By Kevin Groff, Senior Managing Director, Investment Banking, and MaryJane Prosser, Director, Investment Banking
Over the last five years, LCG’s business advisory teams have become increasingly active across the construction and specialty contracting sectors, also known as the ‘built economy’. Through that work, one theme continues to surface among founder- and family-owned businesses: what helped you build the business can sometimes be what hurts you when it comes time to exit.
Construction is an industry where results are tangible. Projects get completed, buildings pass inspection, new RFPs are bid, and new work enters the pipeline. For an owner who has successfully operated that way for decades, formal financial reporting, documented processes, and established management procedures can understandably feel secondary to getting the job done. A buyer, however, must evaluate the business differently. Backlog, customer relationships, historical growth, and an experienced workforce all contribute to value, but buyers also need to understand how transparent, sustainable, and transferable that value is under new ownership. For contractors thinking about a transaction, there are a handful of areas that tend to receive more attention than owners might expect.
A Pipedream or a Pipeline?
A strong pipeline or backlog can provide visibility into future performance, but a buyer needs to understand what sits behind the number. For construction businesses, that means looking beyond the total value of future work to understand how that work is contracted, how it is expected to perform, and how it ultimately translates into earnings and cash flow.
Progress billing, retainage, bonding capacity, and other project-level considerations can all be part of that evaluation. An owner may have confidence in future work based on years of experience and customer relationships, but a buyer needs to be able to validate that confidence. Clear project-level reporting can help address questions likely to arise during diligence:
- What is actually under contract?
- What has been awarded but not yet signed?
- When is the work expected to start?
- What margins are built into those projects?
- How concentrated is the backlog among customers or end markets?
Consider a $50 million backlog made up of signed projects with established schedules and healthy expected margins. That tells a very different story than a $50 million pipeline made up largely of anticipated awards or projects with uncertain start dates. Buyers will also compare the margins embedded in current backlog with what the company has historically produced. Good backlog reporting makes that conversation much easier. It gives an owner the ability to show not only how much work is ahead, but how much visibility that work provides into the next 12 to 24 months.
Does the WIP Schedule Tell the Same Story as the Income Statement?
For a contractor using percentage-of-completion accounting, the WIP schedule can receive almost as much attention during diligence as the income statement. Revenue and profitability are based in part on estimates: how far along is the job, what has been spent to date, and, most importantly, what will it cost to finish? Those estimates change. That’s normal. What buyers and their quality-of-earnings teams want to understand is whether the company has a consistent process for updating them and whether the WIP schedule supports the earnings being reported.
During diligence, buyers may look closely at costs to complete, margin fade or gain, underbillings and overbillings, and significant project-level adjustments to understand whether WIP is being updated consistently and appropriately reflected in the company’s financial statements.
For some founder-owned contractors, WIP adjustments may historically have been made at year-end rather than consistently throughout the year. That approach may have worked well for tax or financial reporting purposes, but it can create additional questions when a buyer is evaluating trailing-twelve-month EBITDA. A large December true-up, for example, may relate to work performed throughout the year and can distort the economics of a trailing period if not appropriately considered. That doesn’t necessarily mean there is anything wrong with the company’s earnings. It may simply require more work to support them.
Consistent WIP reporting before a process begins, including regular cost-to-complete reviews and consistent revenue recognition, can make it easier to support normalized EBITDA during diligence.
EBITDA Is One Thing. Cash Flow Is Another.
Construction companies can produce attractive EBITDA while consuming a meaningful amount of cash. Buyers know that, which is why working capital often gets significant attention in a transaction. A contractor may be funding payroll and materials well before receiving payment from a customer, while billing schedules, mobilization costs, retainage, underbillings, and overbillings can all create differences between when profit is recognized and when cash actually comes through the door.
Retainage is one example. The contractor may have earned the revenue and recognized the profit but still have 5% or 10% of the invoice sitting on the balance sheet waiting to be collected. On a growing backlog, that can become a meaningful use of cash.
Underbillings and overbillings require similar attention. An underbilling may reflect normal project timing or raise questions about collectibility, while an overbilling may benefit near-term cash flow even though the company still has an obligation to perform the associated work.
All of this can ultimately factor into one of the more heavily negotiated parts of a transaction: the normalized level of working capital the seller is expected to deliver at closing. Owners who understand their historical working-capital cycle and can explain unusual movements in retainage, receivables, underbillings, and overbillings can enter those negotiations with greater visibility into what a buyer may be evaluating.
What Happens to the Bonding Program After a Sale?
For contractors that rely on bonded work, bonding capacity isn’t just another diligence item. It can be fundamental to the company’s ability to keep winning work after a transaction.
A buyer will want to know the company’s single-project and aggregate bonding limits, how much of that capacity is currently being used, what financial requirements support the program, and whether the owner provides a personal guarantee. That guarantee can be particularly relevant in a founder-owned business, where the company may have had the same surety relationship for years and capacity may be supported in part by the owner’s personal financial strength. If that owner sells the business, the existing arrangement doesn’t necessarily carry over unchanged.
A well-capitalized buyer may ultimately improve the company’s bonding capacity, but that conversation still needs to happen. The surety needs to understand the new ownership structure, capitalization, and financial support behind the business. Addressing the bonding program early can help prevent a transaction consideration from unexpectedly becoming an operating issue after closing.
Are the Earnings Repeatable?
Construction earnings rarely move in a perfectly straight line. One year may benefit from a few particularly profitable projects. Another may be hurt by a delayed start, labor inefficiencies, material escalation, or one job that simply didn’t go as planned.
That is why buyers generally won’t stop at consolidated revenue and EBITDA. Revenue and gross profit by project, customer, and end market can provide a clearer picture of what’s driving performance and whether results are being influenced by a handful of particularly strong or weak projects. Buyers may also consider change orders, claims, project closeouts, and unusually profitable or unprofitable jobs. Ultimately, they’re trying to answer a fairly simple question: Is the historical EBITDA a reasonable indication of what this business can earn going forward? The more clearly an owner can explain what has historically driven performance, the easier it becomes for a buyer to understand what may be repeatable going forward.
Can the Business Operate Without the Owner?
For many founder-owned construction businesses, hands-on leadership has been fundamental to the company’s success. The owner may manage key customer relationships, oversee estimating, approve bids, maintain the surety relationship, solve project problems, and make dozens of operating decisions that no one else in the organization really thinks about. That can be a very effective way to run a business. It’s harder for a buyer to underwrite.
If the owner wants to step away after a transaction, the buyer needs confidence that those responsibilities can move elsewhere. Strong project managers, estimators, superintendents, and financial leadership can all have real value in a transaction.
The same is true of customer relationships. A relationship that exists between a customer and the company is generally more transferable than one that exists solely between the customer and the founder.
None of this means an owner has to make themselves irrelevant before selling the business. But the less the organization depends on one person for its day-to-day success, the easier the transition tends to be.
What Makes the Business Different?
Not all construction revenue is created equal. Some contractors have built deep expertise in attractive end markets such as healthcare, education, government, industrial, or mission-critical facilities. Others may differentiate themselves through geography, technical capabilities, self-performed trades, recurring service revenue, preferred-contractor relationships, certifications, or access to specialized contract vehicles. Those distinctions matter because different buyers will value them differently.
A strategic buyer may see an opportunity to enter a new geography, add a trade, or gain access to customer relationships it doesn’t currently have. A private equity investor may place greater emphasis on management depth, market fragmentation, organic growth opportunities, and the ability to make future acquisitions. A good M&A process isn’t just about proving that the company is a strong business. It’s also about identifying why the business is particularly valuable to the right buyer.
Getting Ahead of the Questions
Most of these issues are much easier to work through before a transaction is underway. That doesn’t mean an owner needs to spend two years turning an entrepreneurial construction company into a highly institutionalized organization before considering a sale. In many cases, that’s neither realistic nor necessary. But it helps to understand where buyers are likely to focus.
The goal isn’t to eliminate every question before going to market. It’s to understand where those questions are likely to come from and be prepared to clearly explain the business behind the numbers. There is a difference between building a successful construction company and building one that is ready to go through an M&A process. Understanding that difference, and how a buyer is likely to evaluate the business, can help owners better position what they have built and make more informed decisions about what comes next.
LCG’s Investment Banking team works with business owners and management teams evaluating mergers, acquisitions, recapitalizations, and other strategic transactions. Our professionals provide hands-on M&A advisory support throughout the transaction process, helping clients evaluate opportunities, position their businesses, and navigate the complexities of a transaction. For questions or to discuss your strategic options, contact Kevin Groff at [email protected].
LCG provides investment banking services through its affiliate, LCG Capital Advisors, LLC, a FINRA-registered broker-dealer and SIPC member firm. For more information regarding LCG Advisors or LCG Capital Advisors, LLC, please call (813) 226-2800 or visit www.lcgadvisors.com.