How to Value a Construction Company
Construction companies provide a variety of construction and related services to residential and commercial clients. This includes building construction, engineering projects, specialty trade contracting, etc… According to IBIS World, the construction industry generates over $600 billion per year. As such, there is a very high demand for construction services. In addition, we can expect growth to continue in the coming years. With these conditions, now is a good time to buy, grow, or sell a construction company. Please note that the construction industry is extremely fragmented and competitive. To succeed, it is helpful to learn how to value a construction company.
To learn how to value a construction company, it is best to receive a business appraisal. During a business appraisal, valuation experts discuss the strengths and weaknesses of your construction company. In addition, you will learn the fair market value of a construction company as part of a business valuation. This information can help you understand the next steps in increasing the value of a construction business.
Peak Business Valuation is a professional business appraiser. We work with construction companies on a regular basis. As such, we are happy to provide you with a business appraisal for a construction business! In addition, Peak can discuss any inquiries you may have on valuing a construction company. Schedule your free consultation with Peak below to get started!
How to Value a Construction Company
Valuation experts consider a variety of business valuation approaches when determining how to value a construction company. Often, business appraisers rely on the market approach and/or the income approach. Both of these approaches are effective, however, each method uses a different basis of valuation. As part of the valuation process, business appraisers determine which method is best for your construction company. This can involve utilizing a combination of business valuation methods to value a construction company.
Valuing a Construction Company Using the Market Approach
The market approach is common in small business valuation. To understand the market approach, consider the real estate valuation process. When valuing a home, real estate appraisers assess similar properties that recently sold in the area. Then, they can accurately calculate the value of the home. When using the market approach to value a construction company, business appraisers compare similar properties that recently sold. If the company is private, the valuation analyst utilizes private transaction databases to gather information.
Multiples for a Construction Business
When using the market approach to value a construction company, valuation experts work with valuation multiples. These are ratios that measure the value of a construction company based on financial metrics. Some common metrics include sales, cash flow, and earnings. To find the proper valuation multiples for a construction company, business appraisers apply the proper NAICS or SIC code. Below we discuss common valuation multiples for a construction company.
SDE (Seller’s Discretionary Earnings) Multiple for a Construction Company
- The SDE multiple is common when determining the value of a construction company. This valuation multiple measures the value of a construction company based on its seller’s discretionary earnings.
EBITDA Multiples for a Construction Company
- EBITDA multiples measure a construction company’s earnings before interest, taxes, depreciation, and amortization. This helps business appraisers understand the return on investment (ROI) a construction company can generate.
REVENUE or SALES Multiples for a Construction Company
- The REVENUE or SALES multiple reflects the value of a construction company in relation to its total sales or revenue. Business appraisers can calculate the fair market value of a construction company by applying the multiple to its revenue.
To learn more about the value of a construction company using the market approach, see Valuation Multiples for a Construction Company.
Valuing a Construction Company Using the Income Approach
Another common valuation approach is the income approach. The income approach measures the future income potential of a construction company. This method also assesses the risks associated with buying, growing, or selling a construction company. Below, we highlight a few risks of a construction company.
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- Financial Performance. Many construction companies struggle to maximize profits. As such, it is important to have strong financial management at a construction company.
- Competition. The construction industry is 100 percent fragmented and very competitive. It is vital for construction companies to stand out from competitors in order to succeed.
- Location. The location of a construction company plays an important role in its success. By locating in areas with high demand for construction services, you can maximize the value of a construction company.
- Supplier Relationships. Construction companies acquire inputs from manufacturers, wholesale trades, and other construction companies. It is beneficial to develop strong supplier relationships.
Methods to Value a Construction Company Using the Income Approach
There are many ways to value a construction company using the income approach. The most common methods are the capitalization of cash flow method and the discounted cash flow method. In the following sections, we discuss how to value a construction company using the capitalization of cash flow method and/or the discounted cash flow method.
Capitalization of Cash Flow Method
When using the capitalization of cash flow method, business appraisers determine a reasonable amount of income for a specific period. The income is then divided by a capitalization rate which indicates the rate of return an investor can expect. Additionally, the capitalization of cash flow method assesses the risks associated with a construction company. This income approach is best for construction companies with long and stable histories.
Discounted Cash Flow Method
The discounted cash flow method is best for construction companies with strong financial histories and reliable forecasts. When using this method, valuation experts project future cash flows over a 3-5-year period. The expert then applies a discount rate rather than a capitalization rate. The discounted cash flow method takes the time value of money into account to determine the value of a construction business. Keep in mind, that this method is less common since it is limited to future cash flow estimates which can be arbitrary.
Summary
When valuing a construction business, business appraisers may use a variety of valuation approaches. At Peak Business Valuation, our valuation experts often use the market approach and/or the income approach. To understand which method is most suitable for your construction company, obtain a business appraisal. As part of a business appraisal, you will learn about the risks and opportunities of a construction company you are buying, growing, or selling. Additionally, business appraisers will calculate the fair market value of a construction company. This can help you understand how to maximize the value of your construction business.
Peak Business Valuation is happy to assist! At Peak, we work with construction companies on a regular basis. We are happy to provide you with a business valuation for a construction company. Additionally, Peak can answer any questions about how to value a construction business. Schedule your free consultation by clicking the link below!
For more information see Valuing a Construction Company, Value Drivers for a Construction Company, and Valuation Multiples for a Construction Company.
