Historically, contractors have had limited options when it came to succession planning: transition to a family member or creation of an employee stock option plan (ESOP). These two predominate options often miss the mark on garnering top valuation and ensuring capital available to grow the business.

Today, contractors are finding themselves well-positioned for private equity’s newfound interest in the space, opening the doors for additional options for construction industry exit planning.

At an initial meeting with a business owner, the focus is on ascertaining which exit strategy might best fit each situation; one size does not fit all. The following is a breakdown of each and their pros and cons:

Keeping It in the Family

For owners who have family or adult children in the business, this can feel like the best outcome. It is the succession planning version of a Norman Rockwell painting — multiple generations happily working together in the business. Like anything else, it comes with opportunities and challenges.

Opportunities

• It keeps the equity in the family and creates an opportunity for the next generation to build wealth.
• The owner might have the opportunity for a longer transition period, staying on and mentoring the next generation while reducing risk

Challenges

• This approach will likely result in a reasonable or fair valuation but rarely the highest. Selling a business to family members and getting a premium valuation are likely mutually exclusive.
• The owner will likely need to finance a large portion (if not all) of the sale.
• The family members may not be qualified or ready to own the business.
• If the transition doesn’t happen or go well, it could result in hard feelings among family members.
• As the business moves beyond the second generation, ownership can become complex with many families involved.
• There is potential for loss of non-family member leaders within the company.
• It could harm employee morale.

Management or Employee Buyout

For owners who do not have family in the business but are looking to transition out and reduce risk, a management buyout could be a good option. Many of the pros and cons will be similar to selling to family members.

Opportunities

• ·      It provides continuity and stability for the company. There is a high likelihood that the culture of the company will remain the same, which may be reassuring to employees.
• ·      The approach creates an exit for an owner if there’s not a great market for the business (i.e., the business has experienced economic headwinds in recent years).

Challenges

• ·      The owner will likely need to finance a large portion (if not all) of the sale.
• ·      It is not likely to result in the highest valuation.
• ·      If the buyout falls through (or doesn’t go well), then it could negatively impact morale and cause turnover of key members of the management team.

ESOPs

ESOPs have been popular in the construction industry for decades, offering owners a liquidity event when one may not have been possible otherwise. However, given the emergence of private equity in the construction industry, the calculation of when (or whether) to do an ESOP has changed.

Opportunities

• ESOPs are a tax advantageous exit for all stakeholders and will likely increase the cash flow of the business at close.
• The Employee Trust is a known entity and removes the risk associated with sharing information with a competitor or the wariness toward a financial buyer.
• There are many lenders who do the financing of ESOPs.
• It can be an effective way of retaining employees and boosting morale.
• There is an opportunity for the owner to remain in control if they are willing to continue to work.
• The owner’s legacy lives on.

Challenges

• ESOPs will not likely result in the highest valuation; they can pay a fair market value but cannot exceed it.
• For an owner looking to sell 100% of the company, they will likely need to finance the difference between the purchase price and what an outside lender is willing to provide. The owner financing will likely be subordinated to bank financing and to the surety.
• Because the balance sheet will likely look significantly different post-close, the primary beneficiary of the ESOP transaction or managing individual may be required to personally indemnity surety.
• There are ongoing administrative requirements of the ESOP that can be expensive and time consuming.
• The repurchase obligation of an ESOP may hinder future projects, potential acquisitions, or other cash needs, as a failure to meet the repurchase obligation can have disastrous results for the business.

Selling the Business to a Third-Party

Until recently, this option was out of reach for contractors. In the past, if a contractor wanted to sell to a third party, it was likely another contractor in a contiguous metropolitan area. However, with private equity entering the industry, owners have more buyers from which to choose, resulting in increased valuations reflecting demand for specialty contractors.

Opportunities

• Likely the highest valuation of the different exit strategies.
• The sale to a third party has the potential for providing the most cash at close and the least lingering obligations for the transitioning owner.
• Business valuations are a good estimate of what a business is worth, but running a competitive process will determine how marketable the company is, greatly impacting the actual purchase price.

Challenges

• Selling a business can be time-consuming for an owner.
• The loss of confidentiality is possible. Competitors, clients/consumers, and employees could learn about the potential sale if the information is not closely guarded.
• The owner sells a majority of the company, giving up control.
• Buyer could change the culture of the company.
• Buyer could cut jobs or move location of business.

Liquidating Your Business

This is hopefully the last option, but sometimes the best. For companies where there’s not a great market to sell and are reporting weak earnings, liquidating could be the likely outcome.

Opportunities

• This strategy is straightforward and easy to understand. The owner sells the assets of the company and pays off any debt. The difference is what the owner can take.

Challenges

• The business ceases to exist. The legacy of the company is lost, and employees will need to find new jobs.

Conclusion

All the options listed previously are viable exit strategies, but which one a business owner selects will largely depend on their own goals (personal and financial) and the market for the business.

 An educated selection will enable an owner to feel comfortable and confident in their decision, having considered all facets of exit strategies and their resulting outcome.