Thinking of buying or selling a homebuilding business? Even though one may perceive the homebuilding industry is up against headwinds, such as rising interest rates and inflation, it's still a great time to be in the homebuilding industry. This is especially true for homebuilders specializing in high end, custom homes.
A seller might be considering making a move to retire. Or, a buyer might be trying to circumvent the enormous startup time and effort. This could be especially true if you are already employed at the Company who's ready to pass on ownership to someone new. There's a lot to consider.
What are the assets for sale?
First, let's look at what makes your business valuable to a potential buyer. Is it the team you have compiled, the relationships with your subcontractors, favorable trade deals, upcoming projects you have sold, or your customer list.
For the team you have compiled, what makes them unique? Is it an extra specialized talent pool that your competitors drool over? Are they ultra efficient and working at or below market salaries? If this is the case, you have a compelling value proposition to offer a potential buyer. However, if you are on active owner-manager, will the team stay on even after your departure?
The same could be questioned about the extra valuable relationships you have with subcontractors. You may have spent years building these relationships and bending over backwards to offer them things your competitors can't. This could include paying them extra fast and doing everything possible to arrange for them to have an easy working experience at your job sites. Do these subcontractors value your brand enough to stay loyal even after your departure? This could play a role in your overall valuation, or the risk that has to be evaluated.
Favorable trade deals might be a little more easy to value because these are typically based on the long-standing creditworthiness of your business. This is a true selling feature that someone who is just starting their career as a homebuilder won't be able to recreate overnight. These savings can add up over time and even allow you to offer lower pricing to your clients, which might give your business a competitive advantage.
For upcoming projects and current customers, we can value these by looking at the current job budgets and how they are progressing along. Are they on schedule and under budget? If so, that's great and they can easily be factored into the sale price of your business. However, your customer list might not be as valuable as you think. How often do construction companies have repeat customers? Even when your clients have the most premium experience, they probably won't be ready for their next construction project for years, maybe decades. On the other hand, the referrals they send could be priceless.
The above examples are a few different types of assets the Company could own. Other assets could include the metro area(s), access to lots/land on which to build, and long standing reputation. No matter what the assets are, make sure you consider all of them and assign a value to each one.
Future Cash Flows
All of the elements discussed above feed their way into your overall cash flow and we might be able to predict what cash flow in looks like for your Company for years to come. Construction companies have some of most volatile cash flow trends among all industries. This is because the projects you create, and their related material cost, can vary greatly from project to project.
First, we need to look at a few key metrics. These include Total Revenue, Gross Margin, and Net Income (Profit on the bottom line).
Starting with Total Revenue, this tells us overall trends of the Company. It's also important to consider how many jobs this Company is completing every year. Is the Total Revenue increasing but the total jobs per year is decreasing? This could mean the average price per job is increasing. As long as total net income is increasing on the same trajectory, this is a good thing. But, will it continue under new ownership?
For Gross Margin, this tells us what the Company's profitability is when you take Total Revenue and subtract out direct construction costs, also known as Cost of Goods Sold ("COGS"). Theoretically, this Gross Margin percentage can tell you how much the Company can mark up its projects before customers seek out another homebuilder, but there's more to it. We need to consider overhead and fixed expenses...
This is where the productivity of the team plays in. Most homebuilders don't require their core support staff to track hours by job. Sure, the cost of your subcontractors can be easily assigned to each job because they should be invoicing this way, and therefore their costs show up in COGS and they're factored into the Gross Margin. However, your core team members (the Designer and Project Manager) usually show up in the expenses below the Gross Margin line. When you bid a job, you still need to factor in how these fixed expenses impact your overall margins, especially if you don't really know how much staff time each job takes.
Payroll is usually the largest fixed expense for a homebuilder, but it's important to consider other fixed expenses such as Office Rent, Equipment, Office Supplies, Utilities, Travel, Meals, etc.
All of these fixed expenses tell us what margin is acceptable for a project with this homebuilding company. If we extrapolate these current metrics , we might be able to predict how future cash flows will play out for this Company.
Future Cash Flows is what I would encourage you to focus on the most when you are evaluating the sale or purchase of a homebuilding company. Not only should you break it down as granular as possible, but you also need to apply a discount rate. This is usually the rate of inflation and it means your future cash flows need to be discounted by the rate of inflation because the value of your dollar will slightly decrease (or increase during a period of deflation, but that's uncommon). Inflation used to be relatively predictable, but these days it's important to carefully consider predictions from leading economists for what inflation will be years or decades into the future. I suggest Googling "present value of future cash flows" to use a calculator that will spit out what these future cash flows are worth in today's dollars.
Overall Price
Finalizing the overall valuation of a homebuilding business is dynamic and could change from month-to-month. Once you assign a value to all the assets and calculate the present value of future cash flows, add them together and theoretically this should be the current valuation of the company. But, we have another factor that can dramatically change the purchase price... The Human Element!
Yes, humans are dynamic and emotional. Sometimes people come up with a perfectly logical valuation and then deviate from it based on emotion. This could be because the sellers have a personal relationship with the buyers and they want them to succeed, or maybe the buyer is motivated to overpay in hopes of escaping the pain of starting a new business. Another scenario could involve one competitor buying out another competitor. In that case, what kind of a premium is the first company willing to pay to eliminate competition and solidify their place in the metro market?
How is the purchase transaction going to be financed? Does the buyer have cash or do they need to obtain financing to buy out the departing owner(s)? If there is financing, is it going to come from a bank or the sellers, and over what period would the sellers be repaid? In this case, it is in everyone's best interest to be as transparent as possible with these calculations because the sellers may never get fully paid if the business fails.
Disclaimers
In the scenarios above, we assume you have reliable and current financial statements. You need to consider who has been doing the accounting, what is their incentive structure (are they trying to facilitate the sale or not), and what oversight to they have? Is someone reviewing their work to catch mistakes? You need to have a full version of current, reliable, and reconciled financial statements before you can evaluate any of the metrics discussed above.
Finally, in any business combination agreement, we suggest having a qualified attorney look over your purchase agreement. There are plenty of attorneys who specialize in mergers and acquisitions and we highly recommend getting their blessing before moving forward.
All of these calculations might be time consuming, uncomfortable, and expensive but they would never be as expensive as a failed business.
