The amount of commercial goodwill attached to a profitable construction business will depend on its specific characteristics. In general terms, goodwill is the value of a business in excess of its balance sheet “book value”.
“Commercial” goodwill represents intangible value associated with a business’ location, product/service brand or offering, competitive advantage, or other attributes that are independent of the individual owner-manager(s) and employees. Commercial goodwill must be transferable to a purchaser of the business.
Some important factors influencing construction company goodwill value are as follows:
Owner-manager reliance
A company’s apparent goodwill could actually be personal to the owner-manager and not commercially transferable. Construction owner-managers are often the primary driver of new business, owing to a long-established reputation in the industry and personal relationships that provide the company with an opportunity to bid on contracts or be unilaterally awarded contracts. Reputation and personal relationships are difficult, and sometimes impossible, to transfer to a purchaser. Therefore, if an owner-manager leaves a company after a sale, a purchaser may be left with a reduced customer base and idle labour and equipment. Further, customers that initially stay with a company may choose to follow an exiting owner-manager to a new business after the expiry of any non-competition agreement.
Other issues that could cause problems for a purchaser include the prevalence of relationship-based “hand-shake deals” with customers where performance, timelines, and payment expectations are insufficiently documented, as well as a lack of prior investment in advertising and promotion due to the owner-manager generating most of the business.
Size
Small companies can lack the management team depth and documented systems and processes that add additional value to a business and provide continuity in a transition to new ownership. They may also rely on a small number of key estimators, project managers, and site supervisors for the profitable and timely execution of jobs. Often these employees are not under long-term contracts and can easily leave the company in the event of a sale. Additionally, small companies may not have a level of brand recognition in the marketplace that would attract a premium from a buyer.
Customer concentration
Companies that earn most of their revenue from a small number of customers are riskier investments than those that have a broader customer base.
For example, a specialty subcontractor who works primarily with a few general contractors. In the absence of long-term contracts securing the relationship for an extended period, these customers may choose to take their business elsewhere if the company is sold. This risk is compounded if the customer relationships were personally nurtured over many years by the exiting owner-manager.
Competitive bidding
Many construction companies derive a large portion of their revenue from contracts won in a competitive bidding process. In these circumstances, there may be little or no commercial goodwill, particularly where the lowest bid price is the determining factor in the awarding of the contract.
Competitive bidding can lead to a low percentage of recurring business and frequent variations in income that make these companies riskier investments than companies that rely more on negotiated contracts and repeat customers. Competitive bidding can also drive down profit margins, as contractors are incentivized to undercut each other. Elevated risk and low profits will negatively impact commercial goodwill value.
Barriers to entry
Certain segments of the construction industry, for example, concrete forming, roofing, renovations, and small-scale road construction, have relatively low barriers to entry. There are usually no formal qualifications or licensing requirements to begin operations. If expensive equipment is required, it is often possible to rent or lease it. Low barriers to entry can lead to a highly competitive market and downward pressure on profitability. If new companies can easily start up and begin operating in the segment, it is unlikely selling prices will include a significant amount of goodwill value unless there is a sustainable competitive advantage.
Unionized workforce
Unionized labour is typically more expensive than non-unionized. If these costs cannot be passed on to the end customer, it will result in lower profits. Further, there is always a risk of a work stoppage should relations with the union deteriorate.
In conclusion
When preparing a construction business for sale, there are steps that may be taken to improve goodwill value. With appropriate strategic planning and the right advisory team, this could lead to your company being more valuable and easier to sell when it comes time for an exit.
If you have any questions or need further information, please reach out to the Real Estate and Construction group at Fuller Landau.
About the author
Matthew Downey, CPA, CA, CBV, CFF is a Partner in our Valuations team and a member of the real estate and construction group at Fuller Landau. He can be reached at 416-645-6513 or mdowney@fullerllp.com.
