Business Valuations for

Construction Contractors
October 18, 2012

Brian Muncy, CPA, CFE

Paul Wonch, MBA, CPA/ABV, CVA,CFFA
Overview

 Why Contractors Need Valuations

 Valuation Approaches & Methods
 Key Factors
 Example I – Light
 Example II – Heavy
 Rules of Thumb
Why Contractors Need Valuations

 Estate or Exit Planning

 Shareholder Buyout
 Buy-Sell Agreement
 Purchase a Contractor
 Divorce
 Death
 ESOP
Valuation Approaches & Methods
 Income Approach
 Discounted Cash Flows
 Capitalization of Earnings
 Asset Approach
pp
 Adjusted Net Asset
 Excess Earnings
 Market Approach
 Direct Market Comparison
 Guideline Public Company
Key Factors
 Accounting Information
 Quality of information
 Basis of accounting
 Accuracy of Schedule of Construction in Progress
 Estimated Costs to Complete
p
 Type of Contractor
 General Contractors – Engaged by owners to coordinate and
oversee constructions projects.
projects
 Self-performing
 Design/build services
 Subcontractors – Perform specialized tasks related to all types of
construction.
Key Factors

 Contract Risks
 Type of Contracts
 Fixed price (Lump-sum)
 Cost plus
 Guaranteed Maximum Price (GMP)
 Time and Material
 Previously Performed Work with Owner/Contractor
 Poor performing jobs – underbilling can be an indicator
 Collection of Receivables and Retention
Key Factors

 Backlogg
 Realization of the Contract
 Expected Profitability
 50% of Annual Revenue – CFMA Best of Class
 Concentration of Customers and Projects
 Large Concentration with Few Customers
 Key Employee Relationship with Customer
C
 Service Agreements
 Union versus non-union
 Age of Equipment
Example I - Light

 Suntower Inc.
Suntower, Inc
- Serves Telecommunications and Renewable Energy Industries
- Tower erection,, antenna/line installation,, engineering,
g g, testing,
g, etc.
- Wind turbine installation, engineering, maintenance, etc.
- Demand for broadband coverage via smartphones, etc. increasing
- Demand
D d ffor electricity,
l i i rising
i i energy prices,
i technical
h i l iinnovation
i = growth
h
- Highly trained workforce
- Customers include, AT & T, Verizon, American Tower, Alternative Wind, Co.
- Company poised for growth
Example I - Light

Suntower Balance Sheet

2006
ASSETS
Current assets
Cash and cash equivalents $ 250,000
Accounts receivable 950,000
C t andd estimated
Cost ti t d earnings
i in
i excess off billings
billi
on uncompleted contracts 205,000
Total current assets 1,405,000

Property and equipment

Vehicles and equipment 22,000,000
000 000
2,000,000
Less accumulated depreciation 1,500,000
Total property and equipment 500,000

$ 1,905,000
Example I - Light
Suntower Balance Sheet
2006
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable $ 135,000
Line-of-credit payable 210,000
Accrued liabilities 25,000
Other current liabilities 5,500
Total current liabilities 375,500

Notes payable 150,000

Total liabilities 525 500

525,500

Stockholders' equity (deficit)

Common stock 100,000
Retained earnings (deficit) 1,279,500
Total stockholders
stockholders' equity (deficit) 1 379 500
1,379,500

$ 1,905,000
Example I - Light
Suntower Historical Income Statements
2006 2005 2004
Revenue $ 8,652,174 $ 7,865,613 $ 7,491,060
Cost of revenue 6,471,826 5,914,941 5,633,277
Gross profit 2,180,348 1,950,672 1,857,783

General and administrative expenses

Officer salary 181,696
181 696 165,178
165 178 157,312
157 312
Office wages 95,174 94,387 82,402
Repairs and maintenance 34,609 31,462 37,455
Rent 147,087 133,715 127,348
Property and other taxes 25,957 15,731 22,473
Interest 8 652
8,652 15 731
15,731 37 455
37,455
Depreciation 268,217 157,312 194,768
Employee benefits 173,043 157,312 149,821
Other 441,261 401,146 404,517
1,375,696 1,171,976 1,213,552

Net Income $ 804,652 $ 778,696 $ 644,231

Example I - Light
Suntower Projected Operating Income
2007 2008 2009 2010 2011
Revenue $ 10,382,609 $ 12,978,261 $ 15,573,913 $ 16,664,087 $ 17,413,971
Cost of Revenue 7,766,191 9,707,739 11,649,287 12,464,737 13,025,650
Gross profit 2,616,417 3,270,522 3,924,626 4,199,350 4,388,321
Operating expenses
Officer salary 187,873 194,261 200,866 207,695 214,757
Office wages 98,410 101,756 105,215 108,793 112,492
Repairs and maintenance 35,785 36,644 37,524 38,424 39,346
Rent 152,088 155,738 159,476 163,303 167,222
Property and other taxes 26,839 27,483 28,143 43,227 44,265
Interest 8,946 9,161 9,381 9,606 9,837
Depreciation 277,337 283,993 290,809 297,788 304,935
Employee benefits 178,927 185,010 191,301 197,805 204,530
Other 456,264 467,214 478,427 489,909 501,667
1,422,469 1,461,261 1,501,141 1,556,552 1,599,052

Pre-tax
Pre tax operating income 1,193,948
, 93,9 8 1,809,261
,809, 6 2,423,485
, 3, 85 2,642,798
,6 ,798 2,789,269
,789, 69

After-tax operating income $ 850,810 $ 1,256,505 $ 1,683,074 $ 1,835,384 $ 1,937,105

Example I - Light
Suntower Discount Rate Build-up

20 Year Treasury Note Rate (1) 4.00%

Equity Risk Premium (2) 6.00%

Industry Risk Premium (2) 6.00%

Size Premium (2) 5 80%

5.80%

Specific Company Premium (3) 3.00%

Discount Rate 24.80%

 (1) – Economic Research & Data section of Federal Reserve Website.

 (2) – Ibbotson SBBI Valuation Yearbooks published by Morningstar, Inc. or Duff & Phelps Risk
p
Premium report published
p byy Duff & Phelps,
p LLC
 (3) – Based on judgment on a number of factors – See Next Slide.
Example I - Light
 Specific Company Risk Factors
 Abnormal Present or Pending Competition
 Availability of Labor
 Customer Concentration
 Customer Pricing Leverage
 Ease of Market Entry
 Fi
Financial
i l SStrength
h
 Key Person Dependence
 Pending or Threatened Lawsuits
 Profitability and Stability of Earnings
Example I - Light
Suntower Discounted Cash Flows

Discount Rate 24.8%

Growth Rate 4.5% (after year 5)

Discounted Cash Flow Value Calculation

Less cash Projected Present
Projected Plus Less Capital needed for Annual Cash Value
Year After-tax OI Depreciation Outlays growth in WC Flows Factors Present Value Sales Growth
1 850,810 277,337 150,000 52,570 925,577 0.89514 $ 828,524 20.0%
2 1,256,505 283,993 187,500 65,713 1,287,285 0.71726 923,321 25.0%
3 1,683,074 290,809 225,000 78,855 1,670,028 0.57473 959,814 20.0%
4 1,835,384 ,
297,788 240,750
, 84,375
, 1,808,047 0.46052 832,643
, 7.0%
5 1,937,105 304,935 251,584 88,172 1,902,285 0.36901 701,956 4.5%
Terminal Value (cash flows after year 5) - 3,613,518

Total Present Value 7,859,776

Indicated Value (rounded) $ 7,860,000

Example II - Heavy

 Heavier Construction,, Inc.

- Engaged in construction of sewers, water treatment plants, and roads, and
provides excavation and bridge repair services
- Most work is performed under fixed
fixed-price
price contracts with general
contractors, developers and municipalities
- Length of contracts vary and many extend beyond one year
- Prone to fluctuations in the economyy
- Business is currently down primarily due to recession
- Capital intensive with heavy equipment also owning land and building
- Significant
g cash reserves on hand to weather downturns
- Company stabilized at historically depressed level
Example II - Heavy

Heavier Historical Income Statements

2010 2009 2008 2007 2006
Revenue $ 75,000,000 $ 70,000,000 $ 85,000,000 $ 100,000,000 $ 150,000,000
Cost of revenue 75,750,000 67,900,000 80,750,000 84,000,000 124,500,000
Gross profit (750,000) 2,100,000 4,250,000 16,000,000 25,500,000

General and administrative expenses

Operating expenses 1,950,000 2,940,000 1,445,000 4,200,000 4,800,000
Other expenses 75,000 350,000 680,000 1,000,000 1,500,000
Interest expense 150,000 140,000 170,000 300,000 450,000
2 175 000
2,175,000 3 430 000
3,430,000 2 295 000
2,295,000 5 500 000
5,500,000 6 750 000
6,750,000

Other income 500,000 450,000 2,500,000 850,000 400,000

Net Income (loss) $ (2,425,000) $ (880,000) $ 4,455,000 $ 11,350,000 $ 19,150,000

Example II - Heavy
Heavier Balance Sheet
2010
ASSETS
Current assets
Cash and cash equivalents $ 12,350,000
Accounts receivable 20,990,000
Prepaid expenses 300,000
Cost and estimated earnings in excess of billings
on uncompleted
l d contracts 22,800,000
800 000
Total current assets 36,440,000

Property and equipment

Land 10,000
B ildi
Buildings 500 000
500,000
Construction equipment 45,000,000
Office equipment 350,000
45,860,000
Less accumulated depreciation 40,000,000
T l property andd equipment
Total i 5 860 000
5,860,000

$ 42,300,000
Example II - Heavy
Heavier Balance Sheet
2010
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable $ 11,000,000
Accrued losses on uncompleted contracts 2,500,000
Accrued liabilities 1,200,000
Billings in excess of costs and estimated earnings on
uncompleted contracts 350 000
350,000
Total current liabilities 15,050,000

Notes payable 150,000

Total liabilities 15,200,000

Stockholders' equity (deficit)

Common stock 100,000
Retained earnings (deficit) 27,000,000
Total stockholders' equity (deficit) 27,100,000

$ 42,300,000
Example II - Heavy
Heavier Adjusted Net Asset Value December 31, Adjustments Estimated
2010. To Fair Fair Market
Book Value Market Value Value
ASSETS
Current assets
Cash and cash equivalents $ 12,350,000 $ - $ 12,350,000
Accounts receivable 20,990,000 (1,049,500) 19,940,500
Prepaid expenses 300,000 - 300,000
Cost and estimated earnings in excess of billings
on uncompleted contracts 2,800,000 2,800,000
Total current assets 36,440,000 (1,049,500) 35,390,500

Property
p y and equipment
q p
Land 10,000 190,000 200,000
Buildings 250,000 1,250,000 1,500,000
Construction equipment 5,500,000 9,500,000 15,000,000
Office equipment 100,000 (12,500) 87,500
5,860,000 10,927,500 16,787,500

Total assets 42,300,000 9,878,000 52,178,000

LIABILITIES AND STOCKHOLDER'S EQUITY

Current liabilities
Accounts payable $ 11,000,000 - $ 11,000,000
Accrued losses on uncompleted contracts 2,500,000 400,000 2,900,000
Accrued liabilities 1,200,000 - 1,200,000
Billings in excess of costs and estimated earnings on
uncompleted contracts 350,000 100,000 450,000
Total current liabilities 15,050,000 500,000 15,550,000

Notes payable 150,000 - 150,000

Total liabilities 15,200,000 500,000 15,700,000

Value of adjusted net assets (rounded) $ 27,100,000 $ 9,378,000 $ 36,478,000

Rules of Thumb

 Book Value
 Adjusted BV plus Unrecognized GP on Jobs in Progress
 Book Value plus a Multiple of Backlog
 20 to 25 percent of annual sales plus Inventory
 1 to 2 times Sellers Discretionary Earnings plus Inventory
 2 to 3 times EBITDA
 These are provided as a general rule from which actual facts and circumstances should be considered to
determine the actual value.
value
 Questions?

Th
Thank
k You!
Yo !
Contact
Co tact Information
o at o
Brian Muncy – bmuncy@kbparrish.com
Paul Wonch – pwonch@kbparrish.com