Whether valuing a construction company or a business in another industry, there are specific principles which must be taken into account by every analyst in accordance with business valuation standards. In addition to these, the valuation of a construction company also entails the consideration of specific components which are unique to the construction industry.
In many other industries, unless there are changes in the economy or management indicates otherwise, the valuation analyst can use historical operations to project the future earnings capacity of company under the premise that customers will stay with the company and the business cycle will continue to repeat itself. This projection of future earnings is much more difficult in the construction industry. Although the company may have customers and contracts today, it cannot be assumed that those earnings will remain steady and grow into the future; the sustainability of construction revenues is highly dependent on the continuing availability of the specific contractor’s work. Once the existing contracts are completed, what does the company do next? In the construction industry, backlog, or work not yet completed, is a much better indicator of what earnings the company is expecting in the future. By ignoring backlog, a construction valuation could easily go astray.
Often, the most important asset of the construction company is the equipment which is either purchased or leased. The equipment can sometimes have a value significantly higher or lower than book value and could require a qualified equipment appraisal to determine a fair market value. Moreover, leases should be analyzed to determine remaining lives and the potential for increased costs as replacements become necessary.
Many contracts require the company to be bonded to provide the project owner assurance that the job will proceed as scheduled. In order to obtain the bond, the company is often required to meet strict financial covenants. It is important to understand whether the company is generally subject to bonding, such as is required in the public sector, and to analyze whether the company can continue to meet the financial covenants to obtain the bonds.
The construction industry fluctuates between highs and lows, typically over periods of between five to ten years and is extremely sensitive to changes in both the overall economy as well as fluctuations in interest rates. Additionally, the cycle is often different for commercial, residential and infrastructure construction and varies upon the company’s level of specialization and whether they are operating in the private or public sector.
In construction, most jobs are contracted based upon a highly competitive bidding process. The ability of the company to continue developing bids that are both attractive to the customer and profitable to the company is paramount in determining future earnings capacity. Furthermore, the company may be dependent on key relationships with suppliers or vendors in generating their current bids. If the company is relying on one individual or a small group of key people who have all of the expertise and maintain all of the relationships, there is a significant business risk that must be taken into consideration when valuing the company.
The construction industry is highly litigious. Contractual disputes and work-place accidents can subject the company to significant litigation related costs.
The valuation of a construction industry requires a solid understanding of the industry’s unique attributes. Without an analysis of these items, the construction valuation could be grossly inaccurate.
WithumSmith+Brown’s Construction Services Team and Litigation and Business Valuation Group have the expertise necessary to accurately value your construction business. If you are considering a valuation of your construction company, please contact Louis Sandor III, CPA, CCIFP, Practice Leader Construction Services, or Jessica Giresi, CPA/ABV, Litigation and Business Valuation Team Member by filling out the form below.