Preparing for transition
Selling a Construction Company: Four Areas That Build Value
Brian Buwalda died accidentally in the wake of hurricane Irma. He will be deeply missed by our CLA family. Brian’s writing skills provided readers with informative, relevant, and interesting articles. Month after month his stories were the most viewed on the construction industry web page. His life and his writing have impacted many, and we are grateful to have known him and his work.
As construction company owners contemplate the eventual sale of their business, their daily focus should shift from running the business to positioning it for transition. One of the key considerations in preparing for the sale is maximizing the value.
While many would say that maximizing profits maximizes value, owners need to understand the other factors buyers consider when assessing the value of a company.
Many methods are used to value construction companies, but the most common method for profitable contractors is an income-based approach. The basic premise is this: A buyer wants to acquire all of the assets necessary to produce a future cash-flow stream that adequately compensates the purchaser for the investment.
Two key factors are involved in arriving at a valuation under this approach:
- Future cash flow
- The investor’s required return on the equity investment (and the perception of risk)
So it’s fair to say that companies that produce steady profit streams with little risk will be valued higher than companies that produce inconsistent profits and expose the buyer’s investment to greater risks.
We believe there are four areas that drive value in a construction company. Our experience has shown us that owners maximize value when the company focuses and performs well in the areas of finance, growth, execution, and leadership. Strong performance in all of these segments will both maximize cash-flow and mitigate risk to the future owner.
Financial: cash flow and working capital
Future cash flow is increased and purchaser risk is reduced when the contractor has consistent and improving profitability, manages its working capital well, and maintains an up-to-date technological and management information systems infrastructure. The company’s equipment should be well-maintained, so the buyer will not be faced with costs due to deferred maintenance. A company that is ready for sale will have managed its exposure to liabilities related to its past performance. In evaluating the purchase of a company, buyers will perform due diligence to determine whether the expectation of future cash flows would be diminished by factors that would reduce revenues or by the additional capital needed to cure existing issues with the company’s assets or obligations.
Growth: diversify and stay competitive
Buyers believe they will realize a better return on their investment when the construction company has achieved adequate diversification or specialization in key areas. Companies need to be positioned well regionally among the competition and have a clear standing in the local marketplace. A consistent, but manageable, backlog of work suggests an intentionally and professionally managed workload. Particularly within mature markets, a high-value company will have modern, well-maintained equipment and a well-educated and technically savvy workforce. Growth will be enhanced when a company has clearly demonstrated that it understands its capabilities and strengths in the marketplace and has adapted well.
Execution: manage capacity, quality, and reputation
Value is maximized when a company understands and manages its capacity, aligns its leadership to drive results, meets customer demands (with respect to price, delivery, and quality) and understands the regulatory and operating complexities in which it operates. The best-run companies do what they say they will do, when they say they will do it. In most communities, it doesn’t take too much digging to uncover a company’s reputation for quality work and integrity. Due diligence in this area may include assessing the company’s track record with contracts, clients, financial institutions, or even past partners or employees.
Leadership: plan for succession
A company cannot be overly dependent on any one person if it is striving to demonstrate long-term profitability and growth to potential buyers. Owners need to take proactive steps to build a sustainable leadership team that is drawn from a culture of engaged individuals. To be considered a high-value acquisition, an organization must address succession from both a leadership and ownership perspective. Difficult issues may include family dynamics, timing of the transition of the business, and whether new leaders have well-defined roles and clear strategies.
Companies that have established sustainable leadership and management teams will be able to produce more consistent operating results with less risk to the buyer. To maximize the value they realize upon sale, owners should focus on managing the financial, growth, execution, and leadership areas of the company during the years leading up to the sale. When the owner tends to these four key areas, the value of the operation will be higher, and the transition to new ownership will be easier.