No matter how the economy is, some companies find ways to thrive. These firms become top acquisition prospects and can receive extraordinary valuations. What makes these companies so special that they command many times the price of an average firm? What do they do differently?
A company’s depth of expertise, its employees and its ability to complete projects on budget and on time are all important components of maintaining a competitive edge. However, they don’t contribute much to premium valuations.
According to a study by Hinge Research Institute, valuation experts look at the following factors when appraising a construction firm. (Rankings are based on a zero to 10 scale, with 10 being most important to obtaining a premium valuation.)
- Strength of existing client relationships (8.39)
- Technology (8.00)
- Quality of management team (7.86)
- Marketing strategy (7.51)
- Financials (7.21)
- Employees (6.89)
- Profile/Image (6.28)
Here’s a closer look at how each factor fits into a premium valuation.
Strength of Existing Client Relationships
Although this is one of the more difficult factors to quantify, experts value existing client relationships most highly. Considerations include loyalty of existing clients (8.98), client contracts (8.52), and how many long-term relationships have been built up throughout the years (7.68). A company’s ability to attract and retain clients is a key indicator of future success.
Technology has the potential to generate a competitive advantage and create efficiencies that previously weren’t possible. Valuation experts look for innovative, proprietary technology that changes the way a company works—whether it’s back-office software for managing resources or field equipment that makes construction faster, cheaper or safer (8.27). New, patentable green construction techniques, for example, could provide a competitive advantage as the demand for LEED-certified buildings increases.
Quality of Management Team
Successful companies have exceptional management teams. When a company is acquired, top leaders often leave, so acquirers pay attention to the quality and depth of middle management (8.36). If top managers appear likely to remain after an acquisition, a firm’s valuation improves.
Most often, this factor is tied to a firm’s market niche. The more a construction company is specialized in a growing and well-funded market, the better its valuation prospects. Unfocused companies are unlikely to receive a better than average valuation. Other factors considered include revenue concentration (7.16) and marketing strategy (6.00). An acquiring firm almost always looks for synergies that exist between the two companies (8.00).
For a premium valuation, current financials are of less importance than projected growth rate. The market potential must be high and supported by real evidence. Experts pay attention to a variety of factors, including a company’s profitability (8.30), its backlog of work (7.95) and its historic growth rate (7.91). Though physical assets (vehicles, field equipment and offices) have value, they do not contribute to a premium valuation.
Employees are important to a premium valuation, but to a lesser extent than many might think. In a high-value firm, technical competency is assumed. An unusually low staff turnover rate, however, could raise a firm’s valuation.
Acquirers seem to discount the strength of a company’s brand. Obviously, a firm’s reputation and image in the marketplace are critical to its success (7.89), but a company’s identity is usually absorbed into the parent company. The relatively low position of this factor is misleading because a firm’s image is highly important to creating growth potential. And of course, a tarnished public image could irreparably damage a company’s valuation prospects.
Advice from the Experts
Valuation experts who participated in the study offered the following advice to business owners interested in pursuing premium valuations:
Avoid growth without strategy. Demonstrating steady growth is important, but don’t dilute the company’s specialty for the sake of growth. The construction industry is vulnerable to volatility in individual segments, but firms that stick to their strategies in tough times often are rewarded with a high valuation.
Find a strong differentiator. Whether it’s a vertical market niche, specialized expertise or a technological advantage that provides more value at less cost, try to develop a differentiator that separates the company from competitors. Keep in mind that valuation experts value proprietary technology over off-the-shelf solutions, so installing new construction management software probably isn’t going to make a difference.
Build strong customer relationships. If a company consistently anticipates a client’s needs, it is likely to foster long-term, mutually satisfying relationships, which are critical to premium valuations.
If a firm has built up many long-term, loyal clients, and can demonstrate a clear competitive advantage that will carry it into the future, it is well-positioned to earn a premium valuation and interest from prospective acquirers, even in a down market.
Note: A version of this article was originally published in Construction Executive magazine.
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