Six action items to prepare your construction company for sale

A Work In Progress report is a powerful tool: it can increase your bonding capacity, help you manage costs, and give you an accurate picture of both your working capital and the status of your current jobs. This week, we’re talking about why the WIP is crucial and how to do it right.

Topics we cover in this episode include:

• How a WIP report affects your bonding capacity
• The importance of consistency when tracking job costs and why WIP numbers are not always intuitive
• Common mistakes contractors make on their first WIP report
• Addressing stored materials on the WIP report

LINKS

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Rob Williams, Profit Strategist | IronGateESS.com
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | McWins.com

TRANSCRIPT

Rob Williams: Welcome to the Contractor Success Forum. Today, we are discussing six action items to prepare your construction company for sale. Because on the Contractor Success Forum, we discuss financial strategies for running a more profitable, successful construction business. 

And on our show in one corner, we have Stephen Brown with McDaniel Whitley bonding and insurance agency. And then the other corner, we have Wade Carpenter, Carpenter and Company, CPAs. And in this corner we have Rob Williams with IronGate Entrepreneurial Support Systems. 

So today we are talking about six items to prepare your construction company for sale. What do you think about this topic?

Wade Carpenter: I’ll kick it off. I know a lot of times people will turn [00:01:00] around and say they want to sell their business, but they don’t know how. And all of a sudden, one day they wake up and they say, well, I’m ready to sell it. Well, I honestly counsel people, you should be looking at it five years ahead and preparing it so that you can get the most money you can.

Rob Williams: Yeah. Cause Wade, you actually did valuations of these at one point, I guess you still do. I don’t know, but so you really have an idea of what it’s for. And I, and I’ve been in the middle of these, we’ve sold the companies and sometimes they go by these type things. Sometimes they’re just off the wall, I will admit, the way the companies are bought and sold. And Stephen in the bonding agency, what’s the importance of talking about this? I don’t really know how that affects you or how, what you see.

Stephen Brown: Well, it does, because by the time you get your company ready to sell, it’s just exactly what a bonding company wants to see to bond you. Everything is in place that helps you get bonding. So whether you sell it or [00:02:00] not, getting your company ready for sale helps in your bonding.

Rob Williams: Yeah. And, and I’ve seen that I’ve seen people talk about selling their companies and most of these companies can’t sell for different reasons, which we’ll talk about six of these action steps, but it’s so important. And then if you wait till the last minute, it’s too late. Or if you wait too late to sell, when things have declining, that’s not on my list, but the timing of it, you know, is also kind of important. Don’t wait until you’re just about retired and you’ve whittled your company down. You’re not going to do that either. So.

Stephen Brown: The road of life is paved by flat squirrels who were indecisive.

Wade Carpenter: Okay. 

Rob Williams: Flat squirrels.

Stephen Brown: Well, hey, be decisive. Okay, go ahead.

Get consistent cash flow

Rob Williams: All right. So. So the first item on the list today for preparing your construction company for sale is cash flow. You’ve got to have cash flow and have it [00:03:00] consistently cash flowing while you’re growing. And why is that? Why do you want cash flow?

Stephen Brown: It helps the buyers finance to purchase.

Rob Williams: Yeah, it does.

Wade Carpenter: Yeah, It could.

We talked about the valuation of a company and every business owner thinks their company is probably worth more than they are. There are probably seven or eight standard ways to value a company. And one of them is a multiple of cashflow. So going back to what Rob was saying on cashflow, you want to make sure that, you know, a buyer sees that they can consistently get cashflow out of this and they’re not going to be investing in something they’re going to have to continually fund.

Rob Williams: Yeah. What do you want? If I’m a buyer and I have money and I give you money, we talk about in the finance world, well, it’s the net present value of the future cash flows of the line. Well, what the heck does that mean? So, if I give you money for your [00:04:00] company, I want money back. That’s the whole reason that I’m buying the company. 

So I give money and I expect to have more money coming back in, and that’s cash flow. I don’t really care what the books say if I don’t get money. It’s cashflow business and demonstrating that your business can actually bring in cashflow. 

And why could you have profits without cashflow? That’s a whole other subject and you know, topics, but it definitely happens. You can have book profits without the cashflow. So demonstrating that you have a business that works to generate cash flow, to me, is what people are going to pay for. So that’s number one.

Stephen Brown: And listeners we’ve had some pretty good podcasts, people have told us, about improving your cashflow. So I just want to throw that out. Go ahead. Next.

Rob Williams: Have lots of ways to improve your cashflow. 

Demonstrate profits on your books 

Rob Williams: So number two, which we just profits, you [00:05:00] need profits, you’ve got to book profits and keep those books clean and pay your taxes. Wade, you’re the accountant. Have you seen people avoid profits?

Wade Carpenter: Well, a lot of times they’ll want to keep their profit down for tax purposes or whatever, but when they come to selling it, they, you know, they hide profits and I hate to say this, but they pay for anything and everything, their cell phones and their you know, I don’t know, groceries. They try to bury anything and everything.

When you’re getting ready to sell, number one, that does factor in. So if you can prove that the owner is getting these benefits, whether it’s showing up or not, that does go into the sale price, but, just getting back to basic profitability, a lot of contractors, it’s hit or miss whether they make money from one year to the next.

And so a lot of the concepts we talk about on the show are always relevant to the value as well.

Rob Williams: Oh, yeah. Yeah. I [00:06:00] remember we had growing up, we had a remote office also called a motor home that we’d go to football games and things like that, but it was our remote office and I don’t ever recall it being in a subdivision or anything like that. So,

Stephen Brown: It was, you just don’t remember.

Rob Williams: Yeah, that’s that’s right. But that was well, before we sold, we had to get that off the books before selling.

So you do that, you put these in here and you don’t pay the tax. You avoid the taxes, you buy the big pickup trucks, but then, you’re supposed to be demonstrating that you’re making a profit because while we did say cashflow on the first thing, you could have cash flow by selling off assets, or not in a positive way. So you also want to demonstrate that you have profits on your books. So you’ve got to demonstrate the profits and the cash flows, and I’ve really seen this mess up deals before. And people don’t want to have to dig through your books and what’s personal. People say that all the [00:07:00] time. They’re like, well, I’ll explain all that. How we’re really just taking that out personal and, and you just, the buyers can’t see that. Maybe that’s personal stuff. Maybe it’s something that you take it out and then you got to replace it somewhere else. That’s just a lot of noise when you’re trying to sell your company, that will bring the value of your company down, if it doesn’t ruin the deal altogether. 

Have consistent, growing revenue 

Rob Williams: So, all right. So we, number one was cashflow. Number two was profits. Number three, revenue. Have consistent growth and not declining. And we also wanted to talk about the timing of that. 

Wade, I’m curious on the valuation, how do you see that? I guess sometimes there’s a projection of future expectations, but, but maybe you’re basing it on the past. I don’t know.

Wade Carpenter: You know, I mentioned these eight ways to value a company and a multiple of revenue sometimes is appropriate. You know, in construction business, it may or may not be appropriate. You can make a ton of [00:08:00] revenue, but make less profit, so.

Rob Williams: When we sold our company, the revenue and the growth path was a huge factor in that. We had been stuck at about 350 houses, and then we built the factory so we were doubling our volume. We were on a extreme growth projection, and one guy paid us double what the other guy was projecting because he saw our growth path.

And so it’s really, the value of the company is technically the present value of the future net payroll. So they really want to know what the future is, not what the past, but the past demonstrates what the future is. And so in the stock market, I know the stocks, they’re based, not just on their current earnings. It’s the current earnings plus the projected growth. And that’s why we’re seeing these high values, because they’re seeing so much growth in the future. So that’s what people are [00:09:00] buying. They’re buying a growing company and that’s what you want people to see. 

I’ve seen people, they want to sell their company and they’ve gotten kind of tired and lazy the last five, 10 years. So now they’re about to retire and their company’s kind of dwindled down. It’s not really there anymore, so it’s not as much something to buy. So keep that revenue going in an upward pace. Get that timing right. Don’t wait till you’ve whittled it down. You can say well, but they can grow it again. Well, that’s gonna drastically affect your value. Wouldn’t it, Wade? Or…

Wade Carpenter: Well, it absolutely could, if you’re on definitely growth path. But also see a lot of contractors that, you know, they are steady and they’re, showing profit, but, in an industry like home building or something like that, it definitely, if somebody is looking to acquire, I’ve seen that as well, so it can play into it.

Rob Williams: That’s a great point. You don’t want to have the revenue growth over the profit or the cashflow. The cashflow and the profit are more– because you can [00:10:00] certainly grow right out of your cashflow into debt and bankruptcy. So you don’t want to be growing too fast. You want that steady growth demonstrating that you can make a profit while you’re in growth mode.

And if you can do that, boy, that’s really valuable. That’s what we see. It’s really hard to do on working in those cash drivers to demonstrate growth while you’re growing, as opposed to a company that’s stable that may not be able to grow and maintain the cash flow. So if you’ve got your payables and receivables and whatever else in balance, demonstrating that you can make profits and cashflow while you’re growing, that’s a really big beneficiary that I’ve seen these multiples, five times over what they would be. I had a, that was a technical company, but I had a partner. He got a 20 multiplier when he sold his equipment company, because the way his cash flow and stuff worked and their growth projections. So that was phenomenal. 

Wade Carpenter: Going back to what [00:11:00] you’re saying though, you know, when you are in growth mode, typically it is taking the cash. So, it’s a trade off. So, as you’re growing, you’re typically having to reinvest every single thing back into it. So it’s, it’s a trade-off between your first point and, and, number three there.

So.

Have a portfolio of clients

Rob Williams: Yeah. Yeah, it is. So what is number four? Number four, have a portfolio of clients. Don’t be too concentrated with one particular client. Under the portfolio of clients I kind of have a few things. I’ve got demonstrating your marketability versus just the relationship with the owner who may not be there and– not marketability of the company, but marketability of your product that you can sell it to new clients and things too. And then what is your pipeline and backlog? I know the bonding guys love the pipelines and backlogs. See what’s in the work. Well, think about that for the sale of your company as well. So anyway, on all these, what do you, what do y’all think of, Stephen, what do you think about that?

Stephen Brown: Well, a lot of [00:12:00] my contractors have certain customers, they have certain architects and engineers that they work with that love them and vice versa. And they’re always pushing business in that direction. I’ve got clients that are devotedly end up building entire school systems and hospitals. I have contractors that are constantly bidding their type of work. So you would say, well, how do you value a company that hasn’t gotten a bid yet? Well, you get it based on the upcoming projects that are available and the existing customer base you have.

Rob Williams: You did just make me think of a good point because concentrating with one customer, well that might be bad, just say like, Walmart’s always the example. Walmart can put people out. Or here in Memphis you know FedEx can put people out. I hired a manager, had a 10 year company, he built all the rollers and stuff, that things for them and I mean overnight, boom, the new contract, his whole factory, he was out of business. He was hanging his sign [00:13:00] out for a job, because he had one client, but that doesn’t mean you don’t focus and specialize in an area because you can have multiple clients in something that you’re hitting your sweet spot.

Stephen Brown: That’s right.

Wade Carpenter: Yeah, I see it too, exactly what you’re saying. That somebody maybe does retail build-outs and things like that for, Walmart or something like that. And it definitely, if you can have recurring customers, it doesn’t always happen in construction, say like the utility guys or whatever. They do bid work for a county government or something like that. That’s tough to say you got recurring revenue when everything’s out there for bid.

Rob Williams: Yeah. Recurring revenue is good though. Right? 

Wade Carpenter: It is. 

Rob Williams: As long as it’s not just one customer and then that’s all you have.

Stephen Brown: Well, you also show the niche that you have in that bidding. You’ve done those projects before and it’s inevitable, you’re going to get them in the future. You have a track record of doing that type of work and making a profit, and that’s an important way to evaluate your revenues going forward.

Wade Carpenter: Yeah. So I [00:14:00] think what Stephen’s saying, and what I would say too, is that concentration and having one or two clients, it definitely can pump up the value.

Rob Williams: But you can pump up if your specialized, but it can also, if you’ve only got one client, that’s a real risk factor of losing that one client. Cause you know what, I’ve seen some factors in some of the coaching they’ll say, don’t have over 60%, or somebody will say 40%, somebody’ll say 80%. Different numbers as one client, cause that gets kind of scary.

Stephen Brown: Well, another argument would be that if you had a client like Walmart or U.S. Federal government, certain military base or something, whatever it is, you’ve figured out how to do business with them. And a lot of other people can’t. Oh no, no, they say you don’t want to do business with them. Well, the profits can be good, and they can be quick and they can fill in a lot of extra work that you need in between bids.

Rob Williams: So there’s ups and downs about that, that concentration. So there’s positive, [00:15:00] but it’s something to be aware of. So let’s say, what are we talking about with that portfolio of clients, the demonstrated marketability of your product, your company, versus that relationship with the owner.

One concern with a lot of these companies, and I’ve seen this most of the time: what happens when the owner leaves? Is that business still going to be there? And I’ve seen it happen where they did buy it and that owner left and those clients didn’t want to do business with the new owners. So the value of the company was in the tank.

So demonstrating that you’ve got a marketing process that, or like you say, bidding system, something like that, that you can go out there and get new customers. You’ve got a formula that you can continue to do this, even when that business owner is not there. Or maybe when you lose one client, you can go get more and keep your business full.

And then that pipeline and backlog. I think just like you would value that with the bonding, I’ve seen [00:16:00] that in the valuations of these companies. I’ve actually seen them trying to value the company just by buying, they’re pretty much just buying the backlog product and they’re not really buying. They’re trying to buy the company just for those jobs. I’ve seen that, which ought to have more worth than that. But I’ve actually seen that happen. So like, you know, we got two or three years worth of work. We’re projecting this profit and that was almost the sales price. So demonstrating that backlog. So if your backlog went from, you know, two years worth of jobs down to two months, it’s going to be a lot harder to sell your company. 

Maintain accurate books

Rob Williams: All right. So! Accurate books. Wade! 

Wade Carpenter: All right, well, what do you want me to do, preach here?

Rob Williams: Yes. Preach brother preach it.

Wade Carpenter: I counsel a lot of people, start at least five years before you’re ready to sell. I’ve worked through due diligence on both sides of it, whether I’m buying and selling. And if you’ve got in-house books, people are not going to trust them. They want you know, an outside CPA [00:17:00] to– I mean, You can go by a tax return, but internal books, a lot of people would not trust them. And so getting even just the lowest prepared level from a CPA can go a long way, and seeing if somebody is wanting to come behind somebody and say, you put some kind of trust in the numbers. Because otherwise you get a dig in there and, they can, the more they dig in, the more they’re going to find well, what about this? And I believe it breeds distrust when you don’t have those kinds of things in place.

Rob Williams: Well, it does. And, and you lose your credibility. I think, if your books aren’t good, then they think, well, maybe the operations are not good. Which, which may not have any relationship to it whatsoever. But I have definitely seen things go down and we’re not just talking about the accuracies of the books.

I’ve seen, like the accuracies of the inventory kill a deal. I think there was one deal that I was helping look at. This was, I don’t know, 18 months [00:18:00] to two years of due diligence. And when they got down to the inventory, the inventory was so bad that the owner just gut feeling it wasn’t logic. He just said, you know, I I just don’t feel good about the whole thing anymore.

I don’t care if they fix the inventory. I’m out. I’m just done. So there’s those little things that can be psychological about it. 

Stephen Brown: There’s those things listed in the expense items, Wade, that clearly tip off a potential buyer that you’re living vicariously through the company. And they can say, well, I’ll just discount that and figure that into my price, but then you don’t know what else is hidden in there. So you’ve got to kind of clean those books up a little bit, don’t you?

Wade Carpenter: Absolutely. But then again, those perks, we’ll call them, that the owner sometimes were taking, that can add to the price.

A lot of the business brokers, if you’re dealing with some broker, they’re going to point out like, well, he was getting his cell phone through, well, we were paying his… I don’t want to go down that road, but there are a lot of things that, people [00:19:00] run through there that they shouldn’t.

Rob Williams: Yeah, well his cell phone. That might actually be legit it’s but his 

Wade Carpenter: Yes, cell phone’s one thing. 

Rob Williams: And in the kid’s in college.

Wade Carpenter: I didn’t want to go down that road. I didn’t want to say it, but yeah, we see that all the time.

Rob Williams: Yeah.

Stephen Brown: We don’t want to give our listeners bad ideas.

Rob Williams: Yeah. Okay. Good point there, Stephen.

Stephen Brown: Go ahead, Rob. You were, I interrupted you.

Rob Williams: Well, I was throwing in there with accurate books is, your assets, too. It’s just kind of a stretch putting it underneath this, but having your equipment, having accurate values on the assets. I know we would have what was on your books, but then we had a separate list of the value of those, not the depreciated book value, because that didn’t have much to do at all with how the equipment was and whether it was maintained.

So maintain that equipment, which is sort of not really on books, but make sure your equipment is not 10 years deteriorated before you sell it. And that’s what I see a lot. In these companies, they’re like, well, hell, I’m not going to do any maintenance, we’re about to [00:20:00] sell. Or if they’re in a two year sale process and they know the company’s selling, they don’t do any maintenance on any of the equipment and the buildings, I’ve seen this happen, for those two years. So make sure you’re keeping those assets up and the maintenance, cause it’s gonna come back at the end, as you’re doing this. So, so don’t–

Stephen Brown: And then what if the sale falls through and you don’t have any equipment that won’t run?

Rob Williams: Yeah, that’s right. That’s right. And then make sure your accounts payable and your accounts receivable are accurate. Get those receivables, go ahead and take them off the books. If they’re not real, don’t let them discover that that just people think that’s a little trick or something. Well, that’s going to beef up my value. Well, I think it’s going to 10 times diminish your credibility once they start going through all that. Anyway, clean those things up. 

Document your systems and processes 

Rob Williams: All right. I know we’re trying to move on because the show is getting long. So number six, your systems and processes. Have great systems and processes [00:21:00] documented so you as the owner can not be there. We talk in our systems about taking an extended vacation for four weeks. And if your business runs without you, which a lot of these ones it actually runs better when you take that four week vacation, if you’ve got good systems and processes, you’re not in the way. Do that. Get that strong team. What do you think about that guys?

Stephen Brown: I think we got some great podcasts out there on systems and processes.

Rob Williams: But it’s really big because if the owner is not there, that’s the biggest thing. Most of these businesses, especially in construction, do you have some particular skill that is yours? When you leave, does the company, is it gone? Or do you have all these skills with your employees?

Wade Carpenter: Yeah, what I was actually looking at my bookshelf. One of my favorite books was the E Myth Revisited by Michael Gerber. He actually was a contractor. And the [00:22:00] idea is if you’ve got the systems and processes where somebody else can walk in and duplicate what you do, it’s going to be worth more than everything that is bottled up in the owner’s head, when they walk out or they get hit by a bus, that new owner can’t reproduce it. So if you’ve got those systems and processes in place, it’s definitely worth more.

Rob Williams: Yeah. You know, And I’m lumping systems and processes in with teams to keep our list short. But don’t forget about the licensing. That comes up in our industry. Who has the license? Don’t get back to the end and you know, the owner doesn’t have to have the license. People within the company, especially if you’re preparing to sell it, get them to have the licenses. I know one of my companies, we had different people take different parts of the test. I didn’t realize you could even do that. I guess you can still do that. That was 20, 30 years ago.

Stephen Brown: Well, just like tax advice on what you’re able to deduct from your company, we don’t go there either.[00:23:00] 

Rob Williams: Yeah. Right. Just make sure the license will still be there. Whatever the process is in your, in your state, in your area. 

Wade Carpenter: If you’re crossing state lines, this definitely plays into it.

Rob Williams: Oh, yeah. All right. So great. I’ll go over it one more time. So number one, we had to keep your cash flow consistent while you’re growing. Your profits is number two, your revenue, number three, your portfolio of clients, number four. Five, have accurate books, and six have your systems and processes documented. 

All right, guys. Great show here on the Contractor Success Forum. So look up our notes. Got any questions, please contact us. And we’re happy to talk to you guys about any of this. So listen to our next show. We’ll be back.