The existence of a claim does have an impact on the business sale and valuation of a California Construction Business.
Unfortunately, a common occurrence in the construction industry and other contractor industries is litigation or a claim.
A construction claim is typically a demand made by the contractor to the owner for compensation to cover the additional costs of construction work performed on a project beyond the original contract terms.
Simplified, a construction claim is a change order that has not been settled or negotiated between the party that hired the contractor and the contractor. If neither of these things happens, then it will most likely turn into a protracted litigation.
The best outcome for these scenarios is that the customer agrees to pay the amount due or a negotiated amount that satisfies both them and the contractor before the matter heads to court.
What is that impact, and what should you do about it before you sell your construction business in California?
The Requirements to Own and Operate a California Construction Business
Before we even talk about claims, an important reminder about what you need to operate a construction business in California legally is in order. Homeowners can hire nearly anyone to do work around their home, but there are numerous reasons for hiring a licensed contractor. Not the least of these is the validity of litigation.
But it works the other way around as well. For a contractor to have a valid claim, they must have a valid contract with the customer. That means that in California, they must be licensed by the California Contractors State Licensing Board. To obtain a license, the contractor must possess a specific combination of education and experience, or both. They also must be insured in case something were to go wrong.
While most contractors understand this, they may not fully comprehend the impact it has on claims, business valuations, and ultimately, exiting their business and selling it (more on that momentarily).
Contractual Obligations and Claims
For a claim to be valid, the additional work must be beyond the scope of the original contract.
Whether the work falls outside that scope and to what extent the contractor should be compensated for it will ultimately be decided in court, unless it is negotiated beforehand. Either way, the contractor will have to finish the job.
This means walking off the job and refusing to finish the work until they are paid isn’t an option in most cases. If the matter does go to court, the contractor will likely be obligated to complete the work anyway. The issue with that scenario? The contractor will not be able to report the income from that part of the job until a settlement is reached; however, they will be required to report the materials and labor used on that job.
This is because even if you think you will win a claim, the income cannot be counted until:
- The contract or other evidence provides a legal basis for the claim, or a legal opinion has been obtained, stating that under the circumstances, there is a reasonable basis to support the claim.
- Additional costs are incurred due to unforeseen circumstances that were not anticipated at the contract date and are not the result of deficiencies in the contractor’s performance.
- Costs associated with the claim are identifiable or otherwise determinable and are reasonable given the work performed, and
- The evidence supporting the claim is objective and verifiable, not based on management’s feel for the situation or unsupported representations.
What does all this legal language mean? Until you have a signed, negotiated settlement or a final court decision, that money is not assured.
What does this mean to the value of your Construction business?
The Value of a California Construction Business
Will one claim affect the value of your business? That depends on the size of the claim, as it certainly can. The value of a California construction business depends mainly on several factors:
- The value of your assets vs. your debt and liabilities.
- The performance and profitability of your business over the last 3-5 years.
- Current cash flow, profit, and loss.
- Tax liability.
- Current or pending litigation.
This is especially important if you plan to sell your business shortly.
A large enough claim can also have a dramatic impact on your current cash flow and the profit and loss you show. Until that issue is settled, your business could be undervalued. If the claim is ultimately not resolved in your favor, that impact can be even more dramatic and long-lasting.
Selling and the Need for a Qualified Buyer
If you are ready to sell your construction business in California, whether or not you are dealing with a claim, you must understand the need for a qualified buyer.
For a California construction business, this means more than just finding someone with a lot of cash or who can get financing. It also means that the person must have a contractor’s license or be able to obtain one before closing. Closing of the deal won’t happen without it.
That means your target buyer needs to be aware of this and preferably already qualified. Suppose you do sell in the middle of a claim, especially if you are still performing work on the job. In that case, it is vital that they be able and willing to continue that work, and you will have to determine how the potential settlement of the claim will be handled after the sale.
Sound complex? It certainly adds some moving parts to the sale of your business, and a Certified Business Broker can best address those specialized California Construction Industry who can guide you throughout the entire process.
What to Do When You’re Ready to Sell
When you’re ready to sell your California construction business, follow these steps:
- Start with a business valuation. Knowing what your business is worth is the foundation for the rest of the process.
- Settle all claims, litigation, and legal issues. This will make the sale of your business go much more smoothly.
- Recast your books to show the true income potential of your business, rather than the reporting you do to achieve minimum tax liability. Your business broker can also assist with this.
- Evaluate your assets and equipment. Is everything up to date and in good working order? If not, work to achieve that goal.
- Be sure your business is healthy and profitable.
An essential part of this process will be your business broker. At Rogerson Business Services, we’ve sold businesses like yours before, and the construction industry is one of our specialties.
If you need a business valuation or you are already prepared to start the process of selling your construction business in California, contact us today.
We’re here through the whole process, and we want to be your business broker in California.
Andrew Rogerson is a certified business broker based in Sacramento, California. Call Toll-Free at (844) 414-9700. If you prefer, email him at support@rogersonbusinessservices.com. Andrew services the whole state of California.