When Does a Merger or Acquisition Make Sense for Contractors?
At the end of the process, GC had merged with an asphalt company, acquired a concrete company, and established a joint venture with an electrical contractor. This helped GC reduce its overhead and materials costs (for asphalt and concrete), increased profit levels, and diversified its business.
By RICHARD E. GAVIN, CPA, CCIFP
During a challenging economy, many contractors explore opportunities to diversify or grow. Pooling talent, resources and qualifications can often help win a construction project. Those opportunities may include acquiring or merging with other contractors. For example, an HVAC contractor that works in new construction might decide to acquire or merge with an HVAC maintenance business to expand its capacity. Now, when the contractor goes to bid on an HVAC installation, they can also secure a contract to continue their relationship with the developer as the maintenance provider. In addition, companies that do not want to merge or sell their businesses are entering into joint venture agreements to bid on projects in tandem.
One of our clients, a large heavy/highway contractor, decided it was time to explore new opportunities. Let’s first examine their background: with many public contracts under their belt, “GC Highway Construction” (GC) felt they should diversify their capabilities in order to increase profits and/or increase their chance of winning projects by lowering their costs. Due to its line of business, the company most often utilized asphalt and concrete suppliers. If GC could acquire an asphalt and/ or concrete company they could benefit from increased profits and diversify their business. In addition, we asked GC for a list of subcontractors the company most often utilized. Since their niche was heavy highway, we established the firm could benefit from acquiring or merging with an electrical contractor. There were upcoming projects that required a significant amount of specialty electrical work.
In order to determine the best course of action, we organized a comprehensive due diligence process. Using industry-benchmarking information, we were able to project how the firm’s profit margins would be affected if it merged or acquired a supplier or specialty firm, or utilized suppliers and subcontractors for each of the projects. The due diligence process provided a roadmap of what GC needed to do.
First, GC wanted to explore the value of acquiring or merging with an asphalt company. We examined GC’s backlog and determined that they would need an enormous amount of asphalt this year (like most years). Since they felt it was a highly profitable area, management decided to investigate further. With our industry knowledge and contacts, we found a company, Sam & Sons Asphalt (“Sam”) that needed a succession plan and was willing to meet with GC. We began negotiations and conducted a business valuation that determined the value of Sam. The findings yielded a couple of options: Sam was large enough to merge into GC and receive shares equal to their current investment; or, GC could purchase Sam and have control of shares, while Sam’s team would remain employed with the company, but not as owners. After weighing its options, GC decided the most cost-effective method would be to merge Sam into GC. Sam’s ownership team received 10 percent of the current outstanding shares in GC and cash. In return, Sam’s management continued to manage its operations and be involved in the company. This merger was beneficial to both parties; GC got its asphalt plant and the deal provided Sam’s owner with a succession plan.
GC then decided to explore opportunities for concrete suppliers. We identified two companies that were interested in selling their businesses. Once again, we went through the due diligence process, using benchmarking information to compare the available companies, and proceeded to recommend a course of action. GC’s best option was to acquire a small concrete company to fulfill its needs. They had $2 million of concrete work in its current backlog, so the company decided there was enough of a need to purchase a company. Once we helped identify the company that would be the best fit, we conducted a business valuation and then negotiated on GC’s behalf to acquire the company. The acquisition included some smaller projects and clients; the current owner would remain involved as Chief Operating Officer for five years, and collect a salary as part of the sale. This knowledge and intellectual capital helped GC, as the owner had many connections to secure additional projects.
Next, GC decided that they could not afford to also purchase or merge with an electrical contractor. However, there were a few projects that they wanted to bid on involving a substantial amount of electrical work. After reviewing the remaining options, GC opted to engage in a joint venture operation with a large electrical contractor. With this plan in place, GC could capitalize on the electrical contractor’s experience and bid on these impending projects. In addition, the joint venture provided future opportunities to GC through the electrical contractor’s connections.
At the end of the process, GC had merged with an asphalt company, acquired a concrete company, and established a joint venture with an electrical contractor. This helped GC reduce its overhead and materials costs (for asphalt and concrete), increased profit levels, and diversified its business. The firm was able to produce more accurate and competitive bids, utilizing in-house resources, and became a more profitable company. By expanding the services it provided, GC was able to land larger, more substantial projects and continued to grow exponentially.
As we begin to see signs of economic recovery, contractors must stay ahead of the curve, differentiate their companies and remain relevant. Acquiring additional talent, knowledge, and intellectual capital is extremely valuable to the growth of your organization and can prepare you to emerge ahead of your peers.
About the author: Mr. Gavin, CPA, CCIFP is a Partner at Grassi & Co., CPAs where he heads up the Construction Practice Group. Grassi & Co., CPAs is headquartered in Jericho and has additional offices in Manhattan, New Jersey, North Carolina, and worldwide through Moore Stephens International Limited. He can be reached by calling (516) 336-2440 or via email at rgavin@grassicpas.com.