In recent years, we have seen construction firms sell at multiples ranging from four to 15 times their EBITDA earnings. What causes such an astounding degree of variation? We’ve identified six crucial factors that can impact the valuation of your firm when it’s time to sell.
- Specialization. Overall, firms that have established a niche tend to be more attractive to buyers than general contractors. For example, a contractor that specializes in HVAC or other building services will attract more buyers, including other specialized firms that want to expand their customer base or market share.
- Bid or no-bid? Are the majority of your contracts won through bids or negotiation? Buyers tend to view the former as a sign that the target company must compete on price – which is never an ideal situation. However, contractors that secure negotiated work are typically winning more profitable jobs and have a better opportunity to win additional work from their customers in the future.
- Size and location. Buyers without an existing investment in the industry are less likely to pursue contractors with less than $3 million in EBITDA. Profitability below that level typically signals a that the contractor is too small as a standalone investment, and many buyers need to deploy more capital per initial investment. In general, the larger the company, the higher the valuation as a multiple of EBITDA. Additionally, companies located in urban or metropolitan areas are viewed as having greater market potential than rural-based businesses because they have immediate access to more opportunity.
- Revenue makeup. Buyers evaluate your revenues based on total billings, as well as the type of work they comprise. New construction is often seen as more cyclical and may not deliver consistent revenue results. Renovation or retrofit engagements are more favorable because these suggest a continuity in customer relationships, as well as a likelihood of re-occurring revenue. The most attractive position, though, is to demonstrate a high percentage of revenue that is derived from services. Service or maintenance contracts show that your company is generating consistent, long-term and predictable cash flow. Two companies may each have $10 million in revenue. However, if one has 70% of revenues stemming from new construction, and the other has 70% stemming from services, the latter will receive a higher valuation.
- Customer diversification. Having one large client that represents the lion’s share of your revenues can be a profitable and simpler, way to run a business. But it’s a red flag for investors and buyers because of the perceived risk of losing that one client and the resulting impact on the business. Typically, having more than 40% of your billings come from a single customer can be problematic. A stable of clients who each represent 20% or less of your revenues suggests a stronger, less risky investment.
- Leadership. If your desire is to sell and walk away from your business, think again. Construction industry buyers generally prefer to acquire businesses that come along with the expertise and leadership needed to operate smoothly and seamlessly through the transition period. For most companies, this means owners should be prepared to remain on board for two years or more after the sale. Buyers also prefer to see a second-tier management team in place that is already, at the helm.
In each of these areas, one key point is that buyers view the purchase of a business as an investment. When they see that investment as minimizing risk and maximizing the stability and growth of future cash flows, they usually will pay more.
It pays to plan
Regardless of the size, client makeup, location or specialization of your construction firm, there is one piece of advice that can help you optimize its market value: Plan ahead. At HORNE Capital, we believe there is no such thing as preparing too early. We recommend owners start planning two to five years ahead.
Early planning enables you to lay the foundation for putting together the type of financial reporting that appeals to your potential buyers. This will also give you time to improve the value of your business.
That sounds like work. And it is. But if a little planning can nudge your company a few points higher on that “four to 15 times” multiple of EBITDA scale, it may be one of the smartest business moves you will ever make.
Contact us today to find out how to get the best value for your construction business.