10 minute read

Selling a Business That Relies on Contractors

Construction contract employee receiving project details.

When it comes time to sell your business, you may be wondering how relying on contractors rather than full-time employees will impact your valuation and ability to attract buyers. As a business owner, you chose to use contractors for good reasons - flexibility, specialized skills, reduced overhead and administrative costs. But how do buyers view this model? And what steps can you take to maximize value and make your business appealing to potential acquirers?

Contractor-based businesses are common across a variety of industries, from IT services and creative agencies to construction and landscaping companies. If you're considering selling your business, it's essential to understand the distinct aspects of valuing and marketing a company that relies on contractors.

What is a Contractor-Based Business Model?

A contractor-based business fulfills most of its staffing needs using independent contractors and freelance talent rather than full-time employees on payroll. Contractors may work for the company on a project basis or as ongoing service providers.

There are several advantages to this model:

Flexibility to scale labor up or down based on workload
Access to specialized skills and expertise on an as-needed basis
Lower fixed overhead costs and administrative requirements
Ability to take on projects requiring skills not available in-house

However, contractor-based models also come with challenges:

Higher hourly rates compared to W-2 employees
Dependence on external talent and limited loyalty/continuity
Compliance and classification issues
Greater revenue and client concentration risk
Quality control and oversight requirements to avoid operational disruption

Industries that Commonly Use Contractors

Contractor-based business models are prevalent across a wide range of sectors, from professional services to skilled trades and creative fields. Some examples include:

Information Technology (IT): Tech companies frequently engage contractors for software development, cybersecurity, and IT consulting to access specialized skills and manage project timelines effectively.
Accounting and Finance: Many accounting firms and financial consultancies rely on contractors to provide specialized expertise, handle peak workloads during tax season, and deliver project-based services to clients.
Legal Services: Law firms often use contract attorneys to assist with research, document review, and specialized areas of law, allowing them to scale their services based on client needs.
Marketing and Public Relations: Marketing agencies and PR firms frequently work with freelance writers, graphic designers, social media specialists, and event planners to execute campaigns and serve diverse client needs.
Construction and Skilled Trades: Contractors are commonly employed for specific construction projects, home renovations, and skilled trade work such as plumbing, electrical, and HVAC services, enabling companies to scale labor according to project requirements.
Creative Services: Industries such as advertising, film and video production, photography, and graphic design often rely on freelance talent to assist with executing large projects or providing specialized creative skills.
Consulting and Business Services: Management consulting firms, human resources consultancies, and other business service providers often leverage contractors to deliver specialized expertise and support project-based work.
Healthcare and Wellness: Healthcare practices, fitness studios, and wellness centers may work with contracted professionals such as physical therapists, nutritionists, and wellness coaches to provide a range of services to clients.
Education and Training: Educational institutions, tutoring services, and corporate training providers often engage contractors as instructors, curriculum developers, and subject matter experts.
Logistics and Transportation: Logistics companies, delivery services, and transportation providers frequently work with contracted drivers, warehouse staff, and logistics professionals to meet fluctuating demand and cover specific routes or regions.

These are just a few examples of the many industries where contractor-based business models are common. The flexibility, specialized skills, and scalability that contractors provide make them a valuable resource for businesses across diverse sectors.

How Using Contractors Impacts Business Valuation

The use of contractors can have a major influence on your business's valuation, both positive and negative. On one hand, lower fixed labor costs and the flexibility to adapt to market changes often enables higher valuations. However, dependence on contractors also introduces risks around long-term stability, intellectual property, and compliance that can depress valuation.

Key valuation drivers impacted by a contractor model include:

Profitability: In most industries, lower labor costs lead to higher profit margins which positively impacts valuation. However, if ineffectively managed, overuse of contractors can erode margins.
Stability: Concerns about continuity and the stickiness of contractor relationships create uncertainty. Buyers value stability and want to be confident the business isn't overly dependent on individuals who could walk away.
Compliance: Contractors must be properly classified to avoid legal and tax issues. Buyers will look closely at this to assess risk.
Intellectual Property: Contractors often have access to proprietary information, trade secrets, and client relationships. Strong agreements are essential to avoid IP ownership issues.

Specific valuation methodologies and considerations vary by industry:

IT Services: Reputation, marquee clients, recurring revenue streams, and proprietary technology heavily influence value. The mix of full-time vs. contract labor is scrutinized.
Construction: Valuation focuses on project backlog, pipeline, equipment, and historic financial performance. Contractors are assumed but their reputation and availability matter.
Creative Services: Value ties heavily to strength of client relationships, past project portfolio, and talent pool. Creatives on full-time staff can be a selling point.
Home Healthcare: Valuation focuses on factors such as the number of clients, average billable hours, and contracts with healthcare providers. The reputation and qualifications of contracted caregivers significantly influence value. Recurring revenue streams and a diverse client base are key selling points.
Landscaping: The value of a landscaping business is heavily influenced by its reputation, the size and quality of its client base, and its fleet of well-maintained equipment. Recurring maintenance contracts and a strong portfolio of completed projects are essential. The experience and reliability of contracted landscaping crews also impact value.
Catering: Valuation for catering businesses considers factors such as the strength of relationships with event venues, a diverse and loyal client base, and the ability to handle multiple concurrent events. The talent and flexibility of contracted kitchen staff, servers, and event coordinators are critical. A strong brand reputation and positive reviews significantly enhance value.
Cleaning Services: The value of a cleaning business is driven by its client base, the types of properties served (residential vs. commercial), and the reputation of its contracted cleaning staff. Recurring cleaning contracts and a low client churn rate are highly desirable. Efficient scheduling systems and well-documented operating procedures also contribute to value.
Pest Control: Valuation for pest control businesses focuses on factors such as recurring service contracts, a broad customer base, and a strong reputation in the local market. The expertise and certifications of contracted technicians are crucial. A well-maintained fleet of service vehicles and equipment also influences value.

In each of these industries, a track record of steady revenue growth, profitability, and customer retention greatly enhances the business's value in the eyes of potential buyers. The ability to demonstrate a reliable and skilled pool of contractors is also crucial, as buyers want to ensure continuity of service quality after the sale.

Regardless of industry, proven valuation methods like discounted cash flow (DCF) analysis, comparable company multiples, and recent transaction prices are used to determine a valuation range. Entrepreneurs and small business owners should exercise due diligence when weighing the unique opportunities and risk factors when valuing a business that uses a contractor-based model.

Buyers’ Perspective on Contract Labor

Businesses that rely on contract labor are often seen as agile and adaptable, but a new owner may value a solid, dedicated team. In some cases, buyers may view full-time employees as potential acquihire targets, aiming to bring their skills and expertise in-house. However, when it comes to contract labor, buyers may need assurance that the contractor-based model doesn't compromise intellectual property rights or confidentiality and might request more robust agreements and risk management strategies. Furthermore, concerns about long-term stability may arise due to the potential dependence on external talent. After all, any successful business will forecast whether they can sustain growth after a merger or acquisition.

Making Your Contractor-Based Business Appealing to Buyers

As you prepare to sell, put yourself in potential buyers’ shoes. They’re looking for an asset that will provide a reliable return on investment. While they may value the agility your contractor model provides, they also want to mitigate risks. Consider these tips to maximize value and attract buyers:

Create robust contracts. These can help to protect the business and its relationships. Be sure to outline clear terms and conditions, include confidentiality clauses, and state any intellectual property protections to increase buyer confidence and mitigate risks.
Practice labor law compliance. Adherence to labor laws and proper classification of contractors can reduce potential liabilities.
Offer contractor incentives. Improve the odds that your contractors stay with the business post-sale to foster continuity and stability. If they’re incentivized to continue, it can ensure a smooth transition for both parties.
Build strong client relationships. A diverse client base and strong client relationships are attractive to buyers, providing revenue stability and growth opportunities beyond existing contracts.
Source contractors from multiple sources. Diversifying talent sources mitigates risks associated with a thinner contractor pool. Use a variety of recruitment channels and build relationships with talent agencies to stay connected to the best possible resources.
Document processes. Create a knowledge base that facilitates a seamless transition for buyers. Clear documentation ensures continuity of operations and minimizes disruption during the ownership transfer.

Work With an Experience Broker to Sell Your Business

Choosing the right business broker is essential when selling a contractor-based business. Your broker should have experience executing transactions in your industry and a network of buyers who will see the value in your model.

Explore the BizBuySell Broker Directory to connect with experienced professionals who can provide expert guidance and support. Whether you're looking to maximize the value of your own business, create an exit strategy, navigate legal complexities, or attract qualified buyers, a trusted business broker can help you.