Succession Planning for Construction Business Owners: Considerations and Best Practices

In the construction industry, business owners often face a myriad of challenges that can complicate succession planning. One hurdle is the cyclical nature of the industry, which can create financial instability and affect the timing of transitions. Many firms are also family-owned, complicating succession plans due to the complex dynamics and expectations surrounding family involvement.

With owners increasingly looking to sell and retire, succession planning is critical for business continuity and growth beyond the current leadership, especially when targeting private equity buyers. Understanding how your business is valued and preparing your financials accordingly can significantly impact the sale process and valuation of your construction company.

Understanding Business Valuation

The first step in succession planning is understanding how your business will be valued by potential buyers. Construction businesses are typically valued based on their earnings, multiplied by a certain industry-specific multiple. This multiple is influenced by benchmarks and industry norms. Therefore, aligning your financial reporting with Generally Accepted Accounting Principles (GAAP) is important. This alignment ensures that your revenue and earnings are consistent with industry standards, making the valuation process smoother and more accurate.

Preparing Financial Statements

Many small construction companies operate on a cash basis, which can complicate the valuation process. Transitioning to accrual accounting and ensuring your financial statements reflect GAAP standards is essential. This transition often involves updating percentage of completion calculations regularly. Accurate and consistent financial reporting enhances buyer confidence and can increase your business’ valuation.

Are your financials in order? We’ve outlined a couple of actionable items you can take:

1. Conduct financial audits. Obtaining an audit of your financial statements adds credibility to your reporting. This step supports your valuation by providing an objective assessment of your financial health. Buyers are more likely to trust audited financial statements, which can lead to a higher valuation.
2. Know your revenue and margins. It’s important to analyze your revenue on a project basis, understanding the cost and margin for each project. Identifying trends in your financials and preparing narratives to explain any anomalies can help potential buyers understand your business better. In addition, maintaining a pipeline and backlog report that shows future business prospects can demonstrate the sustainability of your revenue streams.
3. Calculate your adjusted EBITDA. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a key metric in business valuation. Adjustments to EBITDA are made for non-recurring, non-operating costs, expenses, or revenue. For example, personal expenses or salaries for family members who do not contribute to the business should be excluded to present a normalized adjusted EBITDA. This adjustment provides a clearer picture of the business’s true earnings potential.

Beyond Valuations

Buyers are interested in ensuring that there is a second layer of management capable of running the business in the absence of the owner. Developing a strong management team can drive value and make your business more attractive to buyers.

Reducing risk by diversifying your customer base is another key strategy. Demonstrating that no single customer or client is critical to your business reduces perceived risk for buyers. This diversification can also apply to the types of projects you undertake and the geographic areas you serve.

Engaging Professional Advisors

Working with a wealth manager, attorney, and investment banker early in the process can be highly beneficial. These professionals can help you plan for the proceeds of the sale, structure the deal to meet your priorities, and provide strategic advice to increase your business’ value. Investment bankers, in particular, can present various transaction outcomes and help you choose the best path, whether it’s selling to private equity, a strategic buyer, or passing the business to existing employees or management.

Conclusion

By following these steps and leveraging professional advice, you can enhance the value of your construction business and ensure a smooth transition when selling to private equity or other buyers. Succession planning is not just about financial gain, it’s also about preserving your legacy and ensuring the continued success of your business.