The low economic barriers to entry in the construction industry turn out to be significant impediments when it comes time for owners to exit.

Much has been written about the low economic barriers to entry into the construction industry. These barriers have risen somewhat over time; however, it is still a fact that with a little money and a large dose of determination, just about anyone can go into the construction business.

Many of these start-ups fail, yet many more germinate into substantial businesses and create economic vitality for their employees and owners. That is the upside of having low barriers to entry. The downside is the never-ending competition, low margins, and a high overall business failure rate for contractors.

An additional downside is that low barriers to entry can create economic circumstances that impede owners from exiting ownership of their firms.

You may wonder what getting into the business of construction has to do with getting out. To explore this we must first look at why it is so easy to become a contractor. The key factors that establish low barriers to entry in the construction industry are work acquisition through competitive bidding; the relatively low level of capital required relative to revenue generated; and the mobile nature of the construction labor force.

Competitive Bidding

Loyal owners are hard to come by. The reality is that either by public policy or corporate policy, the vast majority of construction work in the United States is awarded using a competitive bidding process. When it comes time to exit a construction business, the dynamic of competitive bidding raises the barriers to achieving a successful sale for the following reasons:


  • Strategic buyers do not pay much for contractors because they do not have to. Simply put, why would a buyer pay a huge premium for a seller when it is relatively easy to “Greenfield” entry into a new marketplace? This keeps values low for contractors relative to other types of businesses.


  • Low margins, coupled with high risk, create an intensely competitive environment. It is extremely difficult to create an impenetrable market position in construction. In other words, you cannot simply “buy-out” your competition. This reduces the number of parties who will be interested in purchasing your business.


  • Competitive bidding does not encourage strong owner-contractor relationships. Contractors who obtain the bulk of their work via competitive bidding will find their marketplace value to be generally among the lowest.

    Low Equity-To-Revenue Ratio

    One of the hidden “gold nuggets” in the construction world is that it is possible to generate a very good return-on-equity because you can create a large amount of revenue with a small amount of capital.

    For example, let’s look at an example of a $100 million volume general contractor that has equity of $5 million and generates 2 percent profit annually. The return-on-equity (ROE) for this contractor is as follows:

    $100,000,000 sales x 2% margin = $2,000,000 profit/$5,000,000 equity = 40% ROE

    If this contractor decides to purchase another contractor, he is going to want to generate at least a 40 percent return on that investment. Otherwise, he will dilute his margins. To accomplish this, the contractor would be willing to pay only 2.5 times the profit level of the acquisition target. That is not a very appealing multiple if you are the individual looking to sell your business.

    Construction Industry Talent

    The war for talent in the construction industry is escalating. Simply put, the people are where the real value resides for most contractors. So when it comes time to exit the business, if you do not have a depth of talent, you are not going to find many interested purchasers.

    If you try to go out and “buy” talent, you will find it to be a frustrating process. Finally, if you do have some star talent, it is very likely that they will want to buy the business from you. Rarely can they do this outright, however, and you may have to transfer the business to them, essentially by using your own money. If you won’t do this or they don’t like the buyer, they have the option of going and starting their own business.

    Lowering The Barriers

    How do you overcome these barriers in order to successfully exit your business? Just as start-ups need to be a bit smarter than everyone else, the same logic applies to getting out. Consider the following when formulating a strategic future for your company in order to lower the barriers to exit:


  • Develop an owner base that is difficult to penetrate. This can take on many forms, including a significant private owner base, specialized delivery methods such as design/build or engineer-procure-construct, specialized government contracting such as JOC (job-order-contracting), or simply build a reputation and level of repeat customer work that is rock-solid.


  • Continually “sell” the business to yourself. As discussed, you can generate a very good return in this industry, so be prudent in removing excess capital from your business annually. If you can generate 40 percent returns year-over-year, then you should develop significant wealth outside of the business. This will lower the financial requirement objectives when it is time to sell, which will translate to greater odds of a successful sale.


  • Be the employer of choice. The single best employee retention tool is to be a great place to work. If you take care of your employees, they won’t be lured away by competitors or be inclined to leave and start their own businesses.

    Your company once took advantage of the low barriers to entry to get started in the construction industry. If you are looking to get out, do not forget about these economic conditions when creating your exit plan.

    Reprinted with permission from FMI Corp., 919/787-8400. For more information, visit or call Tom Smith at 919/785-9326.