We previously featured a column that went through the basics of determining the value of your construction business (“Don’t Sell Yourself, or Your Construction Business, Short”). I intentionally didn’t get into any “numbers” — just the process an owner should go through to get ready to determine a reasonable number that can be supported by historical facts and future expectations.
It’s important to keep in mind that even if you do your homework properly or have worked up a valuation at some time in the past, the “number” will change as market conditions change, especially the future market conditions in your area. Remember, what folks are buying is your future cash flows. If those are expected to flatten out or decrease, prospective buyers will not be enticed to overpay based on historical achievements.
On the other hand, a company may have equipment valued in excess of the cash flow multiple used to value the business. In this case, the equipment value should be the number used to value the business, if in fact the equipment can be financed and repaid out of the business cash flow over a four- to five-year period. There will be circumstances, however, where the equipment payment may not be covered by cash flow, which would require a reduction in the price.
Calculate the Value Metrics
Construction company value metrics will change depending on the type of business you have, the asset investment required to operate the business, the history of profits and cash flow and the current backlog of business compared to backlogs from prior periods. When reviewing public companies, values are expressed as:
- Percentage of sales
- Multiple of earnings
- Multiple of cash flow
- Multiple of book value
- Orderly liquidation value of operational equipment
The metrics are different for different types of construction firms. For example, the mega construction firm Fluor has the following metrics as of September 19, 2015:
- Price/earnings of 9.5
- Price to trailing 12-month sales of .31
- Price to book value of 2.0
- Price to cash flow of 6.0
Considering Fluor is a public company, I would suggest the metrics for your private company may be on the more conservative side. On the other hand, if you really make a great buck and will continue to do so based on your operation and the time in this market, your multiples could exceed those of Fluor or any other public construction firm.
Remember, cash flow is king. Asset values are also important. And if you own property, that figures in, as well.
Fluor is selling for six times cash flow, which is only 30% of sales and 9.5 times earnings. Based on my experience selling equipment dealerships and rental companies, some of the valuation models would suggest that 10 times earnings or five times EBITDA (earnings before interest, taxes, depreciation and amortization) is in the ballpark. The EBITDA numbers somewhat represent what cash flow is available to cover debt service interest and taxes, and in some ways puts a price on the business considering that a purchase loan should amortize over five to seven years.
So for those of you selling, determining cash flow for the next 24 to 36 months will be most important when talking value with potential buyers. Knowing the orderly liquidation value of your equipment is also toward the top of your “To Do” list.
Make sure you clearly state how sales are projected and how those sales will convert to cash as the work is being done or the job is closed. To get to this point, make sure you are using industry standards to promote your opportunity.
If you are uncomfortable with this scenario, get some help or guidance from someone who knows the industry and how valuations are produced.
Since projecting construction work can be iffy at times, a seller may have to consider more flexible sales terms that give the buyer confidence that he/she will be able to pay off the purchase price. It is not uncommon to offer up some form of installment payment that is tied to top-line numbers without any deductions. Hit the number and you get another payment until the entire purchase price is paid off. In such cases, these types of terms can generate a higher premium, which benefits the seller.
Here is what I would do if I was considering a sale:
- Produce a clean set of books and tax returns.
- Prepare a history lesson on your cash flow.
- Prepare projections using reasonable assumptions
- Use industry standards for accounting purposes.
- Determine what your tax bite will be.
- Determine what your “take home” is net of tax.
- See if you can find a public company in your line of work.
- Get some help if you need it.
As I have mentioned in the past, my friend Ken Hedlund (317-472-2103) certainly knows the industry and has folks who do valuations for a living. Whether you are a seller or buyer, Ken is able to guide you through the process. (And yes, I did consult with Ken prior to drafting these comments.)
Buying or selling a construction company is one of the most important decisions you will ever make. In short, you can do it “right” for a reasonable amount of money. I know too many folks who have been trying to sell their company for 10 years — and I always wonder why they are still at it. Do you want to be that person?
Garry Bartecki is the managing member of GB Financial Services LLP and a consultant to the Associated Equipment Distributors. He can be reached at (708) 347-9109 or firstname.lastname@example.org.