The onset of shutdowns related to COVID-19 in March 2020 threw the construction industry’s historic expansion into reverse and cast company road maps into question, with the economy taking a brief but precipitous dip of 31.4% on an annualized basis in the second quarter.1
Though the recovery is already underway, a period of uncertainty has altered the playing field for contractors, particularly those poised for a change in ownership before the pandemic, according to new research published in the 2021 FMI/CFMA Ownership Transfer and Management Succession Survey.2
In mid-2020, data was collected from CFMA members and FMI clients around ownership transfer and succession management trends. Prior to COVID-19, over half of all companies indicated that they were either in the middle of an ownership transfer plan or expected to begin an ownership transfer plan in the next two years. Of these, 52% expect a delayed or protracted ownership transfer process due to COVID-19. This is not surprising in light of the economic and operational impact of the pandemic, but it will have major ramifications for the key factors required to successfully exit a business: cash flow and profitability, talent development and management succession, and visibility into future performance.
While FMI has been surveying the construction industry around these trends for over a decade, this is the first time CFMA joined FMI in this type of research built around analysis of financial risks in the new economy. This article synthesizes the top key questions identified by CFMA members and FMI clients during the recent Ownership Transfer and Succession Planning: 2021 FMI/CFMA Industry Study3 webinar and presents strategies for overcoming impediments to ownership progressions.
1. What Is the Biggest Impact That COVID-19 Has Had on Owners & Their Plans to Transfer Ownership?
Internal ownership transfers remain the predominant methodology in the construction industry, with over two-thirds of survey respondents indicating that they intend to transfer equity to employees, family, or both. Properly structured internal transfers can be a great source of liquidity for owners and continuity for the business, but they require up to 10 years longer to execute than an external sale. This is because internal sales often require new owners to buy equity over time, and if earnings are reduced or capital is needed to fund operations, the process can take even longer.
In our research, 75% of all respondents indicated that COVID-19 had a negative impact on their company’s earnings. This economic impact primarily affects those hoping to sell in the next five years. Prior to COVID-19, 43% of all respondents intended to have sold 100% of their equity within the next five years. As a result of COVID-19, only 29% expect they will have sold 100% of their equity within five years.
Now that the recent boom years are in the rearview mirror, owners who put off succession plans or didn’t take advantage of a stronger market to develop their talent pipeline are experiencing more of a crunch than those who anticipated transitions in the years ahead. A significant share of respondents (35%) plan to exit their businesses in less than five years while 52% plan to exit their businesses in less than seven years. Given the squeeze on earnings, conventional wisdom would suggest putting off plans longer and focusing on the business; however, there are other strategic options to consider.
Internal sales can progress in the current market provided that the planning accounts for volatility over the next 5-10 years. Alternatively, owners can consider an employee stock ownership plan (ESOP) or an external sale, given a robust merger and acquisition (M&A) market in the construction industry (as discussed in the next section). However, these alternatives do not create a substitute for leadership development and management succession.
For all companies, whether the owner is looking at an ownership transition in the near future or not, it’s never too late to invest heavily in developing the next generation of leadership.