The Blueprint to Building a Successful Construction Succession Plan
Over the past few months, there have been at least three construction companies who have celebrated big anniversaries: one celebrated 75 years, the second 125 years and the third 130 years. It is not by luck or by accident that these companies have endured and continue on their trajectory with no signs of slowing down. While they are different in terms of building type and market specialties, there is one thing they do have in common; a well-designed, actionable succession plan. While there are many ways to develop succession, the most common are generally: familial ownership transfers, giving key employees the opportunity to buy–in, or selling to a third party.
Familial Ownership Transfers
Typically, a successful construction company is built with the vision of indoctrinating offspring and other family members. It is generally the most popular and easiest transition plan, especially when offspring are involved in operations, are market facing, and are driving growth. The first step in a gifting plan is to have the company valued, inclusive of appropriate discounts.
Once a valuation method is selected and performed, the owner has a multitude of options from gifting ownership interests to transferring interests into a variety of trusts (which, if used correctly, serve as great tax-saving-vehicles designed to get appreciated assets out of the owner's estate), to outright selling their interests.
Matters of family are generally messy with many potholes to consider—especially when dealing with working and non-working family members. For parent-owners with multiple offspring, some active within the company and the others inactive, the succession plan must address how to transfer ownership to the next generation in a way that does not slight the inactive offspring. Further, just because an offspring is active in the business does not necessarily mean s/he is the best individual to lead the company in the future. This may be a tough concept to process, especially if ownership is viewed as a birthright. One solution would be to consider transferring the ownership in a non-voting fashion. While day-to-day operations would be dictated by non-family key employees, profitability remains within the family.
Vesting Key Employees
Key non-family-member-employees have much to offer and should be rewarded. While increased compensation is always a great reward, ownership has a variety of options to help get golden handcuffs on key employees. Popular concepts include, but are not limited to, structured annual bonus plans (which vest over time), project specific profitability sharing plans, and common stock purchase options.
One idea to consider is the transition via OldCo to NewCo. Rather than buying the common stock of the existing company, a new operating company is formed and owned by key employee(s). NewCo becomes the active operating company over time, by procuring contract work—which would have generally been performed by OldCo—that supports NewCo through contributions of capital, equipment, infrastructure, etc. In exchange for this support, OldCo receives a share of earned profits/return on capital, which is distributed to the outgoing ownership group in the wind down of OldCo operations. This is a process that happens over time, with the ultimate goal of transferring all operations, profits, and decision making to key employees.
Another popular ownership transfer tool used in key employee scenarios is the implementation of an Employee Stock Ownership Plan (“ESOP”). This is a qualified retirement plan that purchases the stock of the construction company. There are approximately 11,500 ESOPs in the United States, 250 of which are construction companies. With so few in the construction space, why would an owner consider an ESOP? For starters, the ESOP creates an internal market for the owner(s) to sell shares of the construction company. By leveraging the company's balance sheet, the owner(s) is able to sell shares of the company and get cash out. Key employees are rewarded as they are now owners of the company, which helps retention, motivation and overall profitability. As you can see, this solves the ongoing succession issue in a broad stroke. It also aligns the goals of management and labor and, as an added benefit—since the company is now owned by a retirement plan—income taxes can now be deferred.
ESOPs do have their share of pitfalls. For starters the ESOP debt, which the company now carries, is viewed as a liability by the bonding company. Most underwritings do understand that the debt is related to the long term succession solution for the contractor, but it skews certain key financial performance ratios. Another matter to consider is the stock has to be valued by a third party on an annual basis. This is a timely, expensive process that can impact the financial reporting of the construction contractor to business partners. Further, the value can fluctuate drastically from year to year. As established above, the company is now owned by a retirement plan, which means that the Department of Labor and Internal Revenue Service reporting requirements are more stringent.
There is also the possibility that there is no succession plan for the construction company. In these instances, ownership would be considering the outright sale of the company to a third party; be it a competitor or another construction company looking for an entry way into the geographic market. The structure can be as simple as direct sale of company assets/stock, with ownership retiring immediately, or contain an earn provision whereby the owner stays on for a specified period of time to properly transition operations and then retires.
Recent construction contractor transition plans have included any of the following plan options:
- Sell to key employees
- Familial transfers
- Liquidated operations
- Sell to outsider third parties
- Sell to ESOP
- Merge with another firm
Once the contractor determines the path s/he would like to take to “get out” there is still the very real chance that the plan will fail. The “human factor” cannot be denied or even planned for.
Therefore it is vital to be aware of the primary reasons why succession plans could fail:
- Management cannot identify a competent successor;
- Key employee(s) leaves due to lack transition plan;
- Price owner wants is too high;
- Ownership is not aware of all transition options available;
- Offspring not capable of running the business;
The key to implementing the exit strategy is no different than being successful in executing a construction project—it comes down to planning, the “blueprint”. When the process of developing an ownership transition plan commences, certain topics must be addressed. These matters range from financial-risk, fulfill financial needs, resolving estate planning matters, reduction of personal risk; to lifestyle-personal, desire to retire, explore new opportunities, ensure continuity and legacy; and business, provide growth and diversification options for the company, address changes in competitive landscape.
Planning and taking a clinical approach that ownership transfer for the construction company is just another business matter, like negotiating a new contract, will help to defray the “human factor”. The process, to ensure ownership transition is successful, should include the development of actionable, accountable items, with clear and measurable metrics. While the succession plan vehicle may vary, there are characteristics every version should consider:
- The plan should be a written document;
- The plan should be flexible—revisit and revise, as needed. As the business changes so should the succession plan;
- Make sure the plan addresses the pertinent financial and non-financial issues, discussed above;
- Share the plan with the successors and actively solicit their feedback;
- Execute it
The successful development and execution of a succession plan will carry your construction company well into the future towards your 100 year anniversary!
For more information about succession planning for the construction industry, contact Carl Oliveri, CPA CCIFP CFE, Partner-in-Charge of the Construction Practice at Grassi & Co., at email@example.com.