Preparing for transition
Building Enterprise Value and Planning for Transitions
It’s your business — and most likely is your biggest financial asset. You have invested part of your life in building it. You have grown it by effort and by reinvesting what you have earned. You are profitable, but you wonder if there is something else you could do to prepare yourself and your business for the future.
It takes time to prepare for a transition that maximizes value for the current owners and ensures sustainability for the new owners. Read the full 2016 Construction Benchmarking Report for insights into the construction industry.
Thinking about the future inevitably raises the issue of how much your business would be worth if you chose to sell it. And naturally, an owner would like to maximize the sale price. So what might an owner do to increase the value of the business? How does one make sure it will retain its value after the owner transitions out? How does an owner plan for an orderly succession? One way to answer these questions involves exploring a model called the Value Triangle, which demonstrates how the discreet elements of a business work together to produce long-term success.
Enhancing and sustaining value is a long-term endeavor made up of many decisions and improvement initiatives. The Value Triangle provides an illustration of the essential components, or engines, of your construction business. The strength of the structure depends on all of the elements working in concert. If any element is weak, it affects the others and impairs the organization if it is not recognized and corrected.
Most businesses have times of both fast and slow growth, but this is especially true in construction. When looking at the growth engine, long-term growth is the goal. The conventional wisdom is that construction companies are opportunistic and that growth and contraction are facts of life dictated by the economy. While it’s true that the economy plays a big part in growth, the best companies plan for it and are positioned to respond. When planned properly, growth enhances value because it reduces the risk of over reliance on any one customer or type of work. A strong growth engine means construction companies must identify and pursue the right opportunities, and bid or negotiate for them in a way that enhances sustainability and value.
The execution engine describes how the business operates on a day to day basis. Execution is not just the ability to produce a quality product on time and on budget. Execution also measures how smoothly your organization runs. The best construction companies execute projects intentionally throughout their organization. They produce timely production reports; they are strong communicators; they have implemented industry safety standards; their decision making does not rest with one or two individuals; and their job profitability is understood and predictable. Furthermore, the organization has the ability to scale operations up or down to respond to the demands of the growth engine without causing unreasonable stress on the organization.
Strong execution requires a robust operating system that makes daily performance and continuous improvement the norm and something that’s not only desired but attained. Everyone in the organization is looking for ways to improve all facets of the operations while balancing costs and anticipating the impact of each decision. Best-in-class construction companies look for new technologies and incorporate them into operations with a purposeful and comprehensive plan. They continuously monitor all phases of operations for optimum performance. They are natural innovators because the execution engine continuously searches for ways to become more efficient.
Leaders are responsible for connecting the growth, execution, and financial functions. Leaders actively manage your most valuable resource — your people. Leaders orchestrate their employees’ efforts to achieve value. They help them develop skills, reward their work, and nurture relationships that encourage loyalty and trust.
One of the riskiest periods for a contractor occurs during a leadership or ownership transition. With the right planning and approach, this can also be a period of revitalization and new ideas. Many times contractors have a difficult time even thinking about how to begin a transition because they worry that it will negatively affect the company. They worry about their capital needs and the company’s reputation with sureties and bankers. A business driven by a high-functioning team has enterprise value. And if the business is driven by an individual owner, much of the enterprise’s value leaves when that owner leaves, and a disappointing valuation of the business would be expected at the time of a sale. However, if your leadership style is one that fosters a succession organization, your relationships in the business community will remain strong—and your valuation will reflect the confidence that the organization will continue to thrive.
It takes time to prepare for a transition that maximizes value for the current owners and ensures sustainability for the new owners. The best organizations start the process years ahead of an expected change.
The financial engine interacts with all of the other engines. Profitability and consistent cash flow fuel the investments needed to sustain long-term growth.
Conventional wisdom tells us that financial performance depends on a balance of management practices and marketplace dynamics, and average performers tend to blame changes in the marketplace as the most significant force impacting profits. But, in construction, high performers see management practices as the driving force behind profitability. Simply said, they see operating profitably as a choice.
When it comes to financial performance, decisions made by leadership and management directly affect the ability to consistently generate cash flow under varying market conditions and maintain adequate (but not excess) working capital. A healthy contractor decides to operate with a strong balance sheet. Management chooses best practices, such as adopting accounting policies in line with industry standards and implementing a strong control environment that encourages transparency. Leaders intentionally model strong communication skills when interacting with field and administrative teams. Finally, it is a leader’s decision to embrace strong risk management that includes proactive communications with banks, insurance agents, and sureties.
Understanding the Value Triangle helps contractors prepare for transitions
Using the concepts of the Value Triangle, you can strengthen the foundation of your organization and improve its ability to thrive even in difficult transition periods. Whether your strategy is to remain active in your business for the foreseeable future or to position it for a transfer to others, it is never too early to strengthen its sustainability by building its value. CLA can help you develop a roadmap and timetable to enhance your enterprise and ease the transition, no matter how near or far into the future that may be.
John Raiche contributed to this article. He is the CFO of Quantum Crossings in Chicago.