Originally published in American City Business Journals
By Shane Brown
Selling a construction company can be a challenging and deflating experience for an owner who spent years of toil to create his or her dream. After building a firm with millions in revenue that has provided an honest living for countless workers over the years, an owner expects to be able to retire in comfort by selling the firm for top dollar.
It seems like a reasonable expectation after so much effort and is exactly what so many construction business owners hear from their non-construction-business-owning friends and acquaintances.
Unfortunately, many construction company owners list their companies for sale and find it tough to sell then for book value, if at all.
However, with three to five years of planning, construction companies not only can become marketable, but they also can break away from the industry valuation norm of book value.
The reason why construction companies are often valued at book value — the firm’s assets minus liabilities — is the nature of the industry. Construction firms are often led by a singular, charismatic leader, meaning that a great deal of the firm’s value is tied up in the founder’s energy, presence and professional contacts. In addition, the construction business is highly cyclical, especially for general contractors and subcontractors. Construction has a 0.92 correlation with U.S. GDP, according to the U.S. Bureau of Labor Statistics, meaning that it’s among the industries most correlated with business cycle fluctuations.
During the Great Recession that followed the financial market meltdown of 2008, one Colorado-based firm suffered a 60 percent drop in annual revenue. It’s tough for any business that has to overcome such brutal peaks and troughs to sell for a premium.
Mindful of these principal risks — key-person and economic — construction company executives can take steps to increase the value of their firm by diversifying their business, grooming leaders and exploring sale options such as Employee Stock Ownership Plans.
The construction companies that are most likely to fetch premium valuations are those that diversify to counteract economic cyclicality and/or add service elements to their business. A general contractor could add a self-perform trade such as roofing with a heavy element of service and repair. A new-home builder could add a landscaping, plumbing or improvement division. This type of diversification would generate revenue even if the economy slumps into recession. The housing market may collapse, driving customers to repair and improve as opposed to build. A construction company that is able to obtain a measurable percentage of its revenue from service contracts that can stay strong through a new-build downturn will be able to increase the value and marketability of the company. The idea is to create predictability of earnings — perhaps the single most important factor when calculating a firm’s sale value. Service industries should give markets the option to repair and service versus replace, move, rebuild and expand.
In addition, firms can add specialty construction services that are less cyclical, such as insurance remediation contracts that are driven more by accidents, damages and weather, rather than the prevailing economic winds.
Beyond diversifying, building a professional management team that can continue growing the firm even after the founder retires gives a major boost to the value of a construction firm. Amazingly, only 24 percentof contractors have a formal plan for transitioning themselves out of their businesses, according to Gregory Caruso of Harvest Business Advisors. Even in situations where owners have been able to negotiate a book-value sale, the lack of leaders under the owner can prevent the completion of a sale where the buyer simply doesn’t have the capacity to send resources to completely run the target company.
Construction firms that build a layer of professional management and carefully diversify to blunt the cyclicality of their earnings and can create predictable revenue and cash flow can sell for valuations above book value, but this effort typically takes years of concerted effort to achieve — meaning this should be part of the company’s continual process of succession planning.
Of course, many contractors are more interested in their legacy and retaining the culture of their firm, rather than selling to a competitor or to private-equity investors. According to an Equipment World survey, nearly half of contractors would prefer to transfer or sell ownership to employees or family members upon exiting their businesses.
There are many other strategies for ownership transfers to management. One option is transferring ownership over time through an Employee Stock Ownership Plan. Firms with steady earnings can finance an ESOP by adding debt to finance the purchase, servicing that debt from ongoing cash flow, and by being a patient seller who is willing to stay engaged with the company as a creditor and leader to ensure transition success.
Ensuring corporate sustainability and succession are among the biggest challenges facing the owner of a construction firm, but getting it right is essential for any founders who are hoping to cash out on their success.
Shane Brown has more than 19 years of public accounting experience, led the construction industry practice at EKS&H for 10 years, and now leads overall industry niche development for the firm. He works with businesses on a variety of issues including financial audits, surety/bonding requirements, construction accounting, performance benchmarking and internal controls. He also has experience with employee benefit plan audits and compliance.