Valuing general contractors, especially in the single-family home construction industry, requires a nuanced approach that combines financial metrics with industry-specific factors. General contractors work in a dynamic environment where revenues fluctuate based on market conditions, project scope, and geographic location. Accurately valuing these businesses is crucial, whether for mergers and acquisitions, securing financing, or succession planning.
Understanding the Unique Aspects of General Contractors
General contractors, particularly those in the single-family home construction sector (SIC 1521), are highly reliant on local market conditions, real estate cycles, and broader economic trends. Their revenue can be seasonal, and cash flow may vary significantly based on the number and size of active projects. Moreover, contractors often face unique challenges such as subcontractor management, fluctuating material costs, and labor shortages. These factors must be taken into consideration during the valuation process.
Additionally, general contractors often have different types of income streams. These can include new home construction, remodeling, and project management services. Each stream may have a different risk profile and profitability, making it necessary to break down and evaluate these components separately.
Industry Context: Homebuilding and Construction Trends
External factors like interest rates, material costs, and housing stock levels have caused demand fluctuations in the homebuilding industry. As outlined in the Home Builders in the US report, recent trends indicate:
- Interest rates: High mortgage rates have slowed new housing projects, but a potential decline in rates in 2024 could bring a resurgence in housing demand and construction activity.?
- Material costs: The volatility of material prices, particularly during the pandemic, posed challenges, but these costs have stabilized, making it easier for homebuilders and contractors to plan for future projects.
- Government programs: Various affordable housing programs, primarily in populated cities, offer new opportunities for contractors involved in residential projects. These programs, along with housing starts, serve as key drivers for general contractors operating within the residential sector.?
Market Multiples for General Contractors
Data from Business Valuation Resources provides useful benchmarks for valuing general contractors in the single-family housing sector. Market Value of Invested Capital (MVIC) to sales, gross profit, EBITDA, EBIT, and seller’s discretionary earnings (SDE) provide key insights. Here’s how these multiples stack up based on industry data:
- MVIC/Sales: The median multiple is 0.34, with a range between the 25th percentile (0.22) and the 75th percentile (0.53). This ratio indicates the value of the business relative to its total sales and is particularly useful for companies with lower margins.
- MVIC/Gross Profit: The median multiple is 0.90, ranging from 0.50 at the 25th percentile to 1.30 at the 75th percentile. Since gross profit directly impacts the bottom line, this ratio is a more refined measure than sales multiples.
- MVIC/EBITDA: The median multiple is 2.9, with a range from 1.9 to 5.4. EBITDA is a key indicator of cash flow and financial health, making this multiple particularly relevant for valuation.
- MVIC/EBIT: The median multiple is 3.3, with a range between 2.0 and 6.5. EBIT is crucial as it accounts for depreciation and amortization, two significant costs in construction businesses.
- MVIC/SDE: The median multiple is 2.1, with a range between 1.3 and 2.7. Seller’s discretionary earnings represent the total financial benefit to the owner, which can be a useful metric for owner-operated businesses.
These multiples offer a strong foundation for understanding the general contractor valuation landscape. For example, a contractor with an EBITDA of $1 million and a median MVIC/EBITDA multiple of 2.9 would have a value of approximately $2.9 million.
Factors Impacting Valuation
- Project Backlog: A robust project backlog can increase the value of a general contracting business. A healthy pipeline of projects suggests that the business will continue generating cash flow in the future, which is a key factor in valuation.
- Reputation and Client Relationships: The quality of relationships with developers, architects, and suppliers can significantly affect the value of a contracting business. A contractor known for completing projects on time and within budget will command a higher valuation due to lower perceived risk.
- Geographic Location: Local real estate markets can dramatically impact a contractor's revenues. Contractors operating in high-demand housing markets, such as those in growing metropolitan areas, tend to have higher valuations due to greater project opportunities.
- Workforce and Subcontractor Network: General contractors rely heavily on skilled labor and subcontractors. A well-managed workforce and a strong network of subcontractors can add value by ensuring that the contractor can handle more projects simultaneously or take on larger, more lucrative jobs.
- Economic Conditions: The broader economy, especially factors like interest rates and housing demand, plays a significant role in the valuation of general contractors. For example, a downturn in housing demand can quickly lead to fewer projects, negatively impacting revenue and cash flow.
- Profit Margins: In construction, profit margins can vary widely based on the type of projects being undertaken. Custom home construction, for instance, might offer higher margins than tract home development. The higher the margins, the higher the potential value of the business.
- Asset Base: Construction firms with significant investments in equipment and real estate may be worth more than companies that lease most of their equipment. The asset approach is often used to value contractors with a significant asset base.
- Risk Factors: Contractors face unique risks, such as the potential for project delays, cost overruns, and legal disputes. A higher perceived risk will reduce the value of the business, as buyers will demand a higher return to compensate for taking on that risk.
The Importance of Recasting Financial Statements
Before a general contractor business is valued, it’s essential to “recast” the financial statements to reflect the true economic benefits of the company. Recasting involves adjusting financial statements to eliminate non-recurring, discretionary, or personal expenses that the owner may have run through the business. This ensures that the financials used in the valuation are an accurate reflection of the business’s earning power.
- Adjusting Owner’s Compensation: Many general contractors run owner benefits through the business, such as personal vehicle expenses or health insurance. These need to be adjusted to show the actual business profitability.
- Eliminating Non-recurring Expenses: Any one-time expenses, such as legal settlements or equipment purchases that won’t recur, should be removed to show normalized earnings.
- Accounting for Cash Flow: It’s also critical to adjust for any disparities in how the business accounts for cash versus accrual accounting, particularly if the contractor has a long-term project cycle.
Conclusion: How Business Valuation Advisors Can Help
Valuing a general contractor business requires a thorough understanding of both financial performance and industry-specific factors. The process involves adjusting financial statements, understanding market conditions, and applying appropriate valuation multiples based on industry benchmarks.
Business Valuation Advisors can guide you through this complex process by providing expert analysis, utilizing data from paid resources, and applying industry-specific valuation methods. Our advisors work closely with contractors to ensure that every aspect of the business, from assets to earnings and potential risks, is considered.
For more information or to discuss your business valuation needs, send us a direct message here on LinkedIn.
