Claims and Selling 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 usually a demand made by the contractor to the owner for money to cover the additional cost of construction work performed on a project beyond the original terms of the contract.
Simplified, a construction claim is a change order that has not been settled or negotiated between the person or company who hired them and the contractor. If neither of these things happens, then most likely it will turn into long and protracted litigation.
Obviously 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 things head to court. However, the existence of a claim does have an impact on the business valuation of a California Construction Business.
What is that impact, and what should you do about it before you sell?
The Requirements to Own and Operate a California Construction Business
Before we even talk about claims, an important reminder about what you need to legally operate a construction business in California is in order. Homeowners can hire nearly anyone to do work around their home, but the reasons for hiring a licensed contractor are numerous. 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 claim, they need a valid contract with the customer. That means that in California, they must be licensed by the California Contractors State Licensing Board. To receive a license, the contractor must have a certain amount of education, experience, or both. They also must be insured in case something were to go wrong.
While most contractors understand this, they may not fully understand the impact this has on claims, business valuations, and eventually 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 or not the work is beyond that scope and to what extent the contractor should be compensated for it will ultimately be decided in court if not 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 things do go to court, the contractor will likely be obligated to finish 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, but they will have to report 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 caused by circumstances that were unforeseen 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 in view of the work performed, and
- The evidence supporting the claim is objective and verifiable, not based on management’s feel for the situation or on 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 business?
The Value of a California Construction Business
Will one claim affect the value of your business? Well, that depends on the size of the claim, because it certainly can. The value of a California construction business depends largely 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 cashflow, profit, and loss.
- Tax liability.
- Current or pending litigation.
This is especially important if you are valuing your business with the intention of selling it in the near future. Typically any litigation or claims must be settled by the time of closing or they can drastically impact what a buyer is willing to pay.
A large enough claim can also have a dramatic impact on your current cashflow 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 business 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 person needs to have a contractor’s license or the ability 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. If you do sell in the middle of a claim, especially if you are still performing work on the job, it is vital 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 does add some moving parts to the sale of your business, and those can best be dealt with by a Certified Business Broker who can help 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, so you show the true income potential of your business and not the reporting you do to achieve minimum tax liability. Your business broker can help with this too.
- Evaluate your assets and equipment. Is everything up to date and in good working order? If not, work to get it that way.
- Be sure your business is healthy and profitable. If you’re going to get the best price for your business, and what you need to exit successfully, you need to be selling a healthy business that appeals to potential buyers and investors.
An essential part of this process will be your business broker. At Rogerson Business Services, we’ve sold your type of business before, and the construction industry is one of those we specialize in.
If you need a business valuation or you are already prepared to start the process of selling your business, contact us today. We’re here through the whole process, and we want to be your business broker.