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Evaluating the worth of your company can be complicated, so the earlier you start thinking about it, the better. We’re doing a two-part series on this exact topic on the podcast. This week, we start the discussion from the angle of the seller.
Topics we cover in this episode include:
- Reputation and client relationships
- Your skilled workforce
- Market trends and demand
- Estimating future earnings
- Due diligence requirements
LINKS
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com
TRANSCRIPT
[00:00:00] Wade Carpenter: Welcome to the Contractor Success Forum. In this episode, we are doing the first of a two-part series on what a construction company is worth. In this show, part one, we’re gonna discuss the value of a business from the seller’s perspective. So if you own or are thinking about running your own construction company and that’s of interest to you, stick around and let’s get into it.
If you’re new here, I’m Wade Carpenter with Carpenter Company CPAs, and my co-host Stephen Brown, with McDaniel Whitley Bonding and insurance is back in the saddle and we are really glad you’re back.
I know you’ve been recovering a bit, but how you doing?
[00:00:41] Stephen Brown: Doing good. I just had a surgery on my eye, it’s okay. It’s this one, if I squint a little bit, sorry about that. It’s still healing up, but yeah, I’m good to go. I’m glad to be back, Wade. I’ve missed it and I’ve enjoyed your podcast without me, but I’ve missed it terribly.
[00:00:56] Wade Carpenter: We missed having you. So glad you’re here. What are we talking about today?
[00:01:00] Stephen Brown: Okay. In the introduction you were talking about what’s a construction company worth? And that’s the two part series. What’s it worth from a seller’s and a buyer’s perspective? Now, the seller, the owner of the construction company, you’re starting a company. You wanna know what your company’s worth.
You wanna sell a company, you wanna know what it’s worth. You wanna retire and get out of business and let your employees or other family members take over the company. You wanna know what it’s worth. So that’s the idea of what we were gonna talk about is what is your company worth?
And there’s lots of ways to evaluate it and there’s a lot of perceptions. But, basically your company is your baby. You built it up from scratch. It’s an emotional entity. You’ve put a lot into it. You’ve made a lot of sacrifices to get to where you are. And it’s just, hard work and keeping your nose to the grindstone And in this situation, we were talking about just from an accounting point of view, there’s different traditional ways to value your construction company.
And that’s what we’re gonna delve into a little bit, Wade is it’s the different ways to evaluate your company your perspective and the understanding of of what you need to focus on.
Our second part’s gonna be a guest who is done both. He’s been a buyer and a seller of a construction company.
And we’re gonna talk with him about what he’s been through. Pros and cons, the wisdom that he’s picked up over the years of doing business.
Why don’t we get started? Let’s just say somebody’s coming to you, and you’re their accountant, and they say, what’s my company worth?
And would you just simply look at the first page where it says equity?
[00:02:44] Wade Carpenter: That’s one way to look at it. Earlier in my career I started to go down the valuation path and I had done some of that. I’ve gotten away from it over the years, but there are, generally speaking, eight different ways to value a company.
Some are a multiple of revenue. Some may be a multiple of net profit. Some of it could be around cash flow. A lot of it could be asset-based approach. And a lot of times when a valuation company does these, they will take some of these different factors and they’ll just marry ’em together.
And there’s a lot of things that go into it, and I don’t think we’re gonna get into the weeds today, but I think what we really wanted to talk about was some of the main factors of what drives a company’s worth in construction. Because of those eight factors, A lot of ’em are not relevant to a construction company.
Generally speaking, there’s two different valuation methods that they all fall into. One of them is more of an asset based valuation where, you’ve got, say a heavy equipment guy, with asset based, they’ve got a hundred thousand dollars excavators plus, a lot of that is tied to that equipment.
And for those guys the asset based approach may be relevant versus the second version is more of a market based approach where, it may not be tied to equipment, like a general contractor that subs everything out, they don’t have a lot of equipment.
So in general, does that make sense ?
[00:04:16] Stephen Brown: Yeah it does. I think it was interesting, you telling me the story of a venture capitalist offering one of your clients to buy their business, and they had come across a really good price. Your customer was happy, let his employees go right up into the closing where they changed the terms of everything and it was a no go.
So in that situation, you say my business is worth what someone’s willing to pay for it. That’s all but. Our point is, if you think about that separately, if I was gonna buy my business, how valuable is it? So you can say, is my business producing enough profit? Is my business heavily in debt if I work my way out of that?
All these things bear into mind of what you should think of as the owner of a construction company to increase the value of your business because it produces better results for everyone if you think on it from that perspective.
Reputation and client relationships
[00:05:15] Wade Carpenter: There’s a lot of things that go into a construction company that a lot of different industries wouldn’t see. The reputation and client relationships. A lot of times construction can be bid work. but, when you have a established customer that comes back time and time again, a lot of times retail, wholesale, they have repeat customers.
A lot of times that doesn’t happen.
[00:05:38] Stephen Brown: But they need something done and they know that you do it right and fast, they’re gonna call you. They’re a good ongoing customer base. There’s certain industries in town that call you for all their plant work. That’s a good source. But also, if you’re a subcontractor, you’ve got a general contractor that’s gonna use you first.
They’re gonna use your numbers, cause they know they’re gonna be middle of the road, but they know you’re gonna be outstanding in performing your work.
[00:06:04] Wade Carpenter: Like I said, the reputation can go a long way. Walking into a company, the backlog and what the pipeline you’ve got, if you’re out of work and there’s nothing coming behind it, that company probably could be valued less.
[00:06:20] Stephen Brown: Yeah, you gotta evaluate the jobs in progress and look at the estimates and see if they’re gonna hold up after the sale.
[00:06:29] Wade Carpenter: Yeah. Is that gross profit gonna continue on those jobs? Absolutely.
[00:06:33] Stephen Brown: And even so what is your ability to put more work like that in the pipeline? ’cause it just can’t stop while you’re talking about buying and selling a business.
Your skilled workforce
[00:06:42] Wade Carpenter: I guess another factor would be, if you’ve got a skilled workforce behind you, because a lot of times the knowledge is baked into the owner’s head. But if you’ve got a team behind you that, if that owner steps out, then it can continue, then that skilled workforce can be a factor in the valuation.
[00:07:01] Stephen Brown: Yeah, there’s a tangible cost to getting quality employees.
[00:07:05] Wade Carpenter: And keeping them.
[00:07:06] Stephen Brown: And keeping them. That’s right. You can measure that. And that’s worth something if you don’t have to do that when you’re buying it. So your workforce is everything. What you’ve built up. And their loyalty to the company and what you continue to do for them to help them feed their families and retire.
Market trends and demand
[00:07:25] Wade Carpenter: So there’s also things like the market trends and the demand. I think me and you really stay more on the commercial side, but a lot of our listeners, if they’re on the residential side, I think back to 2008. And there was a huge demand for these home builders, but after 2009, 10 for several years, there was no demand for home builders. So the valuation of a home builder went down.
[00:07:51] Stephen Brown: Yeah. Yeah,
[00:07:52] Wade Carpenter: Other industry?
[00:07:54] Stephen Brown: It is definitely trendy. You can predict certain trades too, that are gonna have more work depending on what’s coming out in your municipality or in federal government work. You can definitely tell which trades are gonna be worth more and where a buyer may be more interested in looking at that trade.
For example, Wade, let’s talk about say, HVAC contractors. For a while, maybe it was 10 years ago or whatever, these clusters were going like crazy. These mergers buying up your, local shops and it wasn’t venture capitalist, but that made sense to the bigger HVAC contractors just to be more of an entity.
[00:08:31] Wade Carpenter: I guess that’s coming back around ’cause I’ve got a $6 million deal working right now. One of our companies that they’re buying up one here in Atlanta.
[00:08:38] Stephen Brown: Yeah, so you know what they’re looking for.
[00:08:41] Wade Carpenter: Yeah.
[00:08:42] Stephen Brown: They’re one of your clients, you know what they’re looking for. But from a seller’s perspective, there’s certain things, Wade, that are maybe psychological from a seller’s perspective that might be holding up their objectivity as to what their company’s worth.
[00:08:57] Wade Carpenter: I know there’s a lot of factors in here that we could talk about. Technology and the systems and having the accounting system or the project management systems that could factor into it. But I agree. There’s a lot of things from a seller’s perspective, and I think that’s really the focus of today, and I know you’ve got a couple of situations you’re dealing with right now. Any thoughts from the seller’s perspective you wanted to jump into?
[00:09:20] Stephen Brown: Some sellers, they’re gonna look at the asset based evaluation.
And they’re gonna say well, you know, I got a lot of old equipment. Or I don’t have a lot of equipment. I rent a lot. I don’t have a lot of assets for you to buy from. Then they might say a market valuation, there’s a big demand for my type of trade. And I’ve got a good crew and I know what I’m doing, so that’s another way to look at it. I understand that.
But also how you perform and your reputation, that’s definitely worth something to a buyer. But of course you have to have that reputation and you have to prove that.
But how do you value that? We talked about looking at their backlog, gross profit and saying as a seller I have all these projects in the works. And a buyer might say yeah, but I don’t do what you do, and I gotta make sure they’re finished and they’re completed. So if it’s a contractor that’s buying another company that they know can do the same work that company can do, then it’s worth more value to the buyer and the seller.
So someone buying your company who does not have experience and established crew to finish your jobs would be on the downside because anybody that buys your company as a seller is gonna look at the current profit and the future profit to drive the financing of it.
So you may think as someone selling their company, my company’s worth all this. But think about the perspective of who’s gonna buy it. Why are you buying it, and what do you want to get out of it? And if you don’t know ’em, and they’ve come out and throw a crazy number at you and they don’t do what you do, then you need to know that financing is gonna be so heavily tied to your performance over X number of years, so they’re just buying your experience and abilities.
[00:11:13] Wade Carpenter: I think from a owner’s perspective, especially if they built it from the ground up and their blood, sweat and tears and they get this emotional attachment to their company. And unfortunately I think that perception can cloud their perspective that their company is worth more just because of the sentimental value and they know what they’ve put into this. Somebody if they’re buying it, they wanna make sure they can recoup their investment. They really could care less how much blood, sweat, and tears you put in there, and that probably is hard for a lot of owners to hear that they really don’t care what you’re, what you had to go through to get there.
[00:11:51] Stephen Brown: Yeah. That they don’t they can’t even if they’re doing what you do for a living and they want a merge in a buy and they’ve done all you’ve done. They’ve got their own horror stories of nightmares, jobs, and working around the clock and losing money on a specific job that just was a nightmare until it was completed.
All the costs were charged and then they could move on. But I can tell you from a surety bonding standpoint what a lot of surety underwriters look for is I’ve heard ’em call it before, like a phoenix contractor, someone who’s gone through really tough times and just strapped on their boots and built the company back up.
So the phoenix was the mythical bird that would burn and be reborn from its ashes. So that’s where that nickname came from, Wade. And, it is emotional when you’ve done that, it’s emotional, and then when you have a bonding company, say you don’t have enough net worth or, working capital.
They’re like, what do I need you for? You need a bond, but you’re thinking to yourself, I don’t need you to do this project. I can do it in my sleep. I don’t need your input. I don’t need your criticism, and all that part of it. The sooner that goes the better because it is all about, it’s all about working to get the job done for you, whatever it is, whether you’re gonna sell your company or whether you need a bond.
It’s about getting the job done and getting it worked out and making sure everybody’s pulling with the same set of oars, so you’re right, Wade. The psychological part of it is can be overwhelming.
[00:13:28] Wade Carpenter: Yep. Another factor I see is sellers they overestimate what the earnings are gonna be in the future, and maybe they’ve had a couple of good years where their revenue keeps going on up and maybe they got in this big project.
But what I see too often is, as that revenue goes up, that overhead goes up more than proportionally to what the revenue goes up.
I could give you several huge examples over the years where, they chase the big, the top line. We talk about it all the time on this podcast.
[00:13:59] Stephen Brown: it’s an ongoing thing.
[00:14:01] Wade Carpenter: Yeah, the profit never follows, but in the owner’s mind, their perception is like, Hey, we’ve got all this work. You’re gonna make all this profit, but if you’re running the same operation, a seller’s not gonna walk in and, see that you’re gonna be making more simply because you got more on the top line.
[00:14:18] Stephen Brown: You’re right. You’re at a family gathering and somebody’s yeah, your company’s doing good, man. What’s it worth right now? Yeah. We’re hoping we’re planning on doing X million dollars for sales next year. Whoa. And that really doesn’t mean anything.
It’s the profit that you make, that’s the worth. But then again, while you’re doing a job, you build up more worth in the company. Sometimes a construction project, finances, equipment, so there’s an asset that can be sold. It’s always adding extra materials and supplies to your stockpile that help out in little ways.
So the bigger your company gets and the more tangible assets it is something it’s worth a lot to you for sure. And then you gotta evaluate that to someone who’s buying your company as well and make sure they understand the importance of it.
[00:15:05] Wade Carpenter: Yep. Another thought I had on this was, they really don’t have an objective comparison. Maybe they’re in a trade organization, where, obviously they become friends. They’re competitors, but they’re friends and they talk. And one company that is, a lot bigger, maybe they were a $20 million company and they got, x number value, multiple of the revenue, and my $5 million company, that is poorly run, we should get that same multiple. So say that’s worth $5 million, but it doesn’t, they get this value in their head based on what other people have done, which may not be at all relevant because you’re not comparing apples to apples.
[00:15:50] Stephen Brown: I’m thinking about the insurance industry of which I’m a part of. It’s a percentage of commission income and that’s easily measured, but it’s paid going forward.
A lot of people selling their company anticipate just a big chunk of cash in a construction company or an insurance agent.
It doesn’t seem to work that way.
[00:16:12] Wade Carpenter: Nope.
I guess a couple other thoughts I had, we already touched on this, talking about the economy sours based on, home building, let’s just say. ’cause people understand that. Right now there’s probably a lot of federal contracting, I think with the Infrastructure Act.
But other times, federal contracting is not as prevalent as it might be right now due to the market fluctuations or what people want that can affect the value of your company.
[00:16:41] Stephen Brown: Absolutely. I can’t imagine the stress of inflation and interest rates on the home construction industry. What a stressful business to be in when you’re going all out and you’re trying to get your organization going at maximum capacity, and then it stops.
[00:16:59] Wade Carpenter: Right.
[00:17:00] Stephen Brown: On a federal standpoint, you’ve always got some infrastructure work that needs to be done by municipalities or by the federal government. There’s always buildings that are gonna get old municipal buildings, federal buildings that get old and need to be torn down and are replaced. There’s always gonna be water lines, electrical lines natural gas lines, fiber optic cables, everything else that’s run underground.
Where there’s a city, there’s gonna be drainage issues, there’s gonna be bridges, there’s gonna be asphalt paving, there’s gonna be concrete curbs and gutters. There’s gonna be electrical work, there’s gonna be lighting. It goes on and on. You gotta maximize your position and whatever trades you’re doing and that’s something that everybody’s working to do. That’s speaking to the choir, I think everybody knows that.
[00:17:49] Wade Carpenter: Yep. I also see others that think they probably command the same or similar multiple, but if they look at their statistics, their ratios, their KPIs, and compare ’em to their industry, a lot of times they’re under the industry average.
That may negatively impact the valuation. Maybe they do truly have a unique spin on, I’ve got one that was in the underground utility stuff and they had a patent on fire hydrants.
They felt like they had something that was worth more. the perception out there, nobody knew what this was. They didn’t see the value of this, so it was not any higher valuation based on a comparable business, even though they felt like in their brain that it really was a difference.
[00:18:40] Stephen Brown: Sure. That makes sense, and you might say you’re not recognizing our value, Mr. Potential buyer it’s not gonna work and then you wanna find someone else that’s gonna come buy your company. Say you’re the seller, the owner of the construction company, and you wanna put it out on the market to sell it.
Then you have to go through finding the right buyer that understands what makes you so special. So I guess Wade, if we were talking about it, will we say what are the best practices of doing both building up your asset and market value, and then the other intangibles, like you mentioned the patent.
I did have a contractor once that had developed a patent on a part to construction equipment. It was owned in the company name. It was an asset that was drawing in royalties.
There’s also the perception of the buyer of how much works out there, what is the potential of the company.
Exactly where is it now? How much cash are you bringing in? How much profit, how much net income. Their first perception is, okay, if you’re making a consistent 5% Profit and your overhead’s 5%, for example, I’m gonna come in and cut that overhead at 2% ‘ cause I’m bigger and that’s what we do.
That’s our key to making construction companies work is slashing overhead to nothing.
So if you’re generally making 10, 15% profit on your jobs and your overhead is seven, 8%, it’s just not as big a deal. So what are your thoughts on that?
[00:20:14] Wade Carpenter: Yeah, I see that too. And unfortunately, I’ve seen situations where you have these big national companies that come in and they do have the infrastructure to keep that overhead low. It can wreck the culture. Basically they gut the accounting department and the way they’ve been doing things and for every positive one, there’s ones that go wrong,
[00:20:33] Stephen Brown: Yeah.
[00:20:34] Wade Carpenter: Another thought I had on this was from a seller perspective, a lot of owners underestimate the due diligence requirements of this. They get to a certain age and say, I can’t be doing this much longer. Let me sell this thing and retire, and, we preach that all the time.
If you’ve never had really good books, going, in doing due diligence, a buyer’s gonna want to know, and have you be able to back up the numbers you have. So if you’ve only done a tax return and you pulled it together on a spreadsheet and taken it to H and R Block, that’s not gonna hold a lot of weight.
You gotta be ready for that buyer to come in and dig into your numbers, and if they can’t prove it out, it’s gonna impact your valuation.
[00:21:21] Stephen Brown: It is gonna be such a headache. It’s gonna cost so much to evaluate the business. The buyer’s gonna say, ah, nah. We want a company that runs a company correctly and they should have this, and this. But I can tell you there’s forensic accounting when there’s a divorce involved and there’s a family business, but forensic to me seems to be almost like a science from an accounting standpoint.
You’re digging into every number and you’re verifying it. You’re validating it. You’re looking for things that smell funny, that you know from experience. Let’s just talk about you’re a buyer and you’re looking at some projects that have lost a lot of money.
And then the seller’s not giving you an adequate explanation of what happened.
[00:22:05] Wade Carpenter: Yeah. I know we were just discussing that before we started.
[00:22:08] Stephen Brown: Yeah.
[00:22:09] Wade Carpenter: We have a situation like that.
[00:22:11] Stephen Brown: Yeah, and you gotta have some answers. If you’re selling your company, you gotta have the answers. You gotta know what they are. Or then the buyer’s gonna figure out what the answers are and value the business based on their perception of what it is. It’s not emotional, it’s just facts.
That’s the way they see it when they’re doing that evaluation, but I can also tell you that we talked about systems in places. We talked about the fact that if you buy an accounting software program, it’s worth, nothing. You bought it, you put it in your computer until you build it up and start using it, it starts working for you and it starts working as a tool.
Like any other tool in the construction industry, it’s worthless.
So your systems and processes are worth something to a buyer. Also it’s good for you. Now these are the kind of win-win things we were hoping to talk about in these next two podcasts, right?
[00:23:02] Wade Carpenter: Yep. There’s several other things that, that factor into it, and I’ll just throw a couple out quick ’cause I know we’re getting long on this one, but I love talking about this stuff. Sometimes people overestimate the risk, and I know that’s the business you’re in, but maybe they are doing some things that potentially have some really big downfalls if something goes wrong. I remember I had a contractor that did grading, but they had a specialization in if you had to move a river or water, apparently there’s a lot of regulation around that and there’s a lot of things that can go wrong with it. Even though it probably can command some serious premiums, it can also be some serious risks.
[00:23:45] Stephen Brown: It could be very profitable. It’s very risky. Yeah. But you know how to do it.
[00:23:50] Wade Carpenter: right.
[00:23:51] Stephen Brown: And that’s based on the podcast that we did about the Rembrandt in your attic. The thing that really drives the worth of your company, and it’s roughly tied into someone buying a house. After they buy the house, they find that there’s a Rembrandt up in the attic. What is your Rembrandt as a construction company? Like you said, we’ve had customers have to do boring underneath the Tennessee River, and the first one’s the toughest to bond, that’s for sure.
[00:24:18] Wade Carpenter: Yeah.
[00:24:19] Stephen Brown: Bonding underwriters, agents, they’re, we’re all standing on the bank of the river while, yeah, they’re explaining it to us, but that kinda expertise is worth, it’s–
[00:24:28] Wade Carpenter: Right?
[00:24:29] Stephen Brown: We’re sweating bullets, but the expertise is there and that’s worth something.
Of course. And we know that. And that’s something that you can’t always tell a seller and that’s why it’s so personal to you. But it also has a value.
[00:24:44] Wade Carpenter: Absolutely. And that knowledge and those key personnel, I think that may be something we may be talking about in the next part of this. But obviously that having that trained workforce and following behind you, can impact that value as well, and if those people leave, and those people leave, that can
[00:25:03] Stephen Brown: Are they happy?
[00:25:05] Wade Carpenter: yeah, exactly.
[00:25:06] Stephen Brown: Do they have family issues that you don’t know about? Do they have drug or alcohol problems that you don’t know about? Do they have gambling problems? Are they challenged by their work? Are they loyal to the company?
[00:25:17] Wade Carpenter: Yep. And that’s where, maybe
[00:25:20] Stephen Brown: to worry about.
[00:25:21] Wade Carpenter: yeah, a lot of things to worry about. But maybe tying them up so that hey, you’re gonna work through if we sell this company, then you’re gonna stay or whatever, and giving them some kind of bonus structure to lock them in can go a long way to helping secure a sale.
[00:25:37] Stephen Brown: That’s right.
[00:25:38] Wade Carpenter: I think there, there’s a lot of other things we could talk about. We’re getting a little long on this one. Any other final thoughts or things that you wanted to hit on this episode?
[00:25:47] Stephen Brown: No, just the most important thing that we talked about at the beginning. If you think about what your company’s worth now, whether you’re gonna sell it or not, you’re gonna make it more valuable. There’s a lot of things that make it valuable, and what makes it valuable to you is the most important thing right now.
It doesn’t matter what a seller thinks, but what makes it more valuable to you and a seller helps you do your business a little bit smarter, a little bit better, wouldn’t you say?
[00:26:14] Wade Carpenter: Absolutely and take more home when you go to sell it.
[00:26:17] Stephen Brown: I thought that went without saying, but then again, it doesn’t. You’ve got all these employees that go home at the end of the day and you take care of ’em, and they’re happy.
That’s fulfilling. You’ve got a great reputation for what you do, and that’s just not yours, but it’s your entire staff and all of you are proud of it, and you all celebrate it together, and that’s a wonderful thing. So that’s what we’re all about here, Wade on the Contractor Success Forum and also I’m looking forward to our next podcast.
To hear from a buyer and a seller construction company and just talk about what they went through and what they looked for when they went to buy a company. Okay. I hope our listeners enjoy it as much as we like talking about it.
[00:27:01] Wade Carpenter: Yep. And forgive me for the blinding flash of the obvious. Stephen, it’s good to have you back. We’re glad you’re healing up.
And thank you all for listening to the Contractor Success Forum. If you’re listening on a podcast engine somewhere, check out the show notes at our Contractor Success Forum dot com or on our Carpenter CPA’s YouTube channel for more information.
Consider subscribing to the channel and follow us each week. We will look forward to seeing you on the next show. Thanks.
