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How To Value A Construction Company? 

How To Value A Construction Company? 

jeremiah grant
By - Jeremiah Grant
Last Updated - August 18th, 2023 12:54 AM
Aug 18

Construction companies are among the top guns when it comes to overall business value. In fact, it’s always been so despite all the ups and downs in the industry, thanks to their massive scale of operations.

But this also poses a significant challenge when valuing one such firm.

You see, the bigger a construction business is, the more frequent valuations it needs. After all, every major project, M&A, stake sale, exit, etc., call for a comprehensive appraisal.

Also, valuing such a large and complex business isn’t an easy feat either.

So you might wonder how to value a construction company in the most efficient manner. And, more importantly, which method should you rely upon for reliable valuation data.

Well, let’s dive right in and have a look at the various ways to conduct a construction company appraisal.

Why is valuing a construction business so important?

Before we get into the various company valuation methods, it’s essential to understand why you should be valuing your construction business in the first place.

To begin with, the construction industry is one of the most competitive sectors in the country. And with some 3.787,470 construction businesses in operation, this sector has already seen a 2.5 percent increase in size so far in 2023.

No wonder why mergers, acquisitions, partner exits, partial or total sale of stakes, etc., are commonplace in the industry. Also, as in any business, bankruptcy claims and proceedings are the order of the day for a lot of construction firms.

Now, as a business owner, you need an accurate valuation in all of these situations to not only secure your interests but also make the best decisions for the future.

Similarly, it is always suggested to hire a valuation expert before bidding for a new project. That’s because evaluating your company and getting acquainted with the findings helps you decide whether or not a project’s scope, including costs, schedule, etc., is profitable for you.

Discover Your Construction Company’s Value Now!

Understanding your company’s value is key for expansion, investment, or getting ready to sell. With our expertise in construction business valuations, we provide you with knowledge tailored to your industry. Hit the ‘Get A Quote’ button for a complimentary initial estimate and a sample report.

In short, the most updated and detailed valuation data is key to determining which decisions are best suited for your business.

Here’s how to value a construction company:

engineers looking at their building plan

Now that we’ve seen the importance of valuing a construction business, let’s turn to the various ways or methods that you can use to calculate a precise value.

While a construction company valuation is similar to any other business, it’s not that straightforward here.

You see, every business has its peculiarities, something that makes certain valuation methods apt for one company but not so ideal for others. And that also applies to construction businesses, wherein some business valuation methods are considered highly dependable.

For instance, EBITDA multiples are regarded as the gold standard in valuing big-ticket businesses such as construction companies. Nevertheless, this method is not full-proof either and might not be suitable for some construction firms.

So let’s have a look at the various construction business valuation methodologies and find out how you can use them to value your company.

#1. Construction EBITDA multiples

EBITDA multiples are known for their simple calculations, the reason why they’re one of the most sought-after valuation methods.

But don’t let the straightforward nature question EBITDA’s reliability, as it is highly effective and used by the largest of corporations.

Talking about construction companies, EBITDA offers a trustworthy valuation figure despite the sophisticated nature of the business. This can especially come in handy during mergers and stake sales, among others.

As you might already be aware, EBITDA stands for earnings before interest, taxes, depreciation, and amortization. And to calculate the value of your company using this method, you need to multiply a number.

Now, the number or multiple that you’ll use here will depend on a host of factors, such as your business’s size, profitability, future growth potential, etc.

For instance, let’s say you’ve got a mid-sized construction business with a $5 million EBITDA, a decent profit margin, and a high potential. Herein, an EBITDA multiple of 15 can likely be applied, putting your company’s value at $75 million.

However, if your company is making losses and/or is projected to have reduced growth, the EBITDA multiple can be 8. And in this case, your business’s value will be $40 million.

How to calculate construction company EBITDA multiple?

Complicated as it might sound, calculating the EBITDA multiple of your company is fairly simple. All you’ve got to do is divide the market value of your firm’s equity with the EBITDA for the past 12 months.

You can calculate the market value of your company’s equity (also termed as market capitalization, used synonymously in a lot of places) by analyzing the balance sheet.

For instance, if a construction business has a market capitalization of $100 million and an EBITDA of $10 million, the EBITDA multiple will be 10.

Here’s an EBITDA multiple formula for a better understanding:

The market value of equity ÷ past 12 months EBITDA = EBITDA multiple

$100 million ÷ $10 million = 10

What are the disadvantages of using EBITDA multiples in construction business valuation?

Like all business valuation methods, the EBITDA approach has its pitfalls too. And among other things, the major problems stem from the fact that its simplistic valuation formula doesn’t consider various crucial factors.

Here are some examples:

Firstly, the fact that EBITDA multiples do not factor in a company’s capital structure makes it flawed. That’s because it leaves a lot of companies with a highly resilient fiscal structure with a lesser value.

For instance, while some companies may have compiled a huge debt, others might have little to no debt. This means the latter has a more sound balance sheet and, thus, higher growth potential.

Nevertheless, the company with more debt may get a higher EBITDA multiple and end up with a much higher value.

Secondly, valuation and accounting experts using the EBITDA formula to derive a company’s value ignore the business’s future profit potential altogether.

For instance, if two construction companies have the same EBITDA but different net profits, the company with a larger net profit will have a higher valuation. Meaning even if the company with a lower present-day net profit has a much higher profit potential, it’ll still end up with a lower value.

#2. Discounted cash flow

As you just saw, construction EBITDA multiples have some major shortcomings, including the fact that they overlook future growth potential.

So how do you value a construction company by factoring in its potential for the future?

Well, that question brings us to the discounted cash flow method, which takes into consideration a construction business’s future cash flow.

You see, the idea is to somehow calculate how much revenue a business can generate in the foreseeable future and then discount that value to the company’s present value. The number thus derived is again multiplied by another number to obtain the company’s value.

Here’s an example for a better understanding:

Let’s say your construction firm is pegged to have a cash flow of $75 million in the next three years.

Now, you can discount the number 75 to the present value using a rate of discount. Herein, the average cost of capital is usually taken as the discount rate for evaluation.

Once you’ve got a discounted figure, you can multiply it by any number between 4 and 6 to derive your company’s value.

For instance, if you discount $75 million to a 10 percent average cost of capital, you’d derive a value of $56.24 million. We can now simply multiply 56.24 by 5 (or any relevant number) and arrive at a company valuation figure of $281.2 million.

What are the disadvantages of the discounted cash flow method?

While discounted cash flow seeks to remedy the inherent concerns in the EBITDA approach, the former also has its own problems.

Here are some major issues in the discounted cash flow method that multiple experts have pointed to:

  1. It isn’t easy to calculate a company’s cash flow for the coming years. Moreover, the cash flow in construction companies depends on the number of contracts won and projects completed, among others, making it all the more difficult to make a future projection.
  2. It is highly likely for the assumptions of future cash flow to be different for different business valuators. Meaning the exact valuation figure will depend on the person valuing your company and not the stats.
  3. Even a minor change in the rate of discount will impact the present-day value in a significant way. And this, in turn, will have an impact on the overall company value.

In short, resorting to the discounted cash flow method for valuing a construction business might not be the best option for a lot of companies.

#3. Net asset valuation method

Talking about construction company multiples for valuation, net asset valuation is yet another solid method, thanks to the simple evaluation techniques and the real-time data it relies upon.

As the name suggests, net asset valuation involves evaluating the assets and liabilities of your business.

Herein, the idea is to calculate the net worth of your business by reducing the total value of liabilities from that of the assets. And the number derived here is further multiplied by a certain multiplier to derive the total value of the company.

How to value a construction company using the net asset valuation method?

When it comes to calculating how much is a construction company worth, the net asset valuation method offers a simple yet realistic number.

In fact, according to the net asset valuation formula, the total value of your business = net worth (total assets – total liabilities) x multiplier.

For instance, if your construction firm has assets worth $950,000 and liabilities worth $380,000, its net worth will be $570,000. Now, if the multiplier is 1.5, the total value of your company will be $855,000.

However, it’s essential to bear a couple of things in your mind when using this approach:

  • First, the total value of assets and liabilities should be 100 percent accurate.
  • Second, the multiplier that you choose for valuation should be reliable.

Note: The assets of your company include both tangible and intangible assets. And while tangible assets include property, inventory, etc., intangible assets are calculated by factoring in the company’s reputation and brand value, among others.

How do you choose the multiplier for net asset valuation?

There are two ways you can choose a multiplier for an asset-based company valuation:

  1. Examine the multipliers of construction companies that are of a similar size and scale as yours, and choose a multiple from among them.
  2. Determine the average multiple of construction firms and use that as your valuation multiple.

Bonus: you can also evaluate your firm’s assets using the TIE ratio

Another way of valuing your company’s assets is by using the TIE ratio or the Time’s Interest Earned ratio. TIE ratio is commonly used by banks and other financial institutions to establish how credit-worthy your business is.

The method is simple; all you’ve got to do is divide your company’s EBIT (earnings before interest and taxes) by the cost of interest. For instance, if your firm has $150,000 EBIT and $15,000 interest expense, you’ll derive a TIE ratio of 10.

What are the disadvantages of the net asset valuation method?

One of the major criticisms that the net asset method faces is that it doesn’t factor in future projections while answering the question as to how to value a construction company.

You see, while the calculation of net asset and net worth projects real-time data, a company might acquire a huge liability in the near future owing to present-day situations. And this is something that net asset valuation fails to take into account.

Similarly, there are questions about the multiplier used to calculate the company’s total worth, with some valuation experts suggesting that it’s not always reliable.

Also, the net assets of a company might fluctuate frequently, more so in the case of a construction business, something that this method doesn’t recognize.

Nonetheless, the net asset approach to valuation offers tangible and verifiable information at the present time. And that comes in handy in a lot of circumstances, including M&As, partner exits, etc.

You might also want to read: How To Value A Gym Business?

Frequently asked questions:

1. How to value a construction company for sale?

When it comes to selling your construction business, we suggest you go for more real-time valuation data. That’s because such valuation lets you project an unambiguous picture of your business’s current state and help you negotiate the best deal.

For instance, the net asset valuation method is considered a good valuation standard for business owners looking for a complete stake sale.

Nevertheless, if your company is not profitable at present but has future profit potential, discounted cash flow or EBITDA multiples can be your go-to method.

2. How much can I sell my construction company for?

The exact amount for which you can sell your construction firm depends on a lot of factors, including:

  1. Whether the business is small, medium, or large-sized.
  2. The total amount of liabilities of the firm.
  3. How profitable the business is, as well as future profitability evaluation.
  4. The worth of the company’s assets.
  5. Market conditions.

In short, there isn’t a fixed amount that you can sell your company for, and the exact amount will depend on your company’s state of affairs and market scenario.

3. Which valuation method is best for your construction company?

There’s no one-size-fits-all approach when it comes to valuing construction firms. So the right method or approach differs for different companies.

However, a rule of thumb for value of construction business is that the method should be universally applicable. Meaning the method you use for company valuation should be one that is used by other companies and recognized in the market.

You might also want to read: How To Value A Landscaping Business?

Discover Your Construction Company’s Value Now!

Understanding your company’s value is key for expansion, investment, or getting ready to sell. With our expertise in construction business valuations, we provide you with knowledge tailored to your industry. Hit the ‘Get A Quote’ button for a complimentary initial estimate and a sample report.

Conclusion

As you can see, when it comes to how to value a construction company, there are plenty of solutions. Not to mention, all the remedies are reliable and widely in use in the construction industry.

Nevertheless, the right valuation method or solution depends a lot on your business’s structure and standing on the market, among other things. At the end of the day, the method should be able to secure your best interests.

Still wondering how to evaluate a construction company?

You can get in touch with us!

At Arrowfish Consulting, we’re the top gun in the valuation industry, and our seasoned elevators have over two centuries of combined expertise. Meaning wherever be the needs and interests of your construction company, we’ve got them all covered.

 

jeremiah grant

Jeremiah Grant

Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.