Business valuation of specialized construction companies

Even in a challenging real estate market quite a few specialized construction companies continue to thrive. The secret of success? Here are a few points to ponder:

• Construction firms in a specialized, well-protected niche, tend to weather the storm better.
• Established companies with strong reputation in their market place stay busy even as competitors exit.
• Word of mouth referrals are even more critical to bringing new business when times are tough.

For example, while new construction volume may be down, construction defect restoration work is still needed. Specialist firms that excel at this often find that their services are in high demand. While no one business is truly recession proof, these types of construction companies are recession resistant.

Interestingly, these successful businesses are sought after acquisition targets – both by larger, well-funded competitors and financial buyers who look for a stable income stream. So even if valuations of many other companies in the market may trend lower, such specialist construction firms hold their value well.

Business valuation methods for specialized construction businesses

Market activity is a very good indicator of a company’s fair market value. Selling prices of similar companies that changed ownership recently offer you a way to estimate what your own firm is worth. Consider using a number of valuation multiples that help you calculate your  business value based on its financial performance, such as revenues, profits, cash flow or business asset base.

Example – valuing a construction defect restoration company using valuation multiples

To demonstrate the method, let’s take a typical construction firm with the following recent financial performance:

• Annual gross revenue: $2,000,000.
• Net sales (less returns and discounts): $1,950,000.
• Gross profit: $950,000.
• Net income: $210,000.
• EBIT: $225,000.
• EBITDA: $230,000.
• Seller’s discretionary cash flow (SDCF): $350,000.
• Furniture, fixtures and equipment (FF&E) assets: $195,000.
• Inventory: $100,000.
• Total business assets: $465,000.
• Owners’ equity: $155,000.

We pick a set of reasonable valuation multiples and calculate the fair market value of this company as follows:

Note that, by convention, the business value above includes all business tangible assets and goodwill. It does not include the cash, accounts receivable, and the business owned real property, if any.

Additional business valuation methods to cross-check your results

To demonstrate the unique value-creating attributes of your construction company, consider using income-based valuation methods. For smaller, owner-operator managed businesses, the Multiple of Discretionary Earnings is a good choice. For larger firms, the Discounted Cash Flow method is typical.

If the company has established itself as a leader in its market, the value of business goodwill can be a large part of total business value. You can measure business goodwill by using the well-known Capitalized Excess Earnings method, also known as the Treasury Method.

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EBITDA valuation multiple

If you need to get an objective estimate of business value, consider using the valuation multiples derived from the recent sales of similar businesses. There are a number of advantages:

1. Business valuation with multiples is easy to understand and explain.
2. In times of economic uncertainty, business people and professional appraisers carefully consider the market trends when valuing a business. Market value estimates using the valuation multiples are an excellent way to do so.
3. If the business is to be bought or sold, market comparisons are a must to defend your asking or offer price.
4. Market comps are also a great way to prove your point if your business valuation is challenged.

Types of valuation multiples

Business appraisal experts and seasoned investors use quite a number of valuation multiples depending on the specific business or the reasons for business valuation. Here are the most common choices:

• Valuation multiples based on business gross revenue or net sales.
• Gross and net profit-based valuation multiples.
• Earnings based multiplies relating the business value to its EBIT, EBITDA, or discretionary cash flow.
• Valuation multiples based on business assets and owners’ equity.

Reasons for choosing the earnings-based valuation multiples

Business valuation is about earnings and risk. For small owner-operator managed companies, the discretionary cash flow based multiples are the usual choice. For larger small and mid-market businesses the typical basis is EBITDA. There are a couple of reasons why the EBITDA based valuation multiple is often preferred:

• Business owners have control over the company’s capital structure. Hence, the interest expense is viewed as discretionary and added back to calculate the available cash flow.
• Many private firms are structured as pass-through entities for tax purposes, such as S-Corporations or LLC companies in the US. Since these companies do not pay tax directly, adding back the taxes makes sense.
• Depreciation and amortization are paper expenses and do not affect the business cash flow. They are added back to calculate EBITDA.

To sum up, EBITDA is a good way to represent the available business cash flow to calculate the value of private companies. The EBITDA-based valuation multiples are a common choice in valuing larger businesses in these industries:

• Manufacturing firms
• Technology companies
• Professional services businesses

Current EBITDA valuation multiples for major industries – some examples

As the market conditions change, so does the value of your business. Valuation multiples based on recent business sales help you track changes in your company’s market value. Here are some typical EBITDA valuation multiples by industry:

The EBITDA multiple for software companies may seem high. However, these firms tend to show considerable variation in earnings. It is a good idea to check your results using other valuation multiples. For example, these firms tend to price at about 2.5 times the net sales.