The trend of private equity in construction
The benefits for a business owner are straightforward. Private equity offers another avenue for them to sell their business, especially if there is no potential to turn it over to a family member, management team, or a key employee. Even if one of these three is in place, these parties may not have access to the required cash flow, which can complicate maximizing potential value in the transaction. The key employee will often have to finance a large portion of the purchase price and in the current interest environment, the financing charges on top of the transaction price may not ultimately make the price palatable for the buyer. Private equity firms typically have cash available to complete the purchase transaction and are more interested in leveraging the business than an individual buyer. Also, if the private equity firm views the seller as a strategic buy or a platform company to build off in a particular industry or geographic area, they may be willing to offer a higher potential purchase price than the other interested parties, specifically if they have cash that they have to invest during that particular time period.
Since 2011, after the Great Recession, total spending on construction and spending on private construction have increased each year per the United States Census Bureau. The annual increase in construction spending aligns with the primary goal of private equity, which is to generate returns and cash flows for their investors over an identified investment time period, which is typically somewhere between three and seven years. Companies identified as potential targets by private equity have typically shown trends of positive earnings before interest, taxes, depreciation, and amortization (EBITDA), upon which private equity will determine the enterprise value.
Due to the existing management teams that private equity typically has in place and additional scale and services that they can provide via experience and their other investments, they can immediately create value beyond the EBITDA of the legacy company. In the construction industry, this is often performed through a rollup strategy, wherein the private equity firm will acquire multiple smaller contractors and consolidate them to generate economies of scale. They can optimize synergies created within their existing management team and the acquiree's management functions and create better volume pricing structures with their vendors, which can immediately create the EBITDA increases previously described. Via these economies of scale, they can also tackle any potential labor issues both in the trades and back office by pooling the available resources they have acquired and use this collective experience to navigate some of the other risks inherent in the construction industry. This has been demonstrated recently in industries such as roofing, which historically had smaller independent companies that private equity firms have been able to acquire and stack onto a platform company to achieve their desired growth targets and return to their investors.
There is no specific playbook that is going to work for every company on the brink of a transaction, but private equity has offered another avenue that previously had not been available. While views on the current economic outlook are mixed, there are still certain industries including data centers, energy, and public utilities/infrastructure, where increased spending is expected to continue due to current and future needs. With the aging demographic of the overall industry and perceived value remaining in many construction verticals, the private equity trend in construction is expected to continue.
Citrin Cooperman's Construction Industry Practice works closely with general contractors, heavy highway, electrical, and superstructure contractors, metal fabricators, and a number of other specialty trades. With years of experience in the industry, we understand the nature of our clients' sales and project cycles. Evaluating project profitability, managing cash flows, and evaluating costs are all factors in determining our clients' ability to maintain a competitive edge.
'Citrin Cooperman' is the brand name under which Citrin Cooperman Advisors LLC and Citrin Cooperman & Company, LLP, independently owned entities, provide professional services in an alternative practice structure in accordance with applicable professional standards.
Corey McCusker is a partner with nine years of experience in public accounting, providing accounting, audit, tax, and business advisory services, primarily in the construction industry. He performs financial statement audits and reviews of general contractors and subcontractors, including evaluation of internal controls, financial reporting and compliance, and construction specific tax planning.
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