Certain aspects of a construction company will obviously raise or lower its value. These include the strength and longevity of ownership, the number of jobs completed and in its backlog, and the accuracy and structure of its financial statements. But there are other distinctive elements that affect a business valuation as well.
Appraisers often value licenses and permits during mergers or acquisitions. A valuation may also be performed when the plaintiff in a lawsuit claims damages to a license or permit because of the defendant’s alleged wrongful actions.
Various factors can affect the value of licenses and permits. One example is the number of licenses or permits available to similarly situated applicants. A permit’s worth is also partly determined by the owner/operator’s ability to transfer the license or permit, as well as the owner/operator’s history regarding renewals or terminations.
Most licenses and permits may be valued by the application of any of the three generally accepted intangible asset valuation approaches — that is, the market, income or cost approach. (Ask your financial advisor for an explanation of each approach and how it might affect the valuation of your company.)
Appraisers are often asked to value construction companies’ engineering-related intangible assets. These include construction engineering drawings — such as architectural designs and drawings, blueprints, and construction specifications.
Process engineering documents are another example that may pertain to construction companies. These include flow diagrams, drawings and schematics that would allow production operators to initiate a flow of information, materials, fluids, electric current or any other substance that moves continuously.
To qualify as engineering-related intangible assets, the items must function in the real world. They can’t be experimental or theoretical plans and they need to be capable of use in a commercially viable application.
Value of goodwill
For construction companies, and most any kind of business, there’s a portion of value that appraisers can’t attribute to tangible or intangible assets. This portion is commonly referred to as “goodwill,” and it has three principal components.
First, there’s operating business assets in place and ready to use. This component is sometimes referred to as the “going concern” aspect of goodwill. If all the elements of a construction company are physically and functionally assembled, it creates intangible value. These elements include capital (equipment), labor (employees) and coordination (management).
For certain taxation or forensic analysis purposes, appraisers may measure going concern value as a separate intangible asset. For fair value accounting purposes, however, appraisers might measure going concern value in aggregate as a single component of the construction company’s goodwill.
A second component is excess income, however measured. For a construction company, excess income is the money generated by the business beyond the amount needed to provide a fair rate of return on all the company’s tangible assets and identifiable intangible assets. Your established business relationships, reputation and ability to win bids play into this component.
Finally, the third component is the expectation of future events not directly related to operations. Goodwill may be created by the expectations of future capital expenditures, future mergers and acquisitions, to-be-developed projects or services, and potential customers. This component relates to the concept of goodwill as the current value of future assets (both tangible and intangible) that don’t yet exist on the analysis date.
Any of the generally accepted intangible asset valuation approaches may be appropriate to value goodwill. Yet because goodwill typically isn’t sold or otherwise transferred separately in the marketplace, the market approach is less commonly used. Similarly, because goodwill is often measured based on future earnings, the cost approach usually isn’t used. The income approach is generally most typical.
The details of business valuation may seem irrelevant if you’re not planning on selling your construction company. However, knowing the value of your business is important in many other contexts, including court cases and estate planning. Work with your financial advisors to keep tabs on it.
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