Construction Business Valuations

Many contractors might consider a business valuation when they decide to sell their company. However, these detailed analyses can prove useful in many other circumstances, such as when applying for loans, speaking with investors or setting up a business succession plan. It is important for construction business owners to understand some of the unique value drivers and considerations involved when a business valuation is performed.

Value drivers

Various “value drivers” are common to construction companies. These include:

• Project backlog, an indicator of future revenue potential and operational stability,
• Profit margins, which may reflect cost management and bidding/pricing strategies,
• Professional reputation and relationships that lead to repeat business and new opportunities, and
• Access to an established, skilled workforce, which enables the company to perform quality work in a timely manner.

One particularly positive value driver is the existence of an experienced management team capable of estimating costs accurately, managing projects efficiently, and maintaining a track record of financial discipline and safety.

Also important is the quality and condition of a business’s hard assets. These include real estate holdings; machinery, tools and equipment; and technology, such as drones, wearables and sensors, bidding and tool-tracking software, and enterprise resource planning systems.

Considerations

Valuing a construction business involves various considerations due to the numerous risks associated with the industry. The industry is inherently cyclical, making economic fluctuations a significant threat. Market downturns can lead to project delays or cancellations, affecting cash flow and profitability. Weather conditions and natural disasters further contribute to unpredictability.

Cost volatility is also common. Supply chain disruptions and economic trends can cause materials and labor prices to fluctuate, eroding profit margins and even causing companies locked into fixed-price contracts to incur losses. Regulatory and compliance requirements, as well as tariffs, can introduce unexpected financial burdens.

For small or family-owned construction businesses, dependence on key individuals poses yet another risk. For example, if a company’s success is closely tied to its owner’s expertise and reputation, transitioning to new leadership may prove challenging. This may, in turn, reduce the business’s value. Moreover, related-party transactions require adjustments to ensure valuations reflect true market conditions.

Accounting Methods

The accounting methods used by a construction business affect its value, too. Many use percentage-of-completion accounting, recognizing revenue as projects progress. However, smaller companies may use the completed-contract method, deferring revenue until jobs are finished. Without proper adjustments, these differences can lead to inaccurate comparisons and misinterpretations of financial performance.

Three Common Valuation Approaches

When working with construction companies, valuation professionals usually consider the following three general approaches:

#1 The asset-based (cost) approach

Based on the business’s net assets, this approach essentially subtracts liabilities from the fair market value of tangible and intangible assets. It may be especially relevant for construction companies with substantial equipment and real estate holdings. However, it tends to undervalue businesses with strong earnings potential but few tangible assets.

#2 The market approach

Here, a valuation professional compares the subject company to prices paid for similar publicly traded and private businesses. The use of public stock prices is typically uncommon in the construction industry because of differences in company size, project diversity, management quality and geographic scope.

 Sometimes valuation professionals turn to private transaction databases for comparable data, refining their selection criteria to account for customer base, size, location and transaction date. Finding reliable comparables for construction businesses is often difficult.

#3 The income approach

This approach projects a company’s cash flows and discounts them to present value using a risk-adjusted rate. For example, the discounted cash flow method is commonly used to value construction businesses.

Experienced valuation professionals understand how to incorporate key value drivers and risk factors into cash flow forecasts and discount rates. Values derived under this approach include goodwill and other intangibles, which may be significant assets for construction companies.

If you decide to obtain a valuation of your company, work with your CPA and a qualified valuation professional.

As always, should you have questions on this or other matters affecting you or your business, please call 215.675.8364 or email us to speak with us today.

DISCLAIMER: All communications by Wouch, Maloney & Co., LLP intend to provide general information, as of the date of the communication, and may reference information from reputable sources. Although our firm has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. Please be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.