OP-ED: Unique Obstacles for Brokerage Owners, Contractors
It is no secret that planning to sell or transition a business, regardless of its type or size, can involve significant work. Some businesses, including brokerages and construction firms, face unique challenges in exit planning due to their structure and to licensing and bonding requirements. The good news is that with advance planning, many of these challenges can be addressed, increasing the odds for a successful business transition.
Owners of some real estate brokerage firms may believe that without tangible assets or long-term contracts, there isn’t sufficient value worth transferring to a successor, whether it be to agents in the business or an outside party interested in ownership. However, many firms have a valuable brand and market presence in their communities that attract both brokers and clients. This can create transferable value, even for smaller firms.
Brokers who join these firms may see themselves as key parts of the firm and potential owners, and can be natural choices as successors in management and ownership. Because long-developed relationships and processes tend to drive revenue, exits within broker firms may involve transitioning ownership to new or non-owner brokers over time, and providing opportunities for the non-owner brokers to establish relationships with the exiting broker’s clients along the way.
Income to exiting brokers can come from a number of sources. A firm can pay a portion of income from certain clients as commissions to the exiting broker on a trailing basis as a phase-out, or as referral fees. Further, firms can establish nonqualified compensation plans to make future payments to the retiring broker. Under some plans, the firm promises to pay the retiring owner a fixed dollar amount for a specific time. In other plans, the firm pays a fixed amount into an account over time, which the exiting owner is entitled to at retirement. These types of plans provide structuring flexibility for the retiring owner’s specific situation, but they often require careful up-front drafting.
Firms with a single principal broker have an additional obstacle: If the primary broker dies or becomes incapacitated, the firm may not be able to continue its business unless a new licensed principal broker is appointed. Without a succession plan, these firms may be forced to shut immediately, sometimes without closing pending transactions. In Oregon, the Real Estate Commissioner may issue temporary licenses (not to exceed one year) to the executor, administrator or personal representative of the estate of a deceased broker, or to a court-appointed fiduciary of an incapacitated broker, or certain other designated individuals. The temporary licensee’s authority is typically limited to winding up the affairs of the principal broker’s pending transactions. Although the temporary license can help close out a deceased or incapacitated broker’s transactions, a more comprehensive succession plan is needed if the broker’s objective is to provide for business continuity or transferability upon death or disability.
Contractors and construction firms
Owners of construction firms and contractors are often required to personally guarantee the company’s bonding and commercial debt obligations. These requirements can be a significant barrier to ownership succession for a couple of reasons.
First, the retiring owner typically wants to reduce involvement and exposure in the enterprise as he or she transitions out of ownership. However, in many cases personal guarantees – in particular, for bonding obligations – will not be released until the owner sells all of his or her ownership interest. The risk of facing potentially unlimited personal exposure on the company’s bond while simultaneously relinquishing control of operations can dissuade owners from gradually selling their interest to key employees or family.
Second, a new owner may not be willing or financially able to take personal responsibility for the company’s bonding requirements or other debts, even though the exiting owner would prefer the new owner assume at least some responsibility for such risks. The bonding guarantee requirement typically applies to individuals who own a material amount (sometimes 10 percent or more) of the business or are actively involved in the business. This can create significant exposure for the owners, because the liability is usually unconditional. Even if the entire business is sold (for example, to a third party), the sellers can face continuing post-sale liability on bond guarantees for project work before closing.
One possible solution is for the company, exiting owner and/or new owner to contribute funds into a contingency account reserved for future liabilities on personal guarantees. The new owner may be expected to contribute more to the fund as his or her ownership in the business increases over time. Additionally, some insurance companies offer personal guarantee insurance, which can cover a substantial portion of the liability of the guarantor in the event the guarantee is ever called. These types of arrangements can help facilitate an owner’s retirement on his or her desired time frame – even if he or she is required to maintain personal guarantees during the course of a long-term transition.
Another challenge is that if a transition plan involves the company’s repurchase of the primary owner’s equity, consideration must be given to ensure that those transactions do not violate the company’s financial covenants or asset requirements in bonding contracts or loan documents. In many cases, a company repurchases an owner’s equity over time, and that installment debt can negatively affect the company’s financial position.
The structure of an ownership transition will differ greatly between businesses, because each one has unique dynamics. To overcome the challenges unique to real estate brokerages and construction firms, it is critical for owners to start planning early to develop their goals and strategies for exits.
Column first appeared in the Daily Journal of Commerce on April 13, 2018.