Example

OK, I'm going to be the first to admit this is not riveting prose. Take a look, though. Gives you a sense of what I do when the assignment is consulting rather than selling/broker stuff.

MEMORANDUM

To:        Client
From:    Bob Peterson
CC:      
Date:     March 19, 2014
Re:        Valuation

In your email of March 18, you described the current situation and asked me to review a couple of the terms of the current agreement and to give you some language that may be appropriate for a "valuation" of the enterprise at some point in the future.

You and I agreed that such a provision should be acceptable to both parties, as simple as it could be and that it should not jeopardize the arrangement under consideration by the parties.

The Parties, as I understand it

1. Your Company, (YC) 100% owned by Client and formed exclusively to own 25% of the operating enterprise
2. Operating Company is the operating enterprise formed for the purpose of completing projects developed and financed by the 65% owner, Mr. Seller, 10% by another party and 25% by YC. Operating Company will operate as a commercial general contractor pursuant to an Operating Agreement.
3. Client will be the COO of Operating Company, salary $200,000 plus benefits as agreed and responsible for complete oversight of all commercial construction operations.
   The Deal
4. All projects developed by Seller will be built by Operating Company.
5. Profits will be divided as per ownership, pro-rata; tax distributions will be estimated by a CPA or other qualified tax advisor and any distributions in excess of tax distributions will be considered return of capital or liquidation proceeds and accounted for separately.
6. YC has the option to withdraw cash from Operating Company when cash accumulated exceeds $1 million.
7. No costs, charges, allocations, depreciation or other similar charges not directly related to the activities of Operating Company or the projects will be made against Operating Company.
8. Only project management software approved by YC, at its sole discretion, will be used to capture, track and confirm all costs, margins and profits associated with Operating Company and its projects.
9. YC will retain the right to authorize any withdrawals from Operating Company bank and similar cash accounts.
10. Profits will be allocated to the Members according to their unit ownership, tax distributions will be made pro-rata as will any distributions in excess of tax distributions.
11. Any member will have the right to audit the results and the recordkeeping of Operating Company at reasonable intervals.

Buyout, Valuation, Termination Overview

Investors from Benjamin Graham to Warren Buffett agree that "In the long run, Earnings Determine Market Price." They also acknowledge that "In the short run, Emotions Determine Market Price." They were talking about publicly traded stocks, but the same principle applies to small companies that I have been working with for over 20 years, just the fine points are different.

Earnings

The first thing to determine in the valuation process is Earnings. In this situation, the best measure of the earnings is, in my opinion, Earnings Before Interest, Taxes, Depreciation and Amortization computed on an accrual basis (EBITDA).

You or the majority holder could manipulate earnings to an advantage if computed on a cash basis. In a construction company, these earnings will need to account for earnings on uncompleted projects based on a percentage completion basis. For tax purposes, you may delay billing or you may lay in a large stock of material and this should not be used to manipulate valuation as it might be with the cash basis method of accounting.

When dealing with partially complete projects, the Agreement should employ a “look back” provision to adjust estimates to actual.

Cash

When "cash" is referenced in this memo, it means liquid assets, not other current assets like inventory. Cash should be dealt with separately in any valuation process inasmuch as it is not reasonable to pay a multiple of cash. If there is substantial inventory that is not specifically allocated to projects, that should also be dealt with separately, usually at cost.

EBITDA

EBITDA in this context should not be affected by one-time or extraordinary impacts on earnings and should be calculated according to GAAP before distributions.

Fair and Equitable Process to Value a Construction Company

At termination or a wrapping up of Operating Company or of YC's involvement and ownership interest in Operating Company, the enterprise will be valued as follows:

VALUATION METHOD ONE: MULTIPLE OF EBITDA PLUS CASH 

1. Total Valuation of Operating Company shall be determined after customary estimated tax payments are calculated by a qualified tax advisor and made on behalf of the Members;
2. Earnings for projects not yet completed shall be valued on a percentage of completion basis. Holdbacks or retention will be discounted at an annual rate of 10%;
3. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) shall be calculated according to Generally Accepted Accounting Practices (GAAP) before extraordinary or unusual charges/income and on an accrual basis as of the twelve months ending at the date of Termination.
4. The value of Operating Company shall be the sum of:
   1. Two times EBITDA as described herein PLUS;
   2. Cash and liquid assets NOT including inventory, after tax provisions and after taking into account and returning any cash contributions made by the members;
5. YC's share of the Total Valuation of Operating Company as determined by its then-current membership shares as a percentage of total ownership shares shall then be paid to YC in cash or other terms as determined by YC at its sole discretion.
6. In the case of partially completed projects, a reasonable amount of the Purchase Price shall be escrowed and a “look back” provision shall be employed to determine at a later time, say three or six months hence, depending on the contract characteristics, the actual versus estimated value of those contracts.

VALUATION METHOD TWO: ARBITRARY, PRESET VALUATION

This method takes the "valuation" issue off the table; the value has been preset at the salary plus benefits (converted to cash) of the COO plus the pro-rata share of the cash earned and retained.

1. The purchase price of the Membership Units would be set at salary plus benefits, say $275,000.
2. In addition, the cash (earnings retained in the company in the form of cash and similar instruments) after consideration of contributed organizational cash and any subsequent contributions from Members and after consideration of any distributions in excess of tax distributions would be distributed pro-rata. Any capital contributed by YC shall be returned dollar for dollar. 

OTHER VALUATION METHODOLOGIES

Different methodologies are appropriate for different businesses. It is the opinion of NBB that none of the other valuation methods can be appropriately used to value a construction company such as the one described to us.

Having said that, should a construction company nearly identical to the one described herein in terms of size, location, quality and quantity of projects, structure and customers were to be found with a sale within a year, that comparable would be the best indicator of value.

Respectfully presented,

Bob Peterson

Principal

Honey, I Just Talked to Divorce Lawyers

Valuing a Construction Company
Or Honey, I just talked to divorce lawyers.

By Bob Peterson | National Business Brokers Company

The other day, I walked into my wife's office and said, "Honey, I just talked to a divorce lawyer."

"Oh?" With raised eyebrows. Way to go, I had her attention!

"An old listing has asked me to provide a value for her construction company in a divorce case and I have agreed to do it." "Oh." The attention was fading. Quickly.

Agreeing to provide a valuation, a deposition and testimony in court for a small fee and a potential listing did not raise my total worth in her eyes; and when I blurted it out, it didn't sound like a brilliant idea to me either.

Subjecting yourself to the humiliation and aggravation of interrogation by a lawyer set to make you look and sound incompetent should be avoided. So why do we do it? The only real reason: I know what a construction company is worth on the market, how difficult it is to find a buyer and close a transaction and I am offended by the highly paid, sublimely degreed imbeciles who compare the value of a construction company to a window manufacturing and installation business in Tampa.

The truth needs to be told. My wife, however, thought maybe someone else should tell it, and I should devote my efforts to something more productive and profitable. She had a point.

If you approach this from a mathematical viewpoint, develop averages, weighted averages and the like, the results are, in my opinion, flawed and extremely inaccurate. In this case, I thought the opinion of the opposing expert that the value was $750,000 was heinously wrong, but these types of valuations are appealing to the court because they do not require "judgment."

My opinion of value was $250,000 and I told her she would be lucky to get it. Especially since she was unwilling to provide a non-compete.

Here is what I subtracted from the "mathematical" viewpoint:

1.     The lack of a non-compete. In this very personal business, the cooperation of the Seller is critical, and, in this case absent.

2.     There was a back charge pending for over $300,000 and retainage exceeded $600,000. My valuation assumed (properly, I think) that only a fraction of these would be collected by a new owner.

3.     Backlog at the time of valuation was $300,000. Compared to annual revenue of $10 million, this was "full-stop." Based on historical margins, this would not pay overhead for a week.

Instead of a company that would perform along the lines of historical averages, I saw a company with uncertain performance, impaired assets and little evidence of future business.

WHY WOULD YOU BUY A CONSTRUCTION COMPANY?

Short answer: There is no better way to amass significant wealth. Except, of course, the two best ways - marry it or inherit it. Sure, I would like to reap the benefits of one of Warren Buffett’s insurance companies, but I don’t have a spare billion dollars or so. While contracting takes money, it is money that is often within the reach of individuals.

But this road to wealth is littered with the bodies of the vanquished, the ones who reached and failed. It is high reward and high risk.

A fundamental guideline: in my experience, it takes construction experience to be a qualified buyer of a construction business.

When establishing a value/making an offer to purchase:

1.     Keep the price within about 1.0 to 3.0 times cash flow.

2.     Recognize the extra value of equipment, but the effect is probably not substantial in most except "heavy" contractors.

3.     Include a “look back” provision in your purchase contract as a way of settling up on matters that will be decided as jobs complete.

4.     Insist on a backlog that will provide a good start for the new owners.

5.     Obtain a meaningful transition process.

6.     In due diligence, look for general contractor back charges, establish a bonding line prior to closing and be very careful about the difference between what you thought you were told by owners/brokers and what you are seeing. Quiz current customers and any contractors you do business with.

PAY UP FOR QUALITY AND GROWTH. When considering the multiple of cash flow, move higher if the company is growing and fairly large, move lower if the company is small (your salary takes more of the "cash flow"). The term "quality" can mean a lot of different things, but make sure that you get a company that has some certainty to the future of the earnings stream although that is extremely hard to discern.

Buckle up, get ready for a ride! Good luck.