For many financial firms targeting the construction industry as their niche market, specific experience provides extensive knowledge of the industry and the intricacies of construction accounting. Those who practice in construction for any length of time will undoubtedly hear the oft-repeated valuation theory for a contractor, which sounds something like this: “A contractor is worth no more than its net book value (NBV).” Given that, one look at the equity section of a contractor’s most recent balance sheet, and the answer is obvious.
However, experience has shown that this theory is not always accurate. In fact, specific factors exist within the industry that separate the group of contractors that are only worth NBV and the group that is worth more—sometimes, much more. Typically, these factors fall into two categories: internal and external. Internal factors influencing value are specific to an organization and can be actively managed by the owners and management team. External factors cannot be managed but should be tracked as they may be indicative of future value opportunities.
Internal Factors Impacting Value
As an owner, you must ponder many questions when assessing contractor value. The first is fundamental in nature: Do you work in your business or do you work on your business? Dig deeper by asking these four questions:
- Are you consumed by the day-to-day aspects of your business, just trying to make it through the day?
- Do you own your firm, or do you feel like it owns you?
- Do you sometimes feel like you’ve lost perspective on why you own your business?
- Would the company fall apart in your absence?
If you answered yes to any of these four questions, your company is likely worth the NBV. If you work on your business, you have an opportunity to build value by establishing that your company is worth more than the last project completed (however, most contractors, because they have to bid to get work, are not worth more than NBV). Below are the specific internal factors that can influence a contractor’s value and some self-assessment questions that can help explain each one.
Technology Factors
Are you still using a pencil and paper? Put differently, does your company embrace the latest technological innovations? Think of the evolution of communications. Society has gone from using a pay phone to make a phone call, to finding a pay phone to answer a page, to using a car phone to answer a page, to text messaging. If your company has not embraced the evolution of technology, your competition is probably blowing you away, and you are likely a contractor that is worth NBV. Do you use technology to add any value to the construction process?
Customer Factors
Have you developed relationships with customers? Have you become somebody’s go-to contractor? Are your customers a strong source of repeat business? Answering yes indicates that your company’s value may be above NBV.
Contract Factors
Does your company have favorable contract relationships with suppliers and for other necessary products or services? More importantly, do those relationships give you an economic advantage over your competition? If the nature of your contracting affords opportunities for long-term service contracts after initial construction, have you taken advantage of them?
Data Processing Factors
Good companies don’t fail in data processing. Are you up-to-date and capable with data processing? Do you close your monthly financial statements by the 15th of the next month? Are the systems in place producing accurate information? Does your data processing work seamlessly in support of producing profitable and competitive bids?
Financial Factors
Do you have children? If you do or if you did, you would hopefully feed them until adulthood, until they could survive on their own. Like a child, your company requires nourishment and attention, but many owners don’t feed their company enough. To truly feed your company, you must have the funding to be successful, which most commonly comes from profit retention. Underfunding limits value-improvement opportunities. If you find yourself answering the questions in this article with “we can’t afford that,” you are probably guilty of underfunding the needs of your company.
Human Capital Factors
Do you train your workforce? Is the training adequate? Good formal training programs enhance value. Are the management-level employees covered with employment agreements? Employment agreements protect the company and also enhance value.
Marketing Factors
Does the market in which your company works know who you are? How much effort has been spent on developing your company’s brand? You should not underestimate the importance of your brand. If you compare two contractors who are virtually the same in every aspect, except that one has developed a recognizable brand, the contractor with the recognizable brand is more valuable.
Engineering Factors
Do you have any proprietary practices that provide an economic advantage? If you do, are they protected to the fullest extent legally possible? Do you have patent protection? Trade secrets and patents that give you a competitive advantage generally are evidence of a value higher than NBV.
Goodwill Factors
Do you have an earnings history that is superior? Reliable sources of industry performance data are available so you can answer that question. If the company is performing better than the industry as a whole, the company has likely developed what some would call goodwill, which also frequently indicates a value higher than NBV.
External Factors Impacting Value
Contractors need to be aware of what is happening in their marketplace. In the past, national entities were created whose sole interest was buying contractors. They were referred to as rollups, they were flush with cash, and they were on a buying spree. This has happened at least three times with three different types of contractor disciplines, and each time, this situation dramatically changed the marketplace for contractors in that particular discipline. Profitable national companies are also active in the construction acquisition market. As an owner, you must be aware of the activity in the marketplace and its impact on valuation multiples for good companies.
Good contractors are those who have refined and improved these internal factors, and the end result usually is a superior earnings history and growth. Superior earnings and growth are what excite the marketplace most, even for contractors. Build these factors and you build an organization with great value. If you ignore them, you will settle for a company worth no more than net book value, and you will no doubt help perpetuate that oft-repeated valuation theory for a contractor.
