Market Forces, Income, Assets – and Handshake Deals All Matter

Valuing a construction company differs significantly from valuing other types of businesses due to the unique nature of the industry. Several factors come into play when assessing the value of a construction company, and these distinctions often require specific approaches and methods used for asset-intensive companies. 

Construction companies rely heavily on machinery and equipment and use a modified accrual basis method of accounting, such as percentage to completion. Unlike technology or service-oriented businesses, where intellectual property or brand value can play a significant role in valuation, tangible assets and projects in a company’s backlog often influence the valuation of a construction company. Generally, a separate real property and equipment appraiser will also need to be engaged by a company’s management team. 

Additionally, construction company revenue is typically project-based, with different projects proceeding along different schedules, sometimes resulting in significantly variable revenue and cash flow from one project to another. The quality of a construction company’s accounting and finance department also matters, specifically its understanding of unique construction-related accounting procedures such as WIP (work-in-progress) reporting and its impact on cash flow. Valuation professionals must consider the pipeline of projects, the historical success rate in completing them within budget and the potential for cost overruns. Project backlog and the ability to secure future contracts become critical indicators of a construction company’s valuation. 

Valuation Approach 

Valuation of a construction company typically calls for the use of three different methods – the market approach, the income approach and the asset approach. While the focus is heaviest on market and income factors, a valuation expert will often shift to the asset approach for certain types of construction companies.  

Not all construction companies are created equal.

Some are focused on residential construction and others commercial construction. But there are many specialties that require a construction company to own more equipment and machinery assets, such as industrial, environmental and public project (roads, bridges) construction. Additionally, companies that build public infrastructure operate in a more regulatory-intensive environment, introducing government incentives that will influence a valuation analysis. 

Impact of Risk 

Construction projects are inherently risky, involving various uncertainties such as weather conditions, labor shortages and unforeseen site challenges. Unlike businesses with stable, predictable cash flows, construction companies face a higher degree of volatility. Valuation models need to account for these uncertainties, often requiring more complex risk assessment methodologies. 

Factors that impact a construction company’s risk profile can include economic uncertainty, over reliance on certain customers or types of projects, geographic concentration and the potential for violation of state and federal safety standards. Valuation professionals will examine a company’s recent history in all these areas and factor the results into the valuation. 

But the valuation professional will also take into consideration risk-mitigation factors. For instance, if a small construction company has a design-build side to its business offering architectural services in addition to construction, this expands its professional services profile and reduces exposure to economic volatility by neutralizing the company’s reliance on construction for all of its revenues. 

Value of a Handshake Deal 

Smaller construction companies often are family owned and have lists of loyal customers for whom they have built many projects over the years. Some of these deals are no-bid contracts that are agreed-upon with a handshake. Handshakes are impossible to place a value on, but a valuation professional will take these relationships into account when looking at a company’s historical performance. What percentage of business over the past five years has been handshake business, and what percentage of revenue did it account for? If the company is to be sold in the next year or two, what is the likelihood that those handshake relationships will remain as repeat customers for the business once the current owner is gone? 

Business valuation is a forward-looking process that is guided by a company’s historical performance as well as prospects for growth.

So a buyer must be assured that historical relationships that have accounted for a large portion of a company’s success will be there for them when they take the reins. While business valuation professionals are experts in forecasting economic and industry trends, they also must have a deep understanding of the role personal relationships play in a company’s success. 

Valuation professionals employ industry-specific methodologies and technical knowledge to ensure that construction companies are valued fairly, and that their valuations help owners meet their goals. If you would like to explore a business valuation for your construction company, contact an Adams Brown advisor