As with all businesses, a proper valuation is an essential step during an ownership transition of a construction contracting firm. However, due to the unique industry, this valuation can be a complex process that requires a trained, experienced analyst.
Because a good portion of a company’s value depends on its income-generating capabilities, most valuations involve some subjective analysis regarding future business and economic trends. In addition, many construction-related businesses rely heavily on the owner or a few key employees. A prospective buyer will naturally discount the value to reflect the loss of continuity.
Despite uncertainties, there are some proactive steps that construction company owners can take to increase the value of their businesses in anticipation of a sale. What’s more, even contractors who do not anticipate an imminent change in ownership can benefit from some basic value-building actions as a strong balance sheet can also help boost credit and bonding capacities.
Variables That Drive Valuation
One place to start when determining the value of a business for sale is to review recent sales or mergers involving comparable companies and similar circumstances. Such market-based valuations can provide a reference point, but because no two transactions are identical, an appraiser must make several adjustments and allowances.
Like the analysis of future business trends mentioned previously, these adjustments require some subjective analysis by the appraiser. In addition, when the comparable transactions involve privately held businesses, much of the relevant information may not be publicly available.
Regardless of whether the appraiser is adjusting the valuation to a comparable transaction or starting from scratch, the final valuation will consider a number of factors, which can be grouped into three broad categories:
- Assets. This includes real property, equipment, other tangible property, notes, accounts receivable, and various intangible assets such as a strong management team, a productive workforce, and a strong and loyal customer base. An equipment appraisal is usually a major component of a construction business valuation.
- Income. Estimates of future income will also depend on some intangible factors, particularly the management team and the company’s customer retention record. From a technical standpoint, appraisers often use either the discounted cash flow method or the capitalization of earnings method and then make adjustments to normalize projected earnings.
- Risks. Litigation risk and potential labor issues are obvious risk factors to consider, but other, less apparent types of risk affect value as well. For example, a company whose revenues come from a single client, or whose work is concentrated in only one type of project or one sector of the economy, is inherently less valuable than one with a more diversified portfolio.
Steps That Can Build Value
Those same three categories—assets, income, and risk—can provide a framework for building a construction business’s value in advance of a sale or other transition. If you are preparing your company for such an event, here are some practical steps you can take to increase the value of assets, improve income prospects, and lower risk:
- Build a strong team. A strong management team makes any business more attractive to a prospective buyer. What’s more, a group of experienced managers could themselves be good prospects for the sale.
- Clean up operations. Strip out non-operating assets and extraneous operations or spin-offs. It often is best to carve out real estate assets or other entities that can be easily separated from the main contracting business.
- Build the backlog. But do not let quality suffer in the pursuit of volume. Instead, find your high success areas and focus there. Analyze job histories to determine which projects produced the highest margins, while also studying the market to determine the best prospects for continued growth.
- Keep assets in good repair. Stay current on scheduled maintenance for vehicles and other equipment and replace aging equipment as necessary. A healthy backlog is less valuable if the new owner will need to replace old, worn-out equipment to perform the work.
- Get the business in order. Dispose of unneeded equipment, and trim back owners’ perks such as cars and personal expenses to be sure the company is running as lean as possible.
Of course, economic trends (local and national) and the roles of key employees will play a large part in the valuation of a construction contractor. But working with an experienced valuation analyst as early as possible in the transition process can help you maximize the selling price and be properly rewarded for your hard work of building your business.
It is never too early — or too late — in an ownership transition to benefit from the advice of a trained valuation analyst, especially one with experience in the construction industry. Dembo Jones’ construction industry specialists can help you maximize your opportunities and avoid the pitfalls. Contact us today.