If you’ve decided that selling your construction company to a third party is an option that you’re interested in exploring, there are a few key items to consider before leaping in with both feet. How to continue with the company’s bond program and eliminate your liability under the surety’s indemnity agreement are two of those important considerations, and we will address those and more in this article. But first let’s start with looking at the market for construction businesses and who some potential buyers are.
Market for Construction Businesses
There has generally been a limited market to sell a construction company to a third party. This is in part due to the fact that many construction businesses have to bid all of their work, so the revenue stream isn’t as consistent or reliable as some other businesses. This obviously varies from contractor to contractor.
The most common buyers of construction businesses:
These buyers have been around for decades. Historically, they bought up similar types of companies like mechanical or electrical contractors and formed “roll ups”. While those still exist to some extent, private equity has evolved significantly, and now there are quite a few private equity firms that have purchased a variety of construction companies.
Private equity firms typically finance the purchase with a substantial amount of debt, which can impact the company’s ability to get the bonding support required. Surety companies have evolved to find ways to underwrite and support construction companies owned by private equity. However, the high amount of debt does change the risk profile for the construction company and makes it more vulnerable to issues. For a selling owner concerned about the long-term health and legacy of the company, this is an important consideration, because the reality is, some of these private equity owned construction companies won’t make it.
The selling owner will generally receive a majority of the payment in cash. Some small portion of the purchase price will be based on an “earn out” meaning the owner will get more or less depending on how the current projects performed. In other instances, the exiting owner may get a percentage of the sale price in stock of the new entity.
A strategic buyer is a company that is looking to get into your specific field. This could be a local general contractor that wants to form a concrete division by acquiring your firm or it could be a large national company that is looking to expand their operation into the marketplace you serve.
The terms of these purchases will vary, but large strategic buyers more often have the resources to pay all cash.
If you have large competitors, they may have an interest in expanding by way of acquiring other companies. Some companies have used this approach as a way of getting labor given the industry shortage. The difficulty with talking with a competitor is the risk of the word getting out into the marketplace about your desire to sell the business.
Like strategic buyers, the terms will vary in large part based on the size and resources of the acquiring company.
What is Your Business Worth?
You’ll want to start by getting an appraisal. Generally, a key valuation metric is based on a multiple of EBITA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Thus, the strength of your net income will be a major driver along with the type of construction work you do, the source of your work (low bid or negotiated), and the stability of your revenue/net income. We’ve seen the multiples range from 2 to 6 times EBITDA.
At the end of the day, while appraisals are important and necessary, it is critical to remember that your company is worth what someone will pay for it. That could mean more, or it could mean less depending on how many and what type of buyers are potentially interested.
Preparing for a Sale
Because so much of the value of the company is driven by the net income and stability of earnings, in the years leading up to the sale it’s important to reduce or eliminate personal transactions and clean up the books. It’s prudent to engage your CPA early on in the process to prepare financials, if you don’t already, and discuss the tax consequences. It can also be helpful to engage a third party valuation firm not only to help you understand the value of your company but what steps you can take to maximize that value.
As we touched on earlier in the article, one of the major considerations is whether the buyer will be able to qualify for the bonds your company needs. You’ll want to address this at the beginning stages of the process. For private equity firms that are unfamiliar with bonding requirements and don’t have other contractors that use surety bonds, this can be a red flag. That’s not to say it can’t be figured out, but it should be addressed before getting to the finish line of the transaction and realizing there is a problem.
The same is true for smaller strategic buyers or competitors. If they have a bond program in place already, it probably won’t be an issue, but if they don’t, it’s something to work on early on in the deal process.
Liability for Existing Jobs
One of the major issues for owners selling their business is what happens to their liability under the existing bonds. This is really important where there are long-term contracts that will take years to complete. That liability will remain in place but there are a few ways to deal with it.
One way to proactively deal with it is to retain enough capital in the company to get the surety to eliminate your personal guarantee in advance of selling the business. This takes planning in advance with your surety agent and for some owners that prefer to invest excess profit personally rather than retain it in the company, it doesn’t always make sense.
In some instances, you may be able to negotiate the buyer of the business replacing all of the bonds with new bonds that do not have your personal guarantee. This requires them to pay premiums twice for the new bonds, which may reduce the purchase price, and it can be cumbersome to get all of the project owners to accept the replacement bonds.
When the buyer is a large, financially strong company, you can have them indemnify you for any losses under the bonds. Just like a surety does, you’ll need to underwrite the guarantee you are getting by reviewing the company’s financial strength to make sure they can weather any issues with your bonded jobs and satisfy any potential liability.
As with any option you are considering exiting your business, you’ll want to consult with your surety agent to strategize on how to deal with the liability under your outstanding bonds and tap their experience and resources. At CSBA, we have been helping our clients transition to the next chapter for decades, and we’ve built up numerous contacts including consultants, appraisers, and ESOP advisors.
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