Building Your Succession Plan – What to Consider

By: Chris S. Lambert CPA, CGMA, CCIFP

The decision to sell your company is one of your most significant financial decisions you will make. You have likely spent years weighing the pros and cons, not to mention working through the emotions of letting go of your life’s work.

Exiting a contracting business is extremely difficult. An estimated 12 million privately owned businesses are projected to transition as baby boomer owners retire or leave the workforce over the next ten years. This transition will likely create more intense competition for qualified buyers and leave out some companies that have yet to differentiate themselves.

In addition, private equity rarely buys because they are not in favor of bonding requirements and the industry’s cyclical nature. As a result, finding a third party is difficult. Competitors can be a source, but you need significant advantages in place for them to pay you a premium for your company. These advantages might include higher profitability than competitors, an enviable workforce, or a diversified customer base. Are your books in order with accurate and comprehensive financial data? Are you reducing unnecessary expenses and managing cash flow most advantageously?

Exiting your company requires thought and planning. Just as a contractor would never take a job and bid without a set of plans or specs, they should not take on a buyer and their offer without a set of plans. To do this, it is important for owners to answer a number of questions.

  • Who is the buyer and what qualifies them to own a construction company?
  • Do I want to continue working with them or leave once the papers are signed?
  • What will I do when I no longer own my company?
  • What range is my asking price?
  • What will my tax burden be?

Another option is to transfer your company to your management team. There are installment sales, phantom stock, stock appreciation rights, cash balance plans, buy/sell agreements, stock options, ESOPs, and more. These methods have different applications based on the benefits the owner is trying to obtain. The business owner should determine what they want from the exit.

Regardless of whether you have an internal or external sale, you’ll want to consider who will succeed you.  Does that person already work for you? Do you already have an alliance with that person/company? Ideally, this person is someone you enjoy working with and can spend three to five years transitioning relationships. What you are selling are your relationships that you have built with your clients. The best buyers of those relationships are the people that already have some form of relationship with your clients.

As mentioned above, an internal sale can be achieved through an ESOP. ESOPs are a method that can provide some advantages. For the ESOP to be a method worth exploring the construction company has to have been operating for over three years, has more than 15 employees, is profitable, has an EBITDA of $1.5 million and has a capable management team that can succeed the owner. This method allows the business owner to maximize the value they keep, is okay with a gradual sale and transfer of the business, is looking for liquidity and has a desire to reward key employees.

The downside is this structure is complex, requiring expertise, compliance and management. The upside is that the structure offers flexibility. If the company has multiple owners all of them do not have to be bought out. Often after tax, a business owner keeps more money in this transaction than they would from selling the company to a traditional third-party buyer. The IRS encourages this behavior and provides huge incentives to sell to your employees. In some cases, this structure can make the company exempt from state and federal income taxes and, thereby increasing cash flow. Often you will likely see an uptick in production because the employees will have skin in the game. Employees are less likely to leave. Interests are tightly aligned.

As noted above contractors struggle to sell their business in a traditional manner. When you do find buyers, they are often competitors interested in purchasing assets from the company. In this sense, a traditional buyer wants to negotiate price based on book value, whereas sellers want to negotiate price based on cash flow multiples. The ESOP provides flexibility.

At Suttle and Stalnaker, we provide clients with all the standard accounting services you can get anywhere. What separates us from the competition is the expertise and experience our construction team will provide you. If you would like to discuss any issues on succession planning, reach out to the construction team today!