Private Equity's Secret Playbook: Building & Buying Construction Firms

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ℹ ABOUT THIS EPISODE

Discover why private equity firms and consolidators are aggressively buying construction companies and what they're really looking for. 

Wade and Stephen break down the secret playbook: how buyers evaluate EBITDA multiples, consolidate overhead for higher margins, and what happens during due diligence. 

Learn the critical factors that drive valuations, from bonding relationships to recurring revenue streams, plus real stories of deals gone right and wrong. Essential listening for any contractor considering an exit strategy.

⌚️ Key moments in this episode:

• 00:29 The Surge of Private Equity in Construction
• 00:55 Valuation and Deal Considerations
• 03:18 Why Buy a Construction Company?
• 05:23 Challenges and Strategies in Mergers and Acquisitions
• 07:10 The Role of Due Diligence
• 09:50 Post-Acquisition Integration and Management

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

Transcript

Wade Carpenter: [00:00:00] Contractors love hammers. Private equity loves spreadsheets. And when those two worlds collide, somebody's gonna get nailed. This episode, we're pulling back the curtain on why investors are buying construction companies, how they make their money by consolidating overhead, and what really happens once accountants show up with their fancy dashboards and four letter acronyms.

This is the Contract Success Forum. I'm Wade Carpenter with Carpenter Company CPAs, alongside Stephen Brown with Daniel Whitley Bonding and Insurance. Stephen, you brought up a topic that I silently have been dealing with a lot more regularly in the last three years: private equity consolidators and individual investors buying up construction firms. What are your thoughts?

Stephen Brown: It is exciting and scary at the same time, from my perspective as an insurance and bonding agent. I'm thinking well, I'm, probably gonna lose a customer over this. If my company isn't buying someone else, I'm out. That part of it is weird.

But, also, I think thinking about how to make these decisions, we've had so many podcasts on [00:01:00] what is the true value of your company? What's it worth? And how do you determine that?

In this situation, we're saying, okay. Here's someone that's gonna buy your company. Is it a good deal? Because if it's a good deal for you, and honestly as you're bonding an insurance agent, I'm happy for you. I like to think we're friends anyway. Anything that's good for you is good for me.

Everybody builds up companies to sell and across the globe in every type of business. You can conceive of people build up businesses to sell. And there are people that make money by building up businesses, selling them, doing it again and again.

And there's people whose job it is to wanna buy your company based on EBITDA, certain factors of your earnings capacity factor. And so that's analyzed. Here I am. I wanna buy your company. I have a rough idea of what your company does in volume and profit over the years, because I've talked to the business broker who is bringing this to me . And I'm saying [00:02:00] based on what I hear in a five minute overview, I can give you a three to five times buyout of your company's value right now. You say, okay, what is that company's value? And what factors might make that value go up or down in the marketplace?

Wade Carpenter: Yeah. And I think it's things that we've kicked around for many years. I always used to say building the systems, building it so that you can build it up and sell it. And I've always advocated, oh, you need great books. They're coming in, they want to be able to prove those numbers, prove that EBITDA number. And traditional buying, selling of any company, I guess, would like some kind of multiple of revenue.

But there are some differences in construction and there are some reasons that some of these private equities, these consolidators, these individual investors are buying that. And we have seen quite a few of those. A lot of it is, yeah, we can get some kind of multiple. There are thoughts that, hey, we can consolidate the overhead and if we can make a higher [00:03:00] margin, we can sort of like capture, I've seen a lot of them where I am trying to chase the East coast.

Construction is a very fragmented industry, You, it is like a lot of individual owners. And when you can put some parameters around it where you can make some good money, it does make a lot of sense for these people trying to get into it.

Maybe we can talk a little bit about why somebody would buy a construction company. Because I know what you used to say is, okay, it's worth what the equipment's worth, right?

Stephen Brown: Yeah. That's basically it. And here's the thing. The surety company never gives you credit for the value of your equipment anyway. Again, we talked about surety is looking at the future, not the past. And so what I see from my perspective, and when someone's buying a company.

The issue, even though surety bonding is a huge part of their business model, in fact, all their work is bonded. whoever's buying the company's not getting the right advice about how to maximize that relationship, and build that comfort with the surety, keep things going smoothly. So that's just part of [00:04:00] it.

But then again, another part, like you were talking about Wade, that's so important to the valuation is, you're looking for a contractor that is consistently good at what they do, and you believe they're getting lower profit margins on their work in their particular area.

So you can go in and you can buy them, you can buy their people, you can buy their systems, and you can take stress off of them financially. You can help them with their back office support. You can give them more business knowledge than they have, and you can demand higher margins at this particular time.

So that's another factor. You're not just buying the employees, but you're buying the name and the reputation as well.

Wade Carpenter: Absolutely. Reputation sometimes. But I've seen some where they're buying hard to obtain licenses or as I said, geographic coverage. I had one particular that a guy left, he had 28 state licenses, and it sort of devastated-- this is a hundred million dollar [00:05:00] company. And they were scrambling, like, how are we gonna cover all these licenses?

We had one person that was the CEO and I don't know the full situation, but they made him mad, he left and he's starting his own and he's jumping right in there. But, minority, women owned, veteran owned certifications that can get you into a door. I've seen your bonding capacity, seen insurance moderates that you may wanna talk about.

You unpacked a lot of things when you said that because we do see a lot of people, when they walk into these different companies and you're trying to consolidate 10 different companies, you got 10 different systems and 10 different ways of doing things.

We can talk about that in a little bit, but we've been brought in on some of these. We've been on buying and selling side. We've seen some people cash out very well. Some people are offering big multiples.

Stephen Brown: What kind of deal do you want, and how is what they're offering you gonna be what you want accomplish? Main thing you see is I wanna retire. I wanna cash out my business. And I can either sell it to my [00:06:00] employees or I can have a fire sale, or I can sell it to one of these business brokers.

And then you're saying, how's that gonna affect my employees? You worry about that because you put together a great team. How does that affect my team? How's that affect my employees? But I want to get out of business. I want to be out of this, and I want to get as much money as I can out of my business and what I'm doing before I retire.

And then what are you signing there as far as how long you're committed to stay there? What kind of length of non-compete there is before you get bored and say, hey, I can help this friend of mine with this company big time. I can show them exactly what to do. I can help them turn around and start making money immediately doing exactly this.

There's just a lot of criteria. Isn't it wonderful though, when it does all come together, that makes sense.

Somebody's buying your company based on EBITDA, but what are you seeing? How does that play out, Wade? What are they looking for? What are they measuring, and why do they [00:07:00] take so long to perfect their offer from the time they offer it to you, from the time of the closing where they transfer money, you have a closing, right?

Wade Carpenter: Yeah. That sort of rolls into the due diligence. Sometimes you're dealing with different ways of doing job costing, different ways of calculating your WIP, a lot of contractors will do things to dress up a financial statement or accelerate billings and stuff like that to make their balance sheet look better. And, some of these savvy investors, they'll have a whole back office team that's digging into the due diligence. But if they've got good records that they can rely on and see that it's in order, it can go a long way to getting a better multiple.

But unfortunately what sometimes we see is they will take these things. Had somebody offer like $20 million to a contractor, and, they hadn't seen their books. The books were unfortunately not-- it wasn't just the books. They were heavily in debt. They did have a really good presence and [00:08:00] reputation, but they strung them along. It was over a year of due diligence, and digging into it. In the meantime, the owner had it in his mind , hey, I'm gonna go buy a yacht and all this, and they get this in their mind.

And so they sign a letter of intent at a certain amount. They get to the closing and they start beating down all these little things, and pretty soon it was a fraction-- I've seen this multiple times, but it's a fraction of what they originally offered. Sometimes that's tactics on their end, depending on which side you're on, but I understand it.

Too often people get in their mind, it's like, hey, they start spending money in their mind. At the end, they're just like, okay, this is the only thing, and you're committed. You're like, okay, I gotta take what I gotta take.

Stephen Brown: And you're also depending a lot on your business broker to guide you through it. Right? And they get a commission if the sale goes through, of course, but that's okay. If they're doing their job. The buyer is trying to drive those multiples down and they're trying [00:09:00] to hold those multiples up. And it seems to me like you need more than one company offering in the same terms and conditions, or you're at their mercy, right?

Wade Carpenter: I've had some that have multiple offers, but a lot of people don't want the world to know they're out there for sale. Most of the people are that way. So you only usually sign a letter, you know, non-disclosure agreements with one company, and then they string you along and you put all this time and effort into it.

But, what are they looking for? It's profitability, cash flow. They can look at your backlog and pipeline. But is it predictable? You already brought this up when we were talking about this. Is it repeatable? Is it recurring revenue that they can, you know, an account that is service type work? Do they have the people, the processes and these SOPs that are transferable?

Reputation, relationships. The people and the processes, that is sometimes one of the reasons they're buying a company. The risk and continuity of the bonding relationship, which, maybe you can talk about a little [00:10:00] more.

Stephen Brown: That's definitely a factor. How do you control risk in your company? What systems are in place, what procedures are in place, what insurance is in place, and what kind of relationship do you have with your ability to control risk?

I would like to think that your agent has a big part to do with that. But also big construction companies have their own risk managers and safety people, and they depend a lot on a partnership and the team working together to make these decisions.

You, as the owner of the construction company, also have your perception of risk. A job that might seem very risky to a competitor or someone buying your company may not be risky at all to you. And there's value in that. That's the value of your company, right? Your ability to analyze risk and overcome it.

Wade Carpenter: Yeah. Along the lines of things the people, the processes, those kind of things. Maybe you've got a particular vice president and they've been in charge of all the relationships. What are you gonna do to keep that person? What's to keep them from jumping ship?

The [00:11:00] accounting back office kind of thing. A lot of times that's one of the key pieces. We actually have a client that came to us about four years ago and was buying a company. He's bought another couple of them since then. But he brought us in originally because what if this person that knows all this stuff in the back office leaves? And that was part of the impetus of bringing us in. They were really worried the whole system would break down.

It turned out to be a great relationship with us that we're continuing to this day. We brought in a system. He did sort of merge in a couple of two very different ways of doing things. We've seen that quite a bit.

As well as we have recently some that have been buying companies and trying to capture a vertical, and a couple of different subcategories. Even different sub categories have different systems and putting all that together so you can report and see where it's making sense, and where you can find some of that overhead savings.

The point of all this was the people and the processes and keeping that in place has some of the [00:12:00] reasons we've been brought into some of these relationships.

Stephen Brown: Yeah, that makes perfect sense, Wade. And you know, what you're talking about as far as, vertical, maybe a general contractor buying a certain trade that they can do in-house, because they're consistently subbing out and they're seeing too many fluctuations in their sub pricing, so they want more control over that.

That's one thing. But if you're a general contractor, selling yourself out to another general contractor, what do you offer that they don't offer? And I guess my point is, if I was looking to buy a business, Wade, I would say, I'm looking at these numbers and they're fantastic. If it's not broken, let's not fix it.

How long can I buy out your company, keep things going the way they are, and get a return on my investment, based on the margins that I demand for myself? And then let things just play out after that depending on the market . Either resell the company or position it for reselling it or liquidate it or sell it to the employees.

Wade Carpenter: Yeah, we've seen exactly that situation where general [00:13:00] contractors, they start buying the subs to pick up a little more margin. They start with maybe drywall and then they start, okay, let's have a concrete division. Let's have an HVAC or electrical, plumbing, those kind of things where they can pick up more margin.

A lot of times that's where they're giving a general contractor, a percent gross profit is far lower than a sub or something like that. And so if they could pick up that margin, if somebody has some equity behind them, they can actually build an even more profitable company when they can capture that margin altogether. So that's a great point that you bring up.

Going back to integrating all these systems is such a hassle. Because a General Contractor works a certain way, HVAC Contractor works another way, Concrete Contractor works a different way.

Stephen Brown: Yeah. What do you tell as a subcontractor, your favorite subs? Hey, I'm selling out to so and so, but hey, listen, it's gonna be great for you. Everything's gonna be the same. They want us to keep our relationship. We're gonna do better work than ever. We're gonna do more work. We wanna [00:14:00] tie ourselves to you.

And then all of a sudden, the new company comes in with even more stringent measures in place, and the sub's like, yeah, I'm not working for the same people anymore. My devotion is to you, Wade, as the owner. You've done so much for me. I owe you Wade. I don't owe these people buying your company.

Wade Carpenter: That is a problem. And I know we've kicked around the things of ESOPs and selling to your own people versus one of these consolidators, a lot of times some of these people may have some money behind them, and they come up offering money and your employees don't have anything. So it's a longer term deal.

How do you sustain the value after you go sell out and how do you make sure all these things come together?

We're brought in sometimes the outsource backed office and we continue with that vertical, because we can usually do a lower fixed cost versus hiring somebody in house. And we do work across some of these industries. That's where we see that kind of stuff.

But I'm just trying to say, what does it look like after we put the whole deal together?

Stephen Brown: That's a good point too. And I [00:15:00] can say this at McDaniel Whitley, we can add value to your bonding experience, whatever's going on. We can discuss the impact on it with you, and we can help you steer to where you will not run your bonding ship aground before this happens.

Back to what we were talking about, Wade. We want what's best for our listeners, whatever they're going through, whatever they want to accomplish. And we've had podcasts on so many topics. You remember the podcast we had with Rob and the fellow who literally buys construction companies. He's a broker for it.

He was just sharing some of the tricks of the trade from their perspective. Okay, that makes sense. We want to buy your company for as little as possible and get as big of return as possible. But there's so many win-win situations when you think about all the aspects of what do I want accomplish? What do they want to accomplish? And how do we come together? And am I thinking about this only one way, or are there multiple ways I can accomplish what I want to accomplish? That's what I see going on. [00:16:00] With my customers right now they're trying to weigh all this.

And I would also say to our listeners that have no time and no ability to think about the value of their company, this is a good time to think about it. I told you how many customers we have, they're not even gonna listen to anything about retirement. The only thing that's gonna get their attention is someone calling to pay $20 million for their company in cash. Okay, I'll sign over the papers to you. You gimme that $20 million check and I'll see you later.

That's fantastic if you can do it, I'm happy for you. If that's what you want.

Wade Carpenter: Yeah, I've seen deals like that . Usually it's tied to okay, you've got to stay with us and keep these relationships. Sometimes it's more okay, like we've got recurring revenue. You have to continue that relationship. And just like CPA firms, if you lose that, sometimes I've seen clauses where they will claw back the purchase price,

if you don't maintain that. There are pros and cons to selling to private equity or whoever, the liquidity maybe cashing out, but, sometimes they lose their [00:17:00] autonomy, their ability to do what they wanna do. And so they're brought in and they hate it.

From the private equity, just to talk about what you were talking about, a lot of times they've got a relationship with their bonding company. And sometimes the private equity will throw that out the window. And they don't realize that you may have some expertise in working with this particular type of construction, and maybe they should consider keeping their bond agent in place.

Same thing I say with accountants, they don't realize how much that relationship for the bonding company and having the agent going to bat for them and knowing as opposed to, their private equity has somebody that they use and just gets it done because they have big money, but they don't know the risk. And all the things that can go wrong with a particular type of construction. Thoughts?

Stephen Brown: As a buyer, what you're going through with your consultant, your bonding agent, and your insurance agent is what economy of scale can I replicate what's going on now and get the right advice going forward?

I can just [00:18:00] tell you, all the underwriters out there say private equity companies absolutely provide no indemnity and take all the cash out of the company, which keeps you from getting bonds.

So how has the work capitalized and funded? How has growth in your company that you've already started, how has that continued? So I would say to someone buying the company, let's look at what it is you want to accomplish and what you need out of it, and how to go backwards from there. Because everybody's seen that movie, Wall Street where Michael Douglas goes in there and just absolutely-- or Pretty Woman, that these arbitrages go in there and they buy your company and then they destroy it, they liquidate it because you've got all these hidden assets you didn't know about. Your plant is worth more being destroyed and developed as real estate at its current location.

You have all these hidden assets and you've got the power to name your terms with the financial institutions that are doing the financing. That's another aspect of it.

I'd like to go back to, Wade, what we were discussing [00:19:00] about backlog gross profit, because backlog gross profit is the predictor of the future. That's what bonding companies look for.

Backlog Gross Profit will tell someone buying the company how consistent you are in estimating your profits. That's huge to me. And your backlog gross profit is determined by your Work In Progress report, which can be at whim to all kind of different elements, all different situations can be thrown into that WIP that can offset those numbers.

So you got to have an accounting firm that understands what's being impact, what's put into those numbers, analyzing that. But then you go back to the backlog gross profit, and you say basically someone's paying for me now, my estimated profit I'd take out of these jobs. And they're gonna make sure that I'm here to make sure that we not only get that profit, but we can eke more profit out of that backlog gross profit.

And then on top of that, we have to replicate that. So you remember I was telling you about a bunch of mergers and acquisitions and insurance agencies in the Memphis [00:20:00] area? This was years ago that was going on. And agent over in the west Memphis comment was like, no, why would I wanna go buy their agency, book of business when I can just go get it myself?

And, I liked his cockiness and he was good enough to go get it himself. He was just like, yeah, if I want your business, I'm gonna go get it. That same attitude comes with the contractor that's hungry for work, right? What are all these elements that are missing that need to be there to make this successful?

Again, there's nothing better than a good story of someone selling their business and making a profit. Living the American dream there.

But at the same time , how do you skin a cat? How do you get through all of this paperwork, all these offers? How do you emotionally take yourself out of the picture to be able to truly analyze the numbers?

You have to say, what is the true value of your company? And then someone comes in here and you say, the value of my company I worked so hard to build up is my equity that I put on my personal financial [00:21:00] statement. It's right in my year end, it's right down at the bottom corner. That's my equity. That's the lowest that I think my companies worth.

But now I know it's worth a whole lot more. Bec ause we got great people. I've got a great name built up for myself. We're making good profits. A lot of people wanna do business with us because of who we are.

That value in your mind is X amount, right? And then the person buying it is X amount. And you gotta come to grips if it's worth it to you. So there's emotional part of getting out of business, that's coming into play now. That's all I wanted to say about that.

Wade Carpenter: Okay. Some great thoughts and I think we could probably spend another hour on this topic because there's so many things. You just also unpack one that I just thought about, as you were saying had a recent situation where somebody took on another large industry and completely different from what they were used to. They just saw it on paper that they were very profitable.

But they realized that their payment, the terms, it took a lot longer to get paid, let's just say. And then they ran into some major [00:22:00] cashflow issues. And that's why they started looking at my book, and that's where we ended up starting a conversation. But there's a lot to think about, whether you're selling it or whether you're buying it. Not discounting the relationships and the expertise that you've got in place, making sure you have that locked down, whether it's the people in house, their bond agent, their accountant, their lawyer, their bankers even can play into it. But a lot to think about.

So if you got some value out of this or you had some thoughts or questions, we'd love to see them in the comments below. We do this every single week and we'd appreciate it if you'd like, share, subscribe. It always helps the channel out. And we will see you on the next show.