Do you remember the day you decided to go into business for yourself? Filled with enthusiasm and anticipation, you made the initial investment in your future. Over time, you nurtured that investment and grew the business from a small construction company with only a handful of clients to a thriving business with a diverse clientele base and solid industry reputation. As your business grew, so, too, did the initial investment. The question is, by how much? What owners really want to know is: What is that investment worth today? Unfortunately, few owners really know with any certainty what the answer is.

Although some contractors, such as excavators, tend to have substantial capital assets, there is far more to the value of the business than what the numbers on the balance sheet show. Business value also includes intangible assets, which can substantially increase a company’s worth and attractiveness to an outside buyer. Accredited appraisers who are experienced in valuing construction operations assess tangible and intangible assets, as well as other business factors to arrive at the true value of a business.  

Assessing Worth
The share value of publicly traded companies is easily accessed by looking in the business section of a daily newspaper, locating the stock tables and multiplying the closing price by the number of shares owned. However, there is no convenient stock table to access the share value of privately held companies. That value can only be accurately determined through a business valuation.  

A business valuation assesses the worth of an enterprise from several perspectives. It examines the business on its own merit, how it compares to similar companies in the industry and how it rates in the marketplace. A valuation also takes into account tangible and intangible assets. Goodwill and intangibles are arguably two important value drivers for privately held companies. For construction companies, goodwill includes:

• A recognized name, slogan or phone number
• Contracts and clientele
• Human capital (e.g., experienced management and crews, certified technicians)
• Transferable licenses and certifications
• Proprietary processes, patents or trademarks

A business valuation can also quantify value enhancers derived from established operational history, successful bidding history, product and service diversification, established market share and repeat business. Conversely, litigation, union disputes, workers’ compensation claims, high employee turnover and bonding troubles deflate goodwill value.

Fantasy vs. Reality
Oftentimes, owners set an unrealistically high expectation for the value of the business. They are too close or emotionally tied to the business and have difficulty understanding why an objective, third-party business appraisal results in a value that is nowhere near their own estimation of the business’ worth.

Generally, there are two worlds of value for small, closely held businesses: theoretical value and emotional value. Theoretical value is determined utilizing sound, recognized business valuation methodology. Value determined theoretically often assumes the standard of fair market value, as well as an open and unrestricted market. Negotiations are not a factor in the value conclusion. Typically, theoretically derived value is based on earnings, the level of net cash flow and the hypothetical buyer’s long-term ROI. The lower the selling company’s earnings, net cash flow and ROI, the greater the risk assessed on the investment and, thus, the lower the company’s resultant value.  

Emotional value or “price” is usually negotiated between two parties, with one party possessing a greater emotional and financial stake in the sale terms and outcome of the transaction. Usually, price is set somewhere between the seller’s desire to receive the highest return on his or her blood, sweat and tears and the buyer’s desire to receive the highest ROI for the lowest reasonable price possible. Unfortunately for the seller, there is usually a negative correlation between blood, sweat and tears and purchase price. The more personal and financial sacrifices an owner has had to make for the business, the less attractive the business is as an investment to a buyer. Thus, the lower the price paid for the business being sold.  

On average, buyers desire to purchase a company that will net approximately 30 percent per year in earnings after deducting officers’ compensation and repayment of debt obligations. Small, closely held companies that do not indicate this level of return are less likely to sell for a price in excess of fair market value. Generally, the marketplace does not allow a seller’s emotions to overshadow the findings derived from sound valuation theory. Although not a hard-and-fast rule, the lower the trend in profits, the lower the value of the business, and thus the lower the purchase price.  

Strategic Planning Begins Early
Although selling a business is somewhat similar to selling a house, a business sale is far more complicated with greater life-impacting consequences. Unlike selling a house, selling a business does not begin with a for sale sign, an advertisement or a broker’s listing. It should begin the first day an entrepreneur contemplates going into business for him/herself. The majority of small businesses are not saleable, primarily because they are not structured or engineered to run without the owner overseeing the day-to-day operations. Developing a company as a marketable investment with transferable value to a hypothetical buyer is essential and takes time.  

To be attractive to buyers, companies need to demonstrate profits consistently over the three most recent years of operation. The balance sheet and income statement should be free of non-operating assets, such as automobiles used by non-employees and other non-business related assets. Personal expenses should also be eliminated. Second, does one person possess the knowledge, licenses, certifications or other related industry skills? The greater the company’s profits are dependent on one person, the lower the value of the company will be. On the other hand, a company that has a strong core of transferable human capital – a management team that is well trained and can run the company without the constant oversight of the current owner – will likely sell for a more favorable price.

Also important is the existence of documented systems and procedures, such as an executed business plan. They help illustrate exactly how the company has achieved its profitability to date and how it will continue to realize profits over the long term, especially after transfer of ownership.

Be Prepared
From the very start, potential buyers look at the selling company’s financials. The condition of the financials sets the tone about the overall condition of the company. Poorly kept financials are generally indicative of a poorly run company. Additionally, the company’s financial reporting may be structured to minimize income for tax purposes. However, when preparing the business for sale, recordkeeping should illustrate the maximum owners’ income to maximize the price.