Buying or selling a construction business

Construction businesses are very much focused on people and relationships and as such have their own individual character. The people who run construction companies must be specialists in managing risk as mistakes in construction can be costly. Building firms are skills-intensive, asset-poor and have a high return on capital employed - partly because they use relatively little equity and good ones also need little working capital. These factors mean that the business value is mainly in goodwill and not tangible assets. Selling or acquiring in this sector, therefore, mainly concerns goodwill value.

Meaningful valuation is fundamental to successful business buying/selling, but in this sector the balance sheet nor even the reported profits are neither the most important value determinants. Valuation is mostly about goodwill measurement. The goodwill in construction enterprises is made up of a number of intangibles, which are explained below.

Relationships with Key Customers

Good customer relations are essential in any construction company, as this can give a competitive edge when tenders are being considered. The degree to which orders are won and prices/margins negotiated versus imposed, the repeatability of customers enquiries and, of course, the financial solidity of the customers themselves all are key factors. One of the most critical parameters is achieving a high win/tender ratio with individual customers and the market together. It would be ideal to win an effective sole supplier status for the business particular service. Overall though, it is important to achieve favoured status and at least be one of a short panel of suppliers.

Sustainability of Sales

Sustainability of sales is a key goodwill determinant comprised of many elements including not only the customer relationship as above, but also the nature (not just the quality) of the service/product provided, and the health of the market sector in which the customer operates. Not all construction services are equal, for example, providing maintenance services is less risky, more resistant to the recession and more sustainable than a niche house builder.

The higher the proportion of maintenance business, the higher the value/earnings ratio of the business, as ongoing sales are more predictable. The structural nature of the maintenance is also important and term contracts (covering several years) boost the sales sustainability and business value. There is, however, a subtlety here.

Holding term contracts may impress a finance provider, but it is frequently the case that a supplier without a formal contract which has established itself as effective sole supplier has a higher goodwill (and therefore business value) rating. This is because term contracts have termination dates which motivate re-tendering. Informal sole supplier relationships last as long as the relationship and do not get re-tendered. There is also the advantage that a sole supplier, particularly of maintenance, acquires effective proprietorial knowledge of the customer's assets. This unique knowledge becomes a strong disincentive for the customer to change supplier - this outsourced dependency is increasingly commonplace.

The regular presence at customers sites afforded by maintenance also benefits that supplier when it comes to competing for non-maintenance jobs and the incumbent supplier can win these with little or no competition, resulting in a virtuous marketing circle. So a good product mix is important.

Strength of Management Team

The quality of management is even more important in construction than in other industries because it is a service-based activity where the service to be provided is often poorly articulated (specification/scope etc). What is more, within construction there is a wide variation in the quality of management, perhaps due to the fact that good builders don't necessarily make good managers.

Systems

Effective client and contract management systems are vital to a building business, and this is mainly because construction is a risk management activity.

One method of achieving this is to make a senior manager (ideally a director) responsible for ensuring that contracts are structured to minimise risk to the business and then diligently applying a commercial test to actual contracts that are taken on. The key phase for this is the tendering and estimating process, which can classically suffer from overlooking or under-costing risk. A robust and effective system ensures a speedy competitive service and the delivery of projects within budget.

Cash Flow Optimisation

Cash flow is a larger issue in construction than in many other sectors, and this is due to the high value/cost, low volume and time-to-completion of the product. Consequently, there is a threat of cash flow becoming unmanageably negative. Establishing a terms of business policy, which balances the commercial need for winning and retaining customers with financial prudence is crucial.

A Service Attitude

A good service attitude is not traditionally a feature of construction businesses, which are notoriously contractual and adversarial in attitude. A good builder is one who realises that he is actually a service provider and adopts all the relevant business practices. A positive approach to service can make all the difference to a company and its clients, and as such this can be one of the most significant factors driving value.

Synergies

The most important requirement for a successful sale or acquisition of a construction business is getting a good fit between buyer and seller. Here the buyer will be motivated to pay the best price.

To achieve good synergy it is important to know what factors influence a good fit, most of these are also what constitute the goodwill value.

To identify a well-matched business, an intimate knowledge of the players in the relevant construction market is required, along with an idea of what motivates them, and what benefits them. Thus the challenge is not only how to reach those prospects but also how to engage with them so that a productive dialogue can ensue. It is often advisable to appoint a good business broker who has an in-depth knowledge of the market.

For a sector where the entry barrier is perceived as low, it is particularly important to be able to spot the difference between good and bad businesses.

In conclusion, it is vital to do due diligence on a very skills-intensive business, where there are few tangible assets to fall back on. The fortunes of building companies are perceived as being closely allied to the performance of the economy as a whole. Consequently, there is increased interest by investors looking to buy construction companies at the bottom of the economic cycle with a view to making good profits going forward. A good building business can buck the economic trend and provide good returns.

In conclusion, it is vital to do due diligence on a very skills-intensive business, where there are few tangible assets to fall back on. The fortunes of building companies are perceived as being closely allied to the performance of the economy as a whole. Consequently, there is increased interest by investors looking to buy construction companies at the bottom of the economic cycle with a view to making good profits going forward. A good building business can buck the economic trend and provide good returns.

We greatly acknowledge the assistance of Peter O'Brien in the writing of this article.

Peter O'Brien at Business Engineering Ltd: an independent business broker set up in 1987 to arrange acquisitions or sales of UK businesses in the engineering, construction or support services sectors; with a turnover range of between £1m and £25m and value of £500k to £15m. Tel 01737 373121

Share this article

Latest Businesses for Sale

View more businesses for sale