Growth Strategies: Things to Consider When Evaluating an Acquisition

Analysts tell us the construction industry has been experiencing strong merger and acquisition (M&A) activity in the past year or so. According to one study, 2014 saw more than 218 major deals (deals worth more than $50 million) in the construction and engineering sectors worldwide. That was a 25 percent increase from the previous year.

Such global macroeconomic trends may not immediately manifest themselves at the local level. Nevertheless, construction companies that are looking to jumpstart their growth plans might want to consider the possibility of a strategic acquisition.

Why Consider a Merger or Acquisition?

In addition to sparking the growth cycle, a merger or acquisition could help your contracting firm diversify into new types of work that are similar or complementary to your current project mix. An acquisition can also help you gain a foothold in a neighboring geographic market.
Your firm might also be interested in taking on another contractor’s workforce, especially if those employees have specialized skills or expertise in areas that are currently in high demand. A strong backlog and ongoing connections with recurring customers can also make a contractor an attractive acquisition target.

Vertical integration can also offer opportunities. For example, acquiring a major vendor or a supplier can help you control costs and ensure a steady supply of essential materials. At the same time, though, be aware of the new management skills and experience that will be needed if you expand beyond your firm’s area of expertise.

Evaluating a Potential Acquisition

Private equity groups and other serial acquirers have in-house experts and well-developed systems for conducting due diligence, valuation, post-deal accounting and other specialized processes that are involved in an acquisition. For a contractor that is considering a single transaction, many of these specialties will need to be outsourced.

Valuation of assets can be particularly challenging. Even relatively straightforward steps such as equipment appraisals can require specialized expertise in order to accurately factor in the equipment’s age, depreciation, condition and expected useful life.

Paper assets, such as current backlog and receivables, present many valuation challenges. For example, contracts in progress must be carefully reviewed to see that estimates were sound, projected margins are realistic and receivables are in fact collectible. Less tangible assets, such as customer contacts and contractor reputation, can be even more difficult to value.

The final valuation will likely be compared to some general rule of thumb such as 1-to-3 times cash flow, or perhaps 3-to-4 times adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). But this is only a starting point. Adjustments must be made to take into account any practices that are outside industry norms, such as unusually high executive salaries or benefits, as well as the value of any equipment being acquired.

Avoiding Common Pitfalls

As a buyer, you will most likely want to structure the deal as a purchase of assets only, rather than a total stock acquisition. This can be an area of serious contention, however, since most sellers generally prefer a “clean” stock acquisition due to the tax advantages such a transaction offers.

From a buyer’s perspective, a total stock acquisition exposes the company to many additional risks, such as possible environmental issues and warranty liabilities. It may be necessary to purchase some form of “tail” insurance to provide coverage for issues that arise after the sale.

You should also be careful not to buy assets that could bring down your firm’s bonding capacity. Talk to your surety about how an acquisition target’s existing contracts could affect your ability to get bonding for additional projects.

Finally, of course, be sure to consult with your legal, banking and accounting professionals before closing the deal. Their objective analysis can help you more accurately assess the pros and cons.

To evaluate a potential acquisition or other growth opportunities, contact us.