OP-ED: Contractors must accept the realities of business exits
Contractors likely have been forced to think about and probably document an “exit plan” at the request of their surety or banker or maybe family. One of these parties may have insisted on seeing paperwork that shows a plan is in place. For these groups, business continuity and succession planning are important to ensure completion of bonded or current projects, to make sure there is adequate funding to do so and to show that transition has been considered.
Perhaps a contractor put together some paperwork, checked the box and then put the bundle in a drawer or left it on a computer until the next renewal date. However, it really wasn’t the exit plan then or isn’t the exit plan now.
Like many private companies, contractors hold more than 70 percent of their hard-earned wealth in their businesses. People work hard to build their businesses, yet unlocking that value without losing much of it to taxes will be the key to their retirement and not outliving their money. Common misconceptions exist in owners’ understanding of a successful business exit. If people do not understand the facts and the lore, their business wealth is likely at risk. Compounding this risk is the reality that 70 percent of transfers of private businesses to a second generation or to an outside buyer fail, and the statistics are worse for a further generational transfer.
Some of the misconceptions are:
“It can’t happen to me.”
This is where that document prepared for the surety or banker will come into play. Typically, that document does not align with the owner’s goals or the best interests of his estate when there is a premature death or disability. Even worse, it was likely prepared at the inception of the business, and many things have changed, including value. Unfortunately, poor planning has resulted in multiple horror stories of expensive litigation, bad tax consequences, disruption in management because a family member now wants to be the “boss” and other unintended consequences. If you do nothing else, reread those documents and update them.
“I will sell my business and then retire.”
This generally sounds like a good plan. Unfortunately, fewer than 20 percent of businesses for sale actually close. In the construction industry, the closing rate for outside sales is even less unless the selling company is in a unique niche or location, or the economy is just right. Most transactions in the construction industry are internal transitions, mainly to management or family by using gifting, stock sales, employee stock ownership plans (ESOPs), profits interests and other transfer mechanisms. These internal transfers require long-term planning and succession training to be successful.
“I will deal with an exit plan in __ years.”
Unfortunately, this becomes the mantra and the __ years never start, with the years rolling forward. In addition, most owners can’t wait. Even if the transition will occur in five, 10 or 15 years, it takes time and effort to replace an owner and to save. Most business owners have not provided for retirement, so they need to start to save early or save aggressively while they are in control of the company. Many strategies and plans are tax-efficient and can be used by business owners for this goal. Planning is key.
“If I get the ‘magic number,’ I will retire tomorrow.”
First, is the “magic number” realistic, both in terms of “value” and provision of dollars needed for retirement? “Value” means several things, depending on its context – i.e., is that after taxes and fees? Furthermore, most owners overvalue their business. Second, would that number together with all other savings and investments provide the income needed for retirement, given circumstances and desires? The exit process requires an analysis of personal and business needs. Third, would you be ready to accept the offer? Transitioning takes time, planning and a mindset open to change to be successful. This is especially true in the construction industry, where licensing, permitting and surety funding generally are tied to individuals and not companies.
“I will do it myself.”
Why can’t successful businesspeople do it themselves? Maybe they can, but the odds are against them. Furthermore, all the information can be overwhelming or lead people down a rabbit hole. Even with advisers, there are plenty of stories of expensive planning and processes leading to bad results. However, more successful transitions are accomplished with good teams than without. So assemble a good team of advisers whom you trust, and start or update that plan and process.
In summary, while exit planning for construction industry businesses is somewhat unique, there are certain realities and misconceptions that are common to all businesses. A good plan that is updated is critical. Then, there is the hard work of implementing it.
Column first appeared in the Daily Journal of Commerce on October 24, 2017.