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.

Matt Bisturis is a Schwabe, Williamson & Wyatt shareholder and a member of its real estate and construction group. Contact him at 360-905-1113 or mbisturis@schwabe.com.

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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.

Brokerage firms

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.

Matt Bisturis is a business and corporate services attorney for Schwabe, Williamson & Wyatt. He focuses on serving the real estate and construction industries. Contact him at 360-905-1113 or mbisturis@schwabe.com.

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Many business owners know that planning for the eventual transition of their business provides opportunities to maximize its value and exit on more favorable terms. However, in the real estate and construction industry – where many businesses are family-owned or closely held – there is often more at stake for an owner than just the terms of his or her exit.

A successful transition may also be defined by how well new ownership has been positioned to assume leadership and continue to grow the business. Owners are less likely to regret selling their business if it has been transferred with a plan and tools in place to help the next generation succeed. Consider the following steps that business owners can take now to help position their business for success during and after a transition.

Help new owners with their succession plan

Only about 30 percent of family businesses survive past the first generation. One reason why is that family dynamics and poor planning can quickly erode the ability of new ownership to continue the business. For example, where ownership is transitioned to more than one child, the selling owners and the new owners should consider jointly developing an agreement to resolve disputes among the children regarding management of the business and disposition of equity.

A number of key questions should be addressed. For example, will the other owner-children have a first right to purchase the interest if a child wishes to transfer outside of the ownership group? Can a majority of the owner-children decide to sell the business to a third party? What happens if a child divorces from his or her spouse?

In some cases, the founder or selling owner may want to retain a right to take the business back upon the occurrence of certain events. Transition to the next generation tends to be more successful if the existing and new owners jointly address these questions before the business is handed over.

Align interests with employees and family

Incentives are frequently used to ensure that desired successors stay with the business until ownership has transitioned fully. However, business owners often make the mistake of not planning for employees and family who are not selected to take over. Failure to create an employee retention plan may be seen as a sign of instability for the company, which, if it’s a contractor, may hurt bonding capacity.

Tools such as stay bonuses and incentive compensation can help keep key employees not selected for ownership motivated to grow the company and ‎ultimately achieve the transition. The same care must be taken with family members who do not work in the business. Encourage all family members to participate in the transition planning process and to understand what could happen – both financially and personally – if the transition is not successful. Consider using estate planning and other tools to help these family members feel they have been treated fairly even if they will not receive ownership in the business.

Identify and address operational barriers

The change in ownership and control of a business may trigger consent and notice requirements that, if not followed, could disrupt business operations. For example, many commercial loan agreements and lease agreements require consent before a change in ownership occurs.

For contractors, care must be taken to ensure that a “responsible managing individual” is identified for licensing purposes and that a responsible party is identified for surety bonding. Companies holding Federal Communications Commission licenses for private radio facilities often must obtain approval before there is a change in control. Additionally, companies that do business with the government may be required to seek governmental consents and should analyze the implications of the ownership change on government contracting requirements – such as organizational conflicts of interest and small business qualifications – to avoid disqualification. These are just a few examples, but with advance planning most can be addressed with little disruption to the business.

Formalize business practices and processes

A business that is reliant on only a few individuals with the personal relationships and knowledge necessary to drive business processes is difficult to transition successfully. Document key decision-making practices before the transition and allow time to work through them – with the successors taking an active role. Recognize when the company has outgrown its initial management structure; expanding the management team to include members outside of the family or ownership group can help provide oversight, validation, skills and diversity that will provide new ownership with tools to succeed.

Develop a contingency plan including new ownership

A contingency plan documents how core business functions will be performed if key personnel with institutional knowledge about the business are no longer involved – for example, due to death or disability. The most effective plans consider the goals and objectives of not only current ownership but also planned successors to ensure that a clear path exists to run the business if an unplanned disruption occurs during a period of ownership transition.

A business owner planning to move on may need to consider more than his or her own exit. Successful transitions – especially those to family or employees – require tools that create continuity and opportunities for the next generation to be successful once they take over the business.

Matt Bisturis is an attorney with Schwabe, Williamson & Wyatt in its business transitions, corporate, mergers and acquisitions, and real estate and construction groups. Contact him at 360-905-1113 or mbisturis@schwabe.com.

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There are many factors that can affect whether a business owner is successful in transitioning his or her business on the terms he or she wants – whether that be through a third-party sale, generational transfer, recapitalization, or sale to employees or management. Understanding and addressing these factors can sometimes involve a significant amount of work. By focusing on items that are most impactful, owners can move the needle forward more quickly.

Below are ten top tips that can focus your planning efforts in 2015, even if a transition is not imminent.

1. Condition your business to maximize value and salability. Value enhancement is driven by actions that “de-risk” the business from legal, regulatory, financial, economic and other variables. For example, putting a written “contingency plan” in place to document how core business functions will be performed if key personnel with institutional knowledge about the business are absent reduces the risk of a disruption in the business’ operations.

2. Reduce dependency on ownership. A business with an experienced and trained management team is more valuable than one in which only the owners retain the key knowledge needed to manage the enterprise. Start by identifying those areas in the business that you don’t trust anyone else to perform, and plan to make those functions replaceable.

3. Engage in tax planning early and often. Coordinating your estate plan and your business plan can save a significant amount in taxes. In the tax world, planning doesn’t happen overnight.  Some changes must be put in place years in advance before owners can realize the full benefits.

4. Know the risk factors and mitigate them. Be able to anticipate and explain the risk factors that a potential buyer will find in your business. Before you can address the risks, you have to know what they are. Conduct at least a cursory audit of your company’s legal, financial and operational records well before a transition to evaluate where the gaps exist. Nothing is worse than having a buyer identify a major problem that the owners have overlooked. Once a seller loses credibility in due diligence, a buyer is likely to discount other aspects of the business.

5. Take care of key assets. Keep proper separation between personal and business assets. Value can be reduced if the business is reliant on assets or services held or provided by related parties. Often employees are the most important asset in a business. Take care of those employees, especially in the years and months leading up to a succession.

6. First impressions matter. If you intend to share information about the company with potential buyers, first impressions can make a world of difference. A company with complete and organized books and records will show much better than one that is disorganized. Think “curb appeal” – while some buyers can look past the mess, many more will wonder what deeper issues may be troubling the business.

7. Plan for family dynamics. Planning the succession of a business within the family requires a focused effort to prepare the successor, preserve family harmony, arrange for active communication, and consider dynamics both across and within generations (think baby boomers and millennials). What is “fair” among family members may not be best for the business.

8. Align interests with employees. Employees – particularly key managers – must be committed to preparing for and facilitating a succession. Without buy-in, employees are less likely to work hard to make a transition successful and even less likely to stay under new ownership. Ensure that key employees are incentivized to help the company grow and ‎ultimately achieve the transition. Do not underestimate the effect a change in company culture will have on employees.

9. Time can be your enemy. Closings typically get delayed because the parties are unprepared to meet contingencies or because unexpected risk factors arise through due diligence. Delays can signify erosion of the deal value. The better prepared the parties are in advance, the more likely a deal is to close on the sellers’ terms.

10. Get the right team of advisers in place. You have to work on your business to position it for a successful transition. That requires the expertise of professionals such as attorneys, accountants, wealth advisers, insurance advisers, and sometimes consultants and family counselors. No business owner can do it all himself or herself while continuing to run the business successfully.

Use these tips as a starting point to put a succession plan in place (or refresh your existing plan) this year. While the process can seem overwhelming, in practical terms, a transition plan is really a way of running the business that maximizes its value and provides a means to achieve business and personal goals and facilitate financial security. That is something worth every business owner’s time.

Matt Bisturis is an attorney with Schwabe, Williamson & Wyatt in its corporate, mergers and acquisition, real estate, and business transitions groups. Contact him at 360-905-1113 or mbisturis@schwabe.com.

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When it comes to planning for a business transition, many business owners fail to implement value enhancement strategies that are often needed to achieve a desirable exit from the business, whether that is a third party sale or a transfer to a new generation of family or management.

According to the 2013 State of Owners Readiness Survey co-sponsored by the Exit Planning Institute, 86 percent of business owners have not taken on a strategic review or targeted value enhancement project. Yet transition planning is one of the most important issues facing any business – and one of the most commonly avoided.

Why? One reason is that many business owners do not associate transition planning with “working on” the business to increase its value. Preparing the business for succession and successfully completing a transfer is often more difficult than building the business itself.

A transition plan (also known as an exit or succession plan) is an integrated plan that asks and answers all of the personal, business, legal, financial, tax, and estate questions that are involved in exiting from a privately owned business. In practical terms, exit planning is a way of running a business that maximizes its value and provides a means to achieving the owners’ personal and financial goals. A key element that connects an exit plan with a company’s larger business plan is value enhancement.

Value enhancement results from actions that “de-risk” the business from legal, financial, and other variables. De-risking can add value to core business functions and can increase the salability of the business. This has benefits regardless of the owners’ time frame for exiting the business.

Before you know how much value enhancement is needed, it is important to determine the value of your company. There is often a large gap between what business owners think their business is worth and what it is actually worth. According to a study conducted by the Alliance of Mergers & Acquisitions Advisors, 95 percent of mergers and acquisitions professionals believe that business owners’ unrealistic expectations of company value is the biggest obstacle to sale or transfer. To help owners move swiftly and cohesively in considering strategic opportunities, it is important that all owners reach consensus about whether the enterprise value is acceptable.

If the value of a business is below what the owners feel they need to support a comfortable lifestyle after an exit, or if the value is insufficient to drive desired strategic growth, owners are usually best served by taking time to enhance the value of the business before transitioning.

What are de-risking strategies and which ones drive the most business value?

As advisors to privately held businesses, we focus on numerous value factors related to personal motivation, business operations, industry and market conditions, legal and regulatory conditions, and financial/economic conditions. Here are some examples of de-risking strategies:

Adopt a written “contingency plan” to document how core business functions will be performed if key personnel with institutional knowledge about those functions are absent.

Ensure that written agreements memorializing the terms of the company’s key relationships are in place, and that the agreements will not trigger a termination right if ownership of the company changes.

Ensure that key employees are incentivized to help the company grow and ultimately achieve a desired transition.

Appoint an advisory board of “outsiders” to advise the company regarding major decisions.

Audit the company’s tax filings and registrations to ensure that the company is paying taxes in all required jurisdictions.

Obtain an environmental assessment of the company’s facilities to identify and address possible environmental concerns.

Confirm that the company has sufficient insurance in place to cover potential liabilities, including product liability claims if applicable.

Identify and register or otherwise protect the company’s intangible assets such as patents, trademarks, copyrights, and trade secrets.

There are, of course, many more value factors and de-risking strategies. Owners should focus on strategies that present the most opportunity for improvement and the potential to yield the greatest benefit. For example, if a significant portion of the company’s value is related to its intellectual property assets, but the company has not secured intellectual property protections, focusing on this strategy is likely to create a high return. Your exit planning advisor can help you identify and rank the value factors applicable to your business.

To most effectively implement value enhancement strategies, focus on five actionable steps that can be completed in a ninety-day time period. Track the status of each action item. Assign responsibility for completing the tasks within the organization. Lay out a road map of all action steps needed to complete each task.

Once actions have been implemented, move on to the next items. Throughout the process, it is critical to take stock of how de-risking is affecting the value and salability of the company. Map the company’s progress by making at least a cursory valuation or “recast” of the financials each year.

The more a company de-risks during its life cycle, the more attractive it will be to a buyer if and when the owners decide to sell. If the owners want to keep the business in the family, de-risking can help preserve the business legacy, ensuring the next generation takes over a business that has a solid structure in place to support growth and to ensure stewardship over the business.

Matt Bisturis is an attorney with Schwabe, Williamson & Wyatt in its corporate, mergers and acquisition, real estate, and business transitions groups. Contact him at 360-905-1113 or
mbisturis@schwabe.com.

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