Construction M&A – What could go wrong?
By: Adrian Nohr
Dry powder continues to remain at all-time highs, and investors are looking for creative ways to deploy capital. We’re seeing significant activity in construction and related segments as these investors evaluate historically less sought after industries. Areas such as residential service and specialty construction are particularly hot. Here are a handful of key construction deal issues that you should consider when evaluating an opportunity in these segments –
Revenue Recognition
GAAP requires revenue associated with long-term contracts to be recognized as performance obligations are met. Many construction companies use the percentage-of-completion method, which bases revenue recognition on management estimates. It is critical to understand management’s historical estimating ability and how that impacts the historical financials. It is also crucial to understand how the current open job estimates compare to the historical closed job estimates, flagging a potential future fade in profitability. Many smaller businesses do not properly utilize percentage of completion accounting; therefore, this is a key item to address early in the diligence process.
Working Capital and Indebtedness
Treatment of under billings and overbillings can vary according to the Company’s billing practices. If the Company is overbilled and presents negative working capital on a cash-free debt-free basis, a buyer may want to consider overbillings to be treated as indebtedness. If this is part of the Company’s normal cash conversion cycle, a seller may be able to argue that overbillings are a part of net working capital. These different approaches can significantly impact the net purchase price.
Unions
If the Company’s labor force includes union employees, it’s important to understand new management’s intention going forward. Is the union still a good fit? If not, what are the consequences for leaving the union? Is the union underfunded and how will that impact the business going forward? How will an underfunded liability impact valuation, if at all?
Captives
Many construction companies invest in captive insurance for reduced premiums and tax benefits, but is it truly a good fit post close? How have the dividends or profits impacted the business? What is the expected go-forward impact? It is important to understand the Company’s role and performance within the captive to analyze potential exposure going forward.
Minority, Disability, or Women Owned Businesses
Will an acquisition impact a company’s minority, disability, or women-owned business designation? It’s important to consult with legal counsel early on when investing in one of these companies to try to understand scope of exposure. Buyers should be sure to understand the EBITDA impact of contracts won due to these designations and if similar post close wins are sustainable.
How we can help
CLA can help you address these deal risk through our buy and sell side due diligence services. Our construction deal services team has industry expertise to help you reduce risk and increase value throughout the entire transaction lifecycle.
Tyler is a principal on CLA's private equity team and provides consulting, assurance, and tax services to private equity groups, portfolio companies, and other closely held private businesses in the manufacturing, distribution, technology, retail, healthcare and business services industries with both domestic and international operations. He specializes in helping clients maximize value and reduce risk during M&A transactions through quality of earnings assessments, working capital analysis, and transaction structuring. He also assists in the oversight of private equity portfolio services, including financial statement assurance, tax, and post-acquisition integration. Outside of work, Tyler enjoys backpacking, hiking, camping, skiing, and other outdoor activities with his wife (Kelly), son (Morrison), and daughter (Arrow).
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