How construction businesses are valued
In the words of Warren Buffet, businesses are valued based on the present value of the cash you can take out of them over a lifetime. This is true in real estate investing, website investing and in buying a construction company.
In this article we will explore various risks and rewards that investors have to weigh when buying and selling construction companies.
Related
If you are considering selling your business and would like a rough valuation on your business, have a look at our construction business valuation calculator.
Prominent risk factors affecting construction business valuation
Unlike passive investments such as stocks. buying a small to mid-sized business means that you are responsible for the operation of the company.
This added complexity along with a much smaller number of buyers than sellers (for businesses under $10M profit) means that businesses sell for much lower profit multiples than their publicly traded peers.
Some of the many factors that buyers will consider when determining fair market value for construction companies are:
- Business age
- Is a competent management team and staff in place
- Does the business have tried and true operating procedures
- What is the businesses reputation
- How has this business weathered poor economic conditions. How defensive/syclical is the industry
- Is it easy to find talent in the businesses location
- Who are the businesses customers and how many are there
- Does this business have residual income and contracts
- Does this business employ union labor
- Rent/employment/leases and other outstanding contracts
- How many sellers are in the business and need to be replaced
- Is this an asset-heavy or asset-light construction company (asset light are typically favored by investors)
- Does this business come with any tangible assets (these are much easier to value than intangible assets)
- Size of the business. See our article on Selling A Construction Business
- Does the business have clean books and records
- Is the business reliant on new home construction
- Is this industry growing
- How stable and predictable is the free cash flow
- Can the business buyer safely forecast future earnings
- Can this business gain market share
- What deal terms will the seller accept
A spectrum of multiples for construction businesses
From the contractor who has an F150 and a Home Depot credit card to the 100 person team that nets $8M annually, the valuation of the business will change greatly.
Depending on how many of the above boxes your business checks and most importantly, how large the business is, construction companies will sell for 1 – 4.5 X annual profit. With more than half of these businesses falling somewhere between 2-3 X. A company’s value is always subjective and that is why these valuation ranges are so broad.
- We are defining annual profit as net profit available to shareholders, with an add back of the owners salary and deductions for any non-recurring expense.
- The multiple range given takes into account that only a portion of the payment is made at close in most cases, with the majority paid over the course of 3-4 years.
Construction business valuation examples
We have seen a great deal of misinformation on this topic in the market. So much so that we encourage you not to take our word for it, but instead, to look at construction companies on the market to get a feel for what they are asking.
When browsing the marketplace, keep in mind that unlike with a hot housing market, businesses will almost never sell for full price, sell within the first 6-12 months or get cash closes.
A far more typical scenario would be a seller pays the broker a retainer after being told the broker will get them 3.5 X profit for the business.
After 12 months on the market and rejecting 1 or 2 reasonable offers, the seller relents and lowers the price to 3 X profit. Another 8 months go by and a few interested parties setup visits but are unable to reach agreeable terms.
Finally, an offer comes in for 2.4 X profit, with 40% paid at close and 60% paid over the course of 3 years. The buyer asks that the seller stays on to run the business for another 6 months and train the new manager.
A $50K broker retainer for 3.5 X profit turned into a 24 month delayed retirement and a 2.4 X closing valuation with seller financing.
If you haven’t already, reach out to us at Minerva and see how we’re not your typical investment firm.
Do you need to let it go?
Maybe you think your business is worth 4x what our calculator tells you it is. Not a problem, you can keep it. We’ll never pressure anyone to sell.
Many business owners are shocked to find out how hard it is to sell a business. People assume that it could be no more difficult than selling a house. Get an appraisal based on a competitor, list it on the market and receive 5 cash offers. People who have spent time in the industry can tell you that this isn’t the reality at all.
If you are entertaining the idea of taking out a loan to grow your business or sell it altogether have a read of our financing a construction business blog. If it is still something that you’d like to discuss, give us a call.