Business owners regularly use valuations for their businesses, but not all businesses are valued under the same method. Construction related companies, in particular, have their own set of challenges. Many construction companies use percentage of completion of their work and run their businesses based on their backlog or pipeline of future work for determining the value of their business. Both are important when determining the weighting and metrics used in the valuation methods described below.
Valuing a business, conceptually, is fairly straightforward. The goal is to arrive at a valuation in which a business is perceived to be worth and will likely transact at, should a deal formalize. In actuality, there are many varying opinions on how to arrive at such a simple concept.
Not all valuators are equal. In terms of methodologies, there is a purely academic approach, performed by certified valuation professionals, then there is a more real-world approach, performed by experienced investment bankers. Certified valuations are most often used in legal cases as well as some select situations, such as new shareholder buy-ins or selling shares to an existing shareholder. Investment banker valuations use industry market trends to help guide valuation. Valuators who have experience with construction related businesses will more accurately increase or decrease the valuation accordingly.
Yes, there is a significant amount of science behind determining a company’s valuation. Most notably are the discounted cash flow (DCF), leverage buy-out (LBO), and comparable transactions methods. Each method allows the valuator certain liberties which impact the overall valuation. Whether the valuator uses a certain discount rate, expected rate of return, or one transaction over another, each method will likely result in a different valuation. These metrics should be unique to the industry and the company itself; considering there are many different types of construction companies and each require industry-specific metrics to effectively determine its own individual valuation.
A good valuation specialist is adept at assembling the various components of a robust valuation. It is the valuator’s thoughtful dialog with management, strict criteria with comparable transactions, and pre-screened assumptions within the LBO which make the results most accurate. To limit any imperfections in one method or another, a weighted average can be applied.
As a result, a valuation from a certified valuator or an investment banker, even with both using the same methods discussed above, will often differ. So, which valuation is more accurate? When a transaction is completed and part or all of the company is purchased or sold, only then is the true value realized. In our experience, it is common for our initial valuations to be within approximately 10% of the transacted valuation.
The sale of a business, whether part or whole, is one of many factors that impacts valuation and the key terms of a transaction. Post-close responsibilities for construction owners often depend on technical expertise, relationships, and current project progress. These areas increase and decrease risk, which can be used as leverage for valuation and other deal points. Deal points, particularly in regards to risk and future cash payments, are often equally as important and valuable as the initial terms in the offer documented in a “Letter of Intent” or “LOI”. A valuation is important and an appropriate first step when considering a potential transaction as well as for the business owners’ personal financial planning.