How your company is valued and why you should care

Do you know the value of your contracting company? Tune in this week to find out why you should care and which factors can affect the final number.

Topics we cover in this episode include: 

  • Why you should care about the value of your company
  • How to bring the value of your company higher than the value of its assets
  • How workflows and systems can increase the value of your company
  • Why you need to begin thinking about increasing your company’s value long before selling it

LINKS

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TRANSCRIPT

[00:00:00] Rob Williams: Welcome to the Contractor Success Forum. Today, we are talking about how your company is valued and why you should even care. 

So here on the Contractor Success Forum, as always, we are discussing financial strategies for running a more profitable and successful construction business.

Rate us, give us a big five-star rating if you like us. If you don’t give us five stars, don’t worry about it. That’s all the way down to the bottom if you want to give us a review, and that would help us out. 

So we have our three long-term construction industry professionals. We have Stephen Brown, a construction bond agent with McDaniel-Whitley bonding and insurance agency. And he has over 30 years of experience underwriting. That’s over three decades, man. Amazing. And experience underwriting and placing bonds for you as contractors. 

And we have Wade Carpenter, Carpenter, and Company, CPAs, and he has been helping contractors nationwide to become permanently profitable for over three decades as well.

And I am Rob Williams, your profit strategist with IronGate Entrepreneurial Support Systems, driving profit in your businesses, with decades of vertical integration, because I was a contractor, a wood component manufacturer, an aviator, and a financial strategist in the construction industry. 

So today, guys, we are talking about how your company is valued and why you should care.

Stephen, what do you think about this?

[00:01:46] Stephen Brown: Why should we care what our company’s worth? That’s what contractors are gonna ask. What’s our company worth? How’s it worth something to someone else? Can we make it worth something to someone else?

[00:01:59] Rob Williams: What do you think Wade? 

[00:02:00] Wade Carpenter: Yeah. You know, contractors are valued very differently than most businesses. You know, if you had a, say a hotel or something that you got recurring revenue and you got a big asset, like the property, whereas a contractor, you know, if you don’t have recurring revenue, it may not be valued the same way, like recurring cashflow. You could, if you had recurring customers that always had contracts with you. 

But in most cases, most contractors are going to be based on things like their equipment value. What they’ve got to sell and what it’s worth. It could be based on some technology, or your specialization. I had one many years ago that had patented this fire hydrant type thing. So they had a little bit of a competitive edge. I’ve had other people that, you know, they bought companies for their, just their employees and their expertise. 

And finally, you know, I think in some cases we buy businesses for the systems that they have in place. You know, just Michael Gerber in the E Myth, build your company to sell it. And if you can run it without you being there, it’s going to be worth more money. 

[00:03:15] Rob Williams: Yeah, I think you just made a great point there in, in reading in there. So there are some companies you could only be worth the value of your equipment, but this is why you want to get a valuation. So you understand how you can be a company that’s not the value of your equipment, but the value of a company that you have built.

So let’s talk about some of those factors. So. You’re right. You know, Stephen, and Wade, in that most of these companies, that’s what they think about. But that’s not what we’re talking about here. We want to point that out because that could be all you’re worth, but that doesn’t have to be all you’re worth.

And that may be one of the big reasons why evaluation is important, because we can talk about all those other factors, like the stream of revenues. So maybe you can sell as a multiplier of your profit rather than just the value of your assets. Wade, do you want to address some of those points of those?

Let’s kind of dive into there of the way people should look at becoming a company that is valued as a company and not their assets.

[00:04:25] Wade Carpenter: Yeah. You know, I had a contractor come to me just last week. He just called me out of the blue because he’s early sixties. He’s looking to retire in the next five years and you know, he has no systems. He knows, he was actually pretty smart about it. It does take time to dress up a company to, to sell it and build the value.

And if he just tried to sell it today, all he could get is probably the value of his equipment. He doesn’t have recurring customers in his case. 

[00:04:54] Stephen Brown: Right. And then as the value of your equipment, what the market is for equipment at the time you’re going to dump your equipment on the market. You know, it seems to me like part of this business valuation kind of ties in to thinking ahead, planning ahead. 

What’s gonna make you different as a contractor? It doesn’t matter what trade you’re in. You can differentiate yourself and make yourself valuable. Is that, would that be accurate?

[00:05:26] Wade Carpenter: Absolutely. And if you’re doing $2 million a year, a lot of people think that maybe they can sell their company for $2 million a year. Well, maybe you’ve built the systems that can do that, but a lot of times you can’t. But other ones say, I could scale this up in a heartbeat. It should be worth $10 million.

Well, there is some truth to the fact that if you built workflows and systems that can support a $10 million company, that may be more valuable than your equipment. 

[00:05:56] Rob Williams: Yeah, that’s a great point because I can remember when I was young, even like in my twenties with some of the companies and I was always looking at my value and the profits, and just automatically plugging in a number and I was not getting valuations. I don’t think I understood how this worked. I, and I don’t know if the purchasing process was as sophisticated back then anyway. But I was part of owners groups that would talk about some of these things, but we weren’t as deliberate about it.

So you really need to have, we keep saying systems, but let’s talk about why those systems are important. Those systems are important because they want to know what that company is worth when you’re not there. If you’re selling the company and you have to work there, a lot of people would just assume, keep the company and, and, and work there if they’re going to have to be there, because they want to sell it so they can retire.

So a lot of these companies are not able to work and function without the owner there. So putting the processes in there is, the intent is so the company, self runs. And even if you lose employees, things like that, you have all these processes and properties in there. 

And, and there are some other factors. I think, you know, a big factor of ours is we had the ability to get neighborhoods approved and, and we had a good relationship in the community and we could build so many houses because we could get them through zoning and we could get them through the things and we had that history. And then we had the supply chain of land available, and lots. 

So there are a lot of different factors. So which the main thing I’m thinking about for most of our viewers is being able to run the company. And Wade, do you want to talk about sorta maybe that four week vacation theory, you know?

[00:07:43] Wade Carpenter: Well, yeah, we can go into that. I think it has a lot to do with that. If you can run your business without, like Mike Michalowicz’s book Clockwork. If you can take a four week vacation, you’ve got something running. 

I actually just had one of my clients buy a contractor in Michigan. And these guys, they had no real good accounting system, and I know I harp on my accounting system. But they had estimators and there are two different estimators. They estimated two very different ways. One of them used POs the other one didn’t. And they were just really inconsistent. And if you could walk in and duplicate what they do and they were consistent, that’s when it has more value. 

[00:08:28] Rob Williams: Yeah. The processes and systems and tying all those things together where it’s a machine, it’s a money printing machine, you know, that you can get these things going. And I think you have a lot of other factors, Wade, because, you know, didn’t you use to, you were in the valuation business or were running that? 

[00:08:46] Wade Carpenter: Right.

[00:08:47] Rob Williams: Go that.

[00:08:47] Wade Carpenter: You know, there are other things that go into it. I’ve had some that you know, they had a certain brand in the community and that could be worth something, but you know, just the employees and the way they do things where you could duplicate that, that it is valuable. 

[00:09:03] Stephen Brown: How do you measure that Wade? If you’re a potential buyer, how, would a potential buyer would hire someone to evaluate your business for them or?

[00:09:16] Wade Carpenter: Well, let me put it this way. If you had two identical contractors, they both did 10 million bucks. They both had 300, I don’t know, whatever, a half a million dollar profit every year, whatever it is. They had identical profits. But one of them had a manual that said, this is how we do billing, and this is how we do collections, and this is how we do the job costing, versus the other one that just had it all in his owner’s head. If you could step into the first one with all the, this is how we do things here, it’s going to have more value. Does that make sense? 

[00:09:51] Rob Williams: Yeah, it does. I know before we sold our company, we had spent you know, I would initially say hundreds of thousands of dollars. We probably spent over a million dollars, if you add all of that time together, putting together all these manuals in the employee manuals and the safety manuals and all these procedures and the checklists.

And this was a residential business, so we even had books of tolerance values, you know, how much can the bump in the sheet rock be? You know, is it an eighth of an inch in for me? We had so many systems and processes to be similar in over 20 neighborhoods, and with all these hundreds of houses, it was, that’s a big value that I didn’t really see the value of it at that point.

But that was a big example of how you had a system because it would run, it would run really well. Until 2009 hit us, but that’s a different story. But, but it would run without the owners very well because of all of that time and effort. And I don’t think we were putting it in place in the intent of value, but I wonder how much more value we could have gotten had that been our purpose.

If we had been getting valuations and had purposes, if we had known that we were going to be selling it and made that a goal. That would have been very interesting and how you can push those. I think that that’s the big why? Because if you’re intentional about it, you, you build that value of the company.

And it’s going to be dramatically more than if you’re not intentional about it. Which brings up the other company, the thing that happens so often is once they build the company and they get all these systems and things in place, then maybe you want to keep it. 

Which, which that other thing, one of the reasons why I know I wanted to get out of some companies, was the personal liability of it. And actually I, even a couple of companies I decided to close rather than sell, because I was so worried about the personal liability, even if I had sold it. I was really paranoid about that. But Stephen, or Wade, y’all talk about that. There are ways if you build that company, you can still own it and then not have the personal liability.

I don’t think I realize that was an option.

[00:12:13] Stephen Brown: Well, if you’re going to do it from a bonding standpoint and you want to get off the personal indemnity that you sign in order to initially get your bonds, you’ve got to have a company that’s showing a good net worth and a strong working capital. Good track record of making profits for a long period of time in order for the bonding companies to waive your personal indemnity.

But the two go hand in hand and you say, well, what if I build up a lot of cash? When it comes time to sell a company, I just take that cash out. But that cash is needed. If you sell the company to your employees, the cash has to stay in there to support the bond program. So you’re really being a financier, so to speak, of your buy-sell agreement, and we have upcoming podcasts we’re going to do on ESOP plans.

But I just thought it was interesting was, we were talking about this is that your average contractor works hard, builds up a reputation for doing good work has to buy equipment to get the work done. And in their mind they think that’s all the company’s worth is, is what my equipment’s worth at fire sale.

And I can tell you the bonding companies don’t give any underwriting credit to the value of your equipment. None. They should, shouldn’t they? If you’ve got $5 million worth of equipment, now in the paving underwriting for paving contractors, they do look at that. Because it’s so equipment heavy. Your debt on your equipment is the tail that wags the dog.

[00:13:48] Rob Williams: That’s interesting. Wade I like the, where you were talking about the two companies that look identical could have different valuations and I was thinking about that and why you would want to have a valuation, so you can understand that. Can you address that a little bit? 

[00:14:03] Wade Carpenter: Well, again, there are different factors in the health of the company, going back to what Stephen said. And I know, I guess I’m going to contradict myself because you know, recurring profit is normally the way a normal business would be valued, but a lot of times contractors will try to expense out, go buy that F-150 on the December 27th, like we talked about all the time, run the profit out. 

Well, a history of profit definitely makes some impact on the valuation because if you can’t show that you can make profit, nobody’s going to want to buy it. 

And the other factor of that is, getting these systems on getting this in place takes time. You don’t, you know, snap your fingers and all the systems are working and you’re magically profitable. A lot of times it takes five years to get you to where you are able to sell it. 

[00:14:53] Rob Williams: Yeah. Well, and you’re the accountant, I’ll tell you I’ve looked at a company that was being involved in the construction business and it was all going pretty well until it came down– I guess they were over a year, maybe a year and a half into the due diligence and their inventory was horrible. And I think some of the books, and it killed the whole deal because there’s just so many different subjective factors that you’ve got to get all those things aligned.

[00:15:23] Stephen Brown: Yeah. Right now inventory could be a huge part of the net worth of your company and the ability to sell it.

[00:15:30] Rob Williams: Yeah. And it wasn’t, it wasn’t the factor that they could just, okay, well this is the new inventory. Okay. Well, it was off about $200,000. Well, we’ll just take 200,000 off the thing. Well, that it was, the whole deal was gone then.

[00:15:43] Stephen Brown: Yeah, they didn’t trust it. Didn’t trust the numbers.

[00:15:46] Rob Williams: Right, right. It just made the whole systems and the value, the whole multiplier effect is… and what I was about to say, it’s subjective. It’s sort of subjective, but it’s, there’s a lot of objectivity in that subjectivity. That’s confusing. Isn’t it?

[00:16:03] Stephen Brown: No, that makes sense. That makes sense.

[00:16:05] Wade Carpenter: Or if you bring in 10 professional valuators, and they go do value with the same company, they’re probably going to come up with 10 different valuations. Believe it or– 

[00:16:16] Rob Williams: They will. That’s a big thing. And you know, there are other reasons to be valued. Your buy-sell. How are you valuing that in exit planning? And if it’s an involuntary exit plan too, you know, knowing what these are. If you’re by yourself, it’s not quite as big of a deal.

But if you’ve got partners and stuff, it’s a real big deal to exit with the exit plan and what these buy sells would be and knowing what those values would be and having a regular interval of it. We touched, so that’s a, that’s a different exit planning strategy conversation.

[00:16:50] Stephen Brown: I can also mention possibly that joint ventures are a good way to develop potential relationships where you might want to buy another company and vice versa. You kind of get involved with them and understand each other’s strengths and weaknesses.

[00:17:07] Rob Williams: You just opened up a whole other topic, which we’ve discussed before. But today I think we’re, we were talking about the standard company, you know, whether they’re, we’ve talked before about, maybe have some technology that somebody wants to buy for that. And so I guess today, we’re not necessarily talking about that, but that is something to think about if you’ve got a different… and maybe the valuation that you get does help point that out to you. What is your highest and best value? Is it, is it your other? I had a partner and he sold not based on that. He sold because of his technology. So they bought his company for his technology. It was wall panel software he had developed.

[00:17:46] Wade Carpenter: I wanted to go back to what you said a minute ago about the buy sells, because I also get in the, I’m sure we all probably have seen it too, but you know, when you got two partners, one of them gets a divorce. Something goes wrong. 

[00:17:59] Rob Williams: Yeah, that too.

[00:18:00] Wade Carpenter: If you don’t have that in place, it can be a, it can be a mess anyway. But if you’ve got that in place, it definitely can protect you from a spouse that you know, divorces and thinks they should be getting $10 million out of that. 

[00:18:14] Rob Williams: Right. Yeah. There’s so many factors in there.

[00:18:17] Stephen Brown: Well, there’s a lot to think about here. There’s a lot of variables. But I think that you should care about value in your company because you should always be striving to maximizing the value of your company. And not just what you can take out of it or what taxes you can defer. The reason is, is because the two go hand in hand. If you’re building your company to run on its own then you’re making more money. So whatever your motive is for having a company, knowing what your company’s worth has value.

[00:18:55] Rob Williams: One big thing that I kind of like to wrap it- we don’t have to wrap it up right now, but the wrap-up things is when you get that company, and you value it and you’ve created something value, it’s so valuable, then you may want to keep it. 

And that actually gives you more value to the company, because once you see this package and somebody starts bidding, then you’re like, well, wait a minute. I’m a bidder, too. I think I’ll just bid for myself. You don’t actually buy it, but I’ve just bid in terms of, I’m going to keep this in retirement. I may be on the beach somewhere, but I still own this company and it runs without me.

So you may be your best buyer and that, that may be your thing. But, but you need to become the buyer and understand through that valuation what you need to be looking at, because I’ve seen some companies, I don’t want to get too specific because he might be listening to this, but I know with his company, he had his kids there and it’s like, okay, well they’re, they’re running it. And then I’m just going to take the income off of my kids’ rent, you know, paying me these things. I’m thinking, you know, that kind of valuation that’s really risky. 

Maybe if he had done some valuations and thought about it in a more valuation formal process, he could have structured that to be a little bit more secure in his retirement. 

[00:20:13] Wade Carpenter: Great points there. Reminds me of one of the ones that sold that we were building up to sell. And he got these processes in place and he was finally able to take a vacation. He could never take a vacation before. And it started running on its own and probably running better when he wasn’t there, believe it or not.

And he started enjoying it again because he wanted to spend time with his wife and his grandkids, stuff like that. And now he could. And so it was amazing to see the transformation. 

[00:20:44] Rob Williams: You get to that point instead of operating your company, you become an investor in your company. So through this valuation, so how can you become an investor? Maybe I should have started this out saying that. How do you become an investor in your company, rather than just operating it?

So, gosh, this is such a great topic we can go on and on about this. I know I can tell looking at you guys, you guys are listening, but our brains, we’re thinking of so many different things. So that’s why we hesitate sometimes because this can go on and on, but it’s something that everybody should be thinking about.

[00:21:19] Stephen Brown: And reach out to us too. Let us know what concerns and questions you have. And we’ll discuss that as well, as a group.

[00:21:27] Wade Carpenter: Final thought from me is it doesn’t happen overnight. So if you’re looking to get out of your business or change the path you’re on, start today. Best time to plant a tree was 20 years ago. Second best time is today. So, you know, again, it takes probably five years to build a company up, to sell it. And so start today. 

[00:21:48] Rob Williams: All right. Great points. 

Well, thanks guys. This has been the Contractor Success Forum. We have Stephen Brown, McDaniel-Whitley bonding an insurance agency and Wade Carpenter, Carpenter, and Company, CPAs. And I am Rob Williams with IronGate Entrepreneurial Support Systems. So like us, review us, keep listening to us, and tune in next time.

See ya.