Succession Planning for Construction Companies: Considerations for a Successful Transition
- Jun 29, 2023
Every industry has unique challenges when planning their company's succession, and the construction industry is no exception. Here are a few details to consider when forming a succession plan for your construction company.
Identify Potential Successors Early
The first step is to identify potential successors in your organization who have the experience and skills necessary to oversee the success of projects and run the company at a high level. You'll need qualified estimators to bid on complicated projects and project managers and superintendents to deliver on the work that's bid. Your successors must be able to build relationships to get contracts, work with banks and bonding companies, go after public bids, negotiate work, and many more challenges that go into the daily operations of a business. Plan to spend years mentoring your key players to build their confidence and teach them the skill they’ll need to succeed in their ownership roles.
When speaking with your employees about potential ownership options, determine whether they understand the true meaning of ownership. They'll likely have to sign with banks and bonding companies, which carries significant risks and rewards. Most importantly, be clear that you're presenting the opportunity of ownership due to their high quality of work and that it's not a requirement; they can continue working in their current role and maintain employment within your company without becoming an owner. Not everyone wants the responsibility of ownership, and the last thing you want is for a valuable employee to leave your firm because your message was unclear.
Consider Provisions in Your Buy/Sell Agreements Carefully
Many companies will start the succession planning process by giving small pieces of ownership (perhaps 2%-5%) to their successors and have them sign buy/sell agreements and restrictive covenants as owners, including non-compete and non-solicitation provisions. These agreements will typically give successors immediate ownership in the company, which means they’re entitled to a percentage of the profits and distributions from the company along with other majority shareholders.
Your agreements should have provisions indicating what happens in the event of the death, disability, retirement, or termination of an owner for a cause (such as committing an illegal act) and the structure of the buyout payment terms in one of these events. A 7-to-10-year payment term with a reasonable interest rate is appropriate, and you can build significant discounts if an owner is terminated for a cause. In the event of an owner's death, consider whether to fund the buyouts with life insurance. In many situations, a cross-purchase (where one stockholder is buying out another) is tax favorable, but that depends on your company's circumstances. You can also include a provision in the agreement that new owner buyouts will be limited, meaning they will receive a nominal amount in the case of a buyout until they have a certain number of years of service.
You'll also need to consider provisions for your successors' voting rights, especially when the founding owners no longer have ownership in the company. For example, if you have two owners who are split 50/50 on a decision, how will it be resolved? The president or managing member of a company may have legal rights to be the ultimate decision-maker on some issues. When critical decisions need to be made in the business, the last thing you want is a stalemate among owners, so it's crucial to address these matters early in the succession planning process.
Whether you're filing a corporate or partnership return, the question is: Are we asking our employees to pay for their stock ownership or membership interest? You may issue ownership in your corporation to an employee at no cost but remember this is deemed compensation and would be reflected on their W2 and taxed. Many companies will consider giving their employees bonuses to pay for stock ownership, and some companies will take back a note, which offers new owners a period to pay for their interest using dividend distributions.
If you're filing a partnership return, you can give a successor ownership in the future equity and profits of the company, eliminating the immediate taxation of granting them ownership because they're not getting any equity built up in the past; they're just getting the opportunity to be part of the future. In addition, there are various tax elections for corporations and partnerships. For example, if there is an actual purchase price, a new partner (assuming they're paying for their interest) could create a tax benefit over time with the purchase of their ownership interest.
Unfortunately, many businesses fail to plan, leaving them vulnerable to unforeseen events that can disrupt operations, affect customer relationships, and ultimately jeopardize their company's long-term viability. We've seen successful transitions for construction companies if they've planned things properly, mentored their key employees, and built up great estimators, superintendents, and project managers who can run the company's internal operations, but you must have all the right players in place to succeed. If you can walk away from the company for long periods, your key people can run it well, and the operations don't miss a beat, you can look in the mirror and smile knowing that you've created an excellent succession plan for your construction company.
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Donald N. Hoffman
Donald Hoffman is Partner-in-Charge of the firm's Maryland office. His expertise includes accounting, tax planning, business consulting, strategic planning, business succession, buy/sell agreements, and estate planning.
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