Overview

There is perhaps no more significant point in the life of a construction company than when the time comes to hand the reins over to someone else. The ability of current ownership to plan for and manage a transition to the next generation or to a third party is critical to the long-term sustainability of the business and legacy that has been built. The following 10 key considerations can help owners and managers of construction companies build successful transition plans.

1. Condition the business to maximize value
Enhance value by taking actions that “de-risk” the business from legal, regulatory, financial, economic and other variables. For example, put a written “contingency plan” in place to document how business functions will be performed if key personnel with institutional knowledge suddenly becomes unavailable. This can greatly reduce the risk of operational disruptions. The most effective contingency plans are integrated with a longer-term succession plan.

2. Prepare (even further) in advance if you want to sell to a third party
Very few construction companies sell to a third party buyer, especially at a premium. If ownership wants to sell to a third party, it is important to put the company’s best foot forward early in the process to differentiate it. Prepare early so that you can anticipate and address the risk factors that an outside buyer will find in the business. Conduct at least a cursory audit of the company’s legal, financial and operational records before a transition to evaluate where gaps exist.

3. Incentivize key employees
Selling to key employees is a common way to transition a construction company. Incentivize employees to stay long-term, and evaluate if they have ownership potential. Incentive plans can include profit sharing plans, cash bonus plans, and phantom stock plans, among others. Plans should be documented clearly in writing, be tied to specific performance standards, and keep the employee invested in the company.

4. Get creative to address bonding and surety requirements
All owners on a company’s bond are typically jointly and severally liable, which can create continuing liability for exiting owners and credit challenges for new owners. Talk to the surety and get creative with solutions. Sureties may only require owners with more than 10-20 percent ownership to be on the bond. Some workarounds may include: 1, having successors pay a “guarantee fee” to compensate retiring owners for continuing risk; 2, creating a contingency fund where the company, new owners and exiting owners contribute funds reserved for future bond liabilities; and 3, seeking personal guaranty insurance to help cover a portion of any personal liability.

5. Reduce dependency on ownership
A business with an experienced and trained management team is more valuable than one where the owners retain the key knowledge needed to manage everything. Identify those areas in the business where the owners have been heavily involved and tend not to delegate, and work to make those functions replaceable.

6. Consider creative transition structures
A buyout structured with a long-term seller note for a significant part of the purchase price is common in construction company sales. However, there can be drawbacks to this structure. First, the buyers may not be interested in obligating themselves on a large, long-term note with a fixed payment structure. Second, if economic conditions change, it may be difficult to modify the debt terms while maintaining installment treatment. Third, if debt is forgiven, it is usually taxable. Fourth, long-term debt can be difficult to handle if the employee leaves during the payment term. Fifth, a failure to properly plan for stock redemption liabilities can financially constrain the company. Consider alternative structures to facilitate a transition, which may include:

• Organizing or restructuring as a limited liability company and granting profits interests to key employees identified for ownership. This structure can provide the next generation with an opportunity to become owners and share in future growth at low to no “buy-in.” Exiting owners can get priority distributions as “cash out” for their equity.
• Reorganizing the company into multiple entities with differing and possibly new ownership. This can be useful where there are distinct business divisions, or ownership groups with different time horizons.

7. Identify the right successors
This is one of the most important – and most difficult – tasks. In smaller companies, an internal successor who has been groomed and trained has a greater likelihood of success. In a family company, a family member with leadership experience outside the company can be valuable. Hiring an experienced leader will usually produce better results than hiring a family member to take on a role for which he or she is not qualified.

8. Tailor buy-sell agreements to your specific business
Mandatory buyouts upon death or retirement sound great in theory, but often do not work well in practice, especially if the company does not have adequate life insurance on the owners. In terms of buyout price, it is easy to use a general “book value” formula, but company-specific adjustments to a book value formula that may be appropriate are often overlooked.

9. Keep separation between business and personal affairs
Proper separation between personal and business assets is critical. Value can be reduced if the business is reliant on assets or services held or provided by related parties. If related-party transactions are involved, keep documented, arms-length terms, especially leading up to a business transition.

10. Plan for family dynamics
Planning the succession of a business within the family requires an intentional effort to prepare the successor, preserve family harmony, arrange for active communication, and consider dynamics both across and within generations. Leaders must be prepared to manage both the business and the family, which can prove difficult – especially for leaders from outside the family.

While every transition path is unique, all companies, regardless of size and status, can take actions now that will help to increase their odds for a successful transition.

Column first appeared in the Daily Journal of Commerce on March 26, 2019.

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