Selling smart: Strategies for transitioning ownership

Transferring ownership of a construction business is no simple task. 

It’s a unique industry based on relationships, projects pipelines and processes. Financial services firm First West Capital has in-depth knowledge of the construction sector. When navigating a business sale, their goal is to ensure a fair deal that rewards the owner and sets up the new one for success. 

One of the most complex tasks is answering a deceptively simple question: What is a construction business worth? 

Construction is project-based

Geoff Devereux, a director at First West Capital, explained that while equipment, real estate and other assets are part of this equation, unlike other industries, construction is mostly a project-based business. The common refrain is that you are only as good as your next project. Most construction businesses can produce a forecast of the next six to nine months based on what projects are in the queue.

“But after that it just falls off a cliff and it’s really tough to estimate how things are going to be,” he said. “Even businesses that have been in the industry for 20 years, they’re still very much averse to thinking about multi-year forecasts not based on an actual pipeline. And so figuring all of that out when you’re buying a business is going to be pretty critical to its value.” 

This is often why valuation multiples tend to be a bit lower than other sectors that aren’t subject to the project dynamic. Having a diverse portfolio of projects, sticking with work that your team is experienced with and cultivating relationships with multiple clients are ways to mitigate some of these risks and maintain a business’s value. 

Finding the hidden value

While important, project value isn’t everything. 

Steve Chen, vice president and head of First West Capital, explained that often construction businesses overlook some of their biggest assets for buyers. 

“When we are talking to construction companies — could be trades or subtrades or whoever — they are always talking about their pipeline, saying ‘these are our customers, this is our pipeline’ and we find a lot of value in that for sure, but I think that they undersell the processes, systems and controls that they have built internally,” said Chen. 

How bidding is organized, project management, software systems and many other factors can be a huge in determining the value of a company. First West Capital added that this is especially true of companies with strong estimating offices that are pragmatic and realistic in their work. 

“A lot of companies do these things well. My two cents is that you should be talking about all these processes and systems that you have put in place and how they have contributed to the ongoing profitability and success of the business,” said Chen.     

Thinking beyond price

Chen added that coordinating ownership changes is about more than money. He believes the early conversations should also include planning how the transition will create success for both parties going forward. 

“At the end of the day there is going to be a valuation that includes something paid now and something that gets paid over time,” he said. “If  you just focus on what’s paid today, no matter how well you structure it, you’re probably not going to get the amounts that are paid later. The business is not going to be successful or the projects will fall off when customers aren’t happy.”

Chen encouraged companies thinking of selling to make sure that good systems and processes are in place that will set the business up for ongoing success after ownership changes hands and key people might not be in place. 

He also stressed the importance of understanding who an ideal buyer might be. It could be a competitor down the street, members of your own management team or a large company on the other side of the country who wants to expand into your market. 

“Identify who your ideal buyer is, why they want your business and what it would take to make them successful,” he said. “If you can do that, you’re maximizing your dollars.”

Common pitfalls 

While it may be tempting to try and simplify the process with a handshake deal, Devereux cautioned owners and buyers from avoiding the details. 

“What we sometimes see is an existing owner and several key employees show up at our door with an agreed upon price but not enough work has been done to support the valuation,” he said. “Then things get bogged down because as soon as you dig in, everyone’s expectations get blown apart and things become contentious.” 

While he noted that there can be some hesitation to include consultants, high quality ones exist and can create a deal that is a win for everyone. 

“Typically there is some contingent compensation or transition period so the deal is going to close and then you’re going to have to still work together,” he said. “And if you’re feeling like you just got sort of whatever short end of the stick, suddenly all that cooperation gets a lot tougher.”

Mary Liu, an associate director at First West Capital, believes that structuring a buyout can be complex and many owners tend to avoid advisors, instead opting to keep things in the company. 

“A lot of that work ends up getting done in-house by having these conversations with their more senior employees and thinking about what kind of home equity can be borrowed to buy out a business,” she said. “So they’ve done it in a very grassroots kind of way and instead of seeking professional help on that and I think  because of that, they’ll tend to leave some money on the table.”

If you are thinking about transferring ownership of your construction business, connect with First West Capital’s team to see if they can help your journey.