors should assess the adequacy of the firm’s insurance coverage to ensure it matches the scale and nature of the firm’s projects and to identify any coverage gaps.
- Subcontractor Diligence and Risk Management. Many engineering and design firms rely on subcontractors for specialized work, but the primary firm typically remains responsible to the end customer for all work performed, including work performed by its subs. Investors should review subcontractor agreements to ensure that key obligations (such as performance standards, indemnification provisions and insurance requirements) are properly passed down. Investors should also confirm that the firm has processes in place to verify subcontractor qualifications, insurance and performance history. Weaknesses in these areas can expose the firm to liability for subcontractor errors or failures.
- Customer Concentration and Pipeline Stability. Some engineering and design firms depend heavily on a small number of clients or projects, which can make revenue streams unpredictable. Investors should analyze revenue by customer and project over several years, assess the reliability of the project pipeline, and determine whether any recent revenue is artificially inflated due to one-time events, such as government stimulus or a demand pull-forward. Additionally, investors should review customer agreements for termination-for-convenience clauses and understand how frequently these rights have been exercised.
- Talent Retention and Non-Compete Agreements. The value of an engineering and design firm often hinges on its key engineers, who may hold essential relationships and licenses. Investors should consider implementing retention strategies, such as equity rollovers or long-term incentive plans, to keep top talent engaged post-acquisition. Additionally, acquisition and employment agreements should include robust, enforceable non-compete, non-solicit and confidentiality covenants, tailored to comply with applicable state law. For dual-entity structures, these covenants should run in favor of both the management company and the professional entity to ensure comprehensive protection.
Conclusion
Engineering and design firms can offer compelling opportunities for infrastructure investors seeking to invest in infrastructure-adjacent assets. However, the sector’s unique legal and operational complexities require a thoughtful, diligent approach and close coordination with experienced counsel.
