“Handshake agreements” in small contractor firm — should I be concerned?

April 05, 2023

by a searcher from Rice University - Jesse H. Jones Graduate School of Business in Spring, TX 77373, USA

I’m currently in the due diligence phase with a small electrical company in Texas. The company has been in business for 30+ years and has steady (modest) cash flow. Rough numbers: $1MM in revenue, $200k in SDE, purchase price $600k.

In my review, I learned that the owner does all of his work — including work for a general contractor — without any formal agreements in place. Naturally, this is a bit concerning for me. The broker suggests that operating off of ‘handshake agreements’ is really common for contractors of this size. The seller has shared that he’d love to introduce me to all of his major clients and make sure we have a good handover — so I’m confident he’s not hiding anything. Just trying to get a feel for how concerned I should be.

Would love to hear any thoughts or experience you guys have to offer in this space. How concerned should I be about ‘handshake agreements’ with a electrical firm of this size?

Reply by a searcher
from University of Florida in Boynton Beach, FL, USA

Went through something similar with a plumbing contractor last year. Definitely common but there should still be proposals with a scope of work and a price. Pay attention to progress billing, it's easy for your seller to get over-billed before closing and pull forward revenue/AR that should belong to you. Also make sure you understand deposits and retainage impact on closing AR.

If you have fear of losing existing projects, I wouldn't worry too much. (1) construction contracts are usually one-sided in favor of the GC and they have a dozen ways to terminate, so the contracts don't help you much anyway. (2) It's a big headache and expensive for a GC to fire you mid-stream and hire somebody else.

Reply by a searcher
from The University of Michigan in 1075 Gills Dr, Orlando, FL 32824, USA

I agree this is common. With my business, I have a number of vendors that are small, private businesses and we don't have a contract in place. We've worked together for years and trust each other.

I would however strongly consider an earn out based on customer/revenue retention. If he's confident the customers will stay without a contract in place he should be OK with this.

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