Seven challenges when valuing electrical contracting companies

Business appraisers unfamiliar with the electrical contracting industry may be in for quite a bit of a shock when valuing these unique businesses. While operations for electrical contractors may appear straightforward on the surface, they present a range of unique accounting and operational factors for valuators to untangle. In the following excerpt from BVR’s special report, What It’s Worth: Valuing Electrical Contracting Companies, experts Erin Hollis and Matthew Crane explore a few of the potential challenges that can arise when valuing electrical contracting companies. Download the entire chapter for free.

1. Backlog of work

   Backlog is comprised of the uncompleted contracts on which the contractor is currently working and will continue to work on. These contracts may or may not be of a long-term nature. For purposes of valuation, all other things being equal, an electrical contractor with a significant backlog is more valuable than another available contractor without the backlog. 

2. Underlying contracts

   The underlying contracts an electrical contractor has are critical. If you are performing a valuation of an electrical contractor, you’ll want to look at some of the larger contracts that the business has in hand and are working on at the time of the valuation date.

3. Underfunding of pension liability

   Valuation practitioners may encounter electrical contractors with an underfunded pension liability. With pension liabilities, if the contractor wants to exit the business—either liquidate or sell the business to a third party—he or she has to settle with the union any underfunding of the pension liability on the day he or she wants to transact with another party. 

   This limits the pool of buyers because any buyer interested in acquiring that electrical contractor has to look at the underfunded pension liability. Does the seller really have the ability to settle this pension liability? The buyer doesn’t necessarily want to assume it. Maybe the buyer will simply prefer to let them go out of business and just pick up the employees from the union hall.

   Whatever the case, how do you account for underfunding on a pension when conducting a valuation? When the valuation process starts and you get the documents from the client, ask the client to go to the union and learn what exactly is the underfunding at this particular date.  

   They may respond that, according to their analysis, the pension is underfunded by $10 million, for example. There is not necessarily a dollar-for-dollar deduction off the valuation in this case because there is a possibility that the stock market will turn around and it might be overfunded at some date, but, if you are valuing the business using the concept of highest and best use and this is a contingent liability, you will have to deduct some dollar amount from the invested capital.

4. Bonding

   Bonding is a key valuation consideration. The company’s ability to get bonding in some markets is a big issue. If a company can’t get bonded and this prevented it in the past from expanding into a different market, then that is a negative that heightens the risk of the company. On the other hand, if a company could get bonding but has not so far, that might represent an opportunity that could be included in the forecast or increase its potential value in the eyes of a third-party buyer.

5. Leasing

   Another common area to look at when valuing an electrical contracting company is leasing. Electrical contractors, for example, don’t have a high need for capital investments, but they do need lifts, trucks, temporary space, and other items that they may not necessarily want to own. So they might enter into long-term leases, which may or may not be at market rates, so you should look into what the leases are at the valuation date.

6. Key person risk

   An issue for valuing electrical contractors, especially small contractors, is the concept of key person risk. In small shops, the owner generally does all the estimating and bidding and has all the relationships with the clients. If you are valuing an electrical firm for gift and estate tax purposes, for example, you should consider key person risk, or personal goodwill at any rate.

7. Nonoperating assets and discretionary expenses and/or salaries

   Electrical businesses are quite often run by families, and they take on expenses on a somewhat discretionary basis. The shareholders determine who gets paid what and how, and whether there are any other benefits in the company they can take out.

For additional guidance on electrical contracting company value drivers, accounting differences, and more, access the complete first chapter of BVR’s special report What It’s Worth: Valuing Electrical Contracting Companies.

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