A blueprint for valuing construction companies

Determining the value of a construction company is complex and requires a deep understanding of industry-specific challenges and financial metrics. Whether a construction business owner is planning a sale or merger, securing financing, preparing for succession, or navigating legal matters, an accurate valuation is essential. Professional valuation experts analyze a range of factors unique to construction businesses — including homebuilders, commercial real estate developers, subcontractors and specialized tradespeople — to provide reliable assessments of value.

Unique risks

The construction industry is inherently cyclical, making economic fluctuations a significant risk. Market downturns can lead to project delays or cancellations, affecting cash flow and profitability. Weather conditions and natural disasters further contribute to the industry’s unpredictability, as they can disrupt project timelines and escalate costs.

Another major risk factor is cost volatility. The prices of materials and labor often fluctuate due to supply chain disruptions and economic trends, which can erode margins — especially for companies locked into fixed-price contracts. Tariffs may also have an impact. Additionally, regulatory and compliance requirements, such as evolving safety standards and environmental laws, can introduce unexpected financial burdens.

For small or family-owned construction firms, dependence on key individuals poses an additional risk. If a company’s success is closely tied to the expertise of an owner or project manager, transitioning leadership to a new owner may prove challenging, potentially reducing the business’s value. Additionally, related-party transactions require adjustments to ensure valuations reflect true market conditions.

Valuation professionals must also analyze a business’s accounting methods. Many construction companies use percentage-of-completion accounting, recognizing income as projects progress. However, smaller firms may use the completed-contract method, deferring revenue until jobs are finished. Without proper adjustments, these differences can lead to inaccurate comparisons and misinterpretations of financial performance.

Key value drivers

Several factors that significantly influence the value of a construction company are:

• Project backlog, an indicator of future revenue potential and operational stability,
• Profit margins, which may reflect cost management and bidding/pricing strategies,
• Business reputation and relationships that, if transferrable to a third-party buyer, may lead to repeat business and new opportunities, and
• Access to an established, skilled workforce, which enables the company to perform quality work in a timely manner.

Moreover, a construction company may command a premium price if it has an experienced management team capable of estimating costs accurately, managing projects efficiently, and maintaining a track record of financial discipline and safety. Prospective buyers likely will also evaluate the quality and condition of the company’s hard assets. These include real estate holdings, machinery, tools and equipment, and technology, such as drones, wearables and sensors, bidding and tool-tracking software, and enterprise resource planning systems.

Valuation methods

Valuators consider the following three general approaches when valuing construction businesses:

1. The asset-based (cost) approach. This technique is based on the company’s net assets — subtracting liabilities from the fair market value of tangible and intangible assets. It may be particularly relevant for construction companies with substantial equipment and real estate holdings. However, it tends to undervalue businesses with strong earnings potential but limited hard assets.

2. The market approach. A valuator may compare the subject company to prices paid for similar publicly traded and private businesses. The use of public stock prices is rare in the construction industry due to differences in company size, project diversity, management quality and geographic scope. Valuators may turn to private transaction databases for comparable data, but it’s important to use relevant selection criteria, including the customer base, size, location and transaction date. Finding reliable comparables for construction companies is often challenging.

3. The income approach. This approach projects a company’s cash flows and discounts them to present value using a risk-adjusted rate. For example, the discounted cash flow method is commonly used to value construction companies. An experienced valuation professional understands how to incorporate key value drivers and risk factors into cash flow forecasts and discount rates. It’s important to note that values derived under this approach include goodwill and other intangibles, which may be significant assets for construction companies.

Build a solid valuation framework

Some construction business owners attempt to estimate their company’s value using simple rules of thumb, such as a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA) or a percentage of annual revenue plus inventory and tools. These shortcuts may provide a rough indicator of value, but they fail to account for the unique risks and opportunities that influence a construction company’s true worth.

A reliable valuation requires a solid foundation — one that considers industry-specific risk factors and value drivers. Our experienced business valuation specialists understand the construction industry and can provide a valuation you can count on. Contact us for more information.

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