March 27, 2003

What is your construction company worth?

  • It’s important to know, even if you’re not selling

    Understanding the value of your construction company is an important step prior to a transaction such as a sale, an ownership transition, or the establishment of an incentive stock plan. Additionally, performing a periodic valuation on your company may yield some interesting operational and financial insights.

    There is a lot more to deriving the value of your company than what is reported in your financial statements.

    Generally speaking, taking an honest look at your company from management, marketing, operations and competitive perspectives will uncover issues that may negatively impact the value of your company. In addition, comparing your company’s valuation to other construction companies is a good way to benchmark how well or poorly you are doing.

    Consider, for example, that many general building, specialty, and heavy and highway contractors that self-perform more than half of their work have significantly higher valuation ratios than their counterparts that self-perform 50 percent or less, according to ZweigWhite’s 2003 Valuation Survey of Construction Companies. For example, value/book value among these contractors is a median of 2.00, while that figure is just 1.26 for those that self-perform less than half of their work.

    Although it may be intuitive that a company that offers a wide breadth of services including self-performed field work would have higher valuation ratios than those that do not self perform, this will not always be the case, according to Michael O’Brien, an associate with ZweigWhite’s Financial Advisory Services group in Washington, D.C.

    “If you aren’t efficient at certain types of work, you’re not going to boost your value by performing it,” O’Brien says. “You’d be better off subcontracting that work to somebody else.”

    Valuations include several different metrics to give a snapshot of company value. Are certain types of contractors generally worth more than others? Do self-performed work, gross revenue projection, and other indicators have a real bearing on value? It all depends.

    Many factors go into determining the fair market value of a company, such as quality of management, profit margins, historical growth, future growth expectations and market perception of the company.

    The value/book value ratio is the total company value (equity plus interest-bearing debt) divided by its book value. It is one of the most common ratios of value used by construction companies — sort of like taking your company’s financial temperature.

    Book value is the bottom line of a company’s balance sheet, total assets minus total liabilities. It is also sometimes referred to as owners’ or stockholders’ equity or net worth. Book value may vary considerably depending on when the balance sheet is completed, what accounting methods are used and shareholders’ distributions.

    Theoretically, a company’s value that is below its book value (a ratio of 1.00) may indicate very poor operating performance or large intangible assets, which may be represented as goodwill. Consequently, appraisers rely on several valuation ratios, including gross revenue, pre-tax, pre-bonus profits and other earnings and cash flow metrics to determine the value of the company.

    Valuation is not a scientific process. For instance, the valuations included in the ZweigWhite survey were performed for a variety of reasons and by practitioners with varying levels of expertise. Thus, there were wide fluctuations in the value ratios.

    To mitigate this problem, ZweigWhite researchers applied a 95 percent confidence interval to each ratio in the survey, eliminating 5 percent of the most extreme values.

    Other valuation ratios can be worthwhile barometers for your business. Value/gross revenue, for example, is determined by dividing the total company value by the gross revenue from the fiscal year most recently completed at the time of the valuation. Gross revenue is defined as the value of construction put in place for the year. The survey found that as the ratio of field staff to office staff increases, so do value/gross revenue ratios.

    The value/profit ratio is determined by dividing the company’s equity value by the net pre-tax, pre-bonus profit. Profit is defined in the study as the company’s total profit before distributions (bonuses, dividends or contributions to profit-sharing plans) and taxes.

    Net pre-tax, pre-bonus profit is preferred over net pre-tax, after-bonus profit as a measure of earning power because the amount of profit that owners may choose to pay out in the form of bonuses or stockholder dividends may vary widely and, in some cases, arbitrarily. Therefore, the pre-tax, pre-bonus valuation ratio reduces any distortion caused by discrepancies in bonus and distribution policies.

    Companies can use and calculate these metrics on their own. Determining company value requires specialized training, however. Whenever a valuation is needed for a sale or other transaction, always hire a professional appraiser who is well-versed in the valuation process and has experience with other construction companies like yours.

    There’s a lot more to it than making a few calculations in a spreadsheet.

    Peter Fabris is managing editor of ZweigWhite Contractor newsletter. ZweigWhite ( is a consulting and publishing firm based in Natick, Mass.

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