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March 29, 2012
We should all take heart in the claims that the recession has ended. Now we can get back to planning! And as a local college basketball team learned earlier this month during the NCAA selection process it is better to be able to control your own fate than depend on someone else’s upset.
This generation of owners and employees face the same questions and the same answers. It is usually through a combination of hard work and planning, along with a little luck, that we succeed. This article addresses the planning part of the equation. You now start planning for the success, and by that I mean planning for the succession, of your construction company.
A construction company may be owned entirely by one family (or extended family) or by a combination of insiders and outside third parties. However, most closely held construction companies do not last beyond the initial owners. Very often the death of a key owner results in the sale of the company at a deep discount of its former value.
In addition to the drastic consequences of an owner’s premature death, the remaining owners face pressure from key employees for an opportunity to share in the success of the company. These employees may choose to leave the company if not given an opportunity for ownership. A loss of employees to competitors can result in lost clients and the need to recruit and train replacements, all which come at a high cost.
Finally, the absence of a succession plan may also be a source of concern with a company’s bonding agent and affect a company’s ability to obtain a favorable bond rating.
The succession planning process provides an opportunity to plan for these issues and to review long-term goals and objectives. We encourage companies to use the annual meeting as an opportunity to revisit any succession plans and evaluate their effectiveness. Just like changing the smoke alarm batteries at daylight savings time, this should be a regularly scheduled event.
The planning process also allows the multiple owners to review their collective and personal needs and recognize and confirm the special talents of the individual owners and potential future owners. The process of formalizing a succession plan may reveal those differences of opinions and potential rivalries that could break out after the sudden passing of an owner. Effective and regular planning has been shown to reduce future conflict.
The choice of succession is not limited to an insider transaction. Many exit strategies involve an outright sale of 100 percent ownership to an unrelated third party. Nevertheless, owners need to prepare for the choice of either transitioning ownership via a sale to a third party or to the company insiders.
If an owner chooses to transition to insiders there are additional issues relating to the perceptions of each group the older generation and the younger generation. These perceptions must be understood to allow for a smooth transition.
One of the most difficult and sensitive issues is the inability or unwillingness of the majority owners to contemplate the needs of the minority owners or the key employees as opposed to focusing on their own personal and financial desires. A perception that the majority ownership group is bleeding every dollar out of the company can lead to a lawsuit or at the very least bad feelings amongst the owner group critical to the long-term success of the company.
Owners should ask themselves the following questions to assist them in determining whether to pursue a transfer of ownership:
1. Is there a transition plan that is open to all capable employees or is control being placed within an elite group?
2. Are funds available either through the company or through borrowing to buy out the retiring or non-performing group so that ownership can be concentrated in the employee group that aligns with the company’s best chance for success?
3. Do the owners have assets outside of the company or are the owners dependent upon the company for their retirement?
4. What are the short- and long-term prospects for the business? Are the business risks and competition increasing or decreasing?
5. What liquidity options are reasonably available?
A successor is the person who will fill the owner’s role upon retirement. Consequently, this individual’s knowledge of the business is critical. For “family” companies, sometimes the best successor can’t be found within the family. If an owner cannot depend upon family members, then the next logical option should be to look inside the company. An owner should try to find an individual at least a generation younger than him or her promotability is the key quality to look for.
Here are some traits to look for:
• Service. An owner pleases clients by providing superior service.
• Social ability. An owner is liked, respected and followed by others.
• Inventiveness. An owner looks for new ways to improve systems and people.
• Focus. An owner concentrates on goals.
• Loyalty. An owner has a strong allegiance to the company.
How does one choose and cultivate employees? Generally, the higher an employee is in management, the more performance measures lean toward ultimate objectives; the lower in management, the more the focus is on critical or interim objectives. Senior employees are responsible for total return on capital; an estimator may have responsibility only for revenue.
Ownership is also more meaningful to employees when they put some of their hard-earned cash on the table. Owners who offer ownership to employees often find that employee investors take an active interest in their company and are more likely to ask questions about financial performance. Investment builds commitment to the company on the part of the employees who become owners.
Employee successors often do not have the resources to support a cash purchase, obtain bank financing to fund the purchase and sustain a business downturn. Succession planning can tie up a company’s liquidity. Therefore an analysis of current and projected cash flow is necessary to set value and conditions of any inside purchase.
A company should set up a training program for chosen successors. If certain skills are missing from the individual, the company should take steps to educate and train the successor in those areas.
Training also involves cross-training of individuals in all aspects of the company business. Estimators should gain experience as project managers. They should also be charged (at appropriate times) with reviewing and assisting in accounting functions, client relations, employee training and company departments.
A succession plan starts with the owners, who must provide leadership throughout the process. The employees must be ready to encourage and facilitate an owner’s plan and to give constructive feedback to the owner throughout the process. Together, owners and employees are essential to formulating and executing a successful succession plan. Such a plan will enhance the value of the company and result in a smooth transition of ownership.
Paul A. Tonella is an attorney with the law firm of Oles Morrison Rinker & Baker LLP. He also has a background in accounting and as a kid spent many hot summers in Eastern Washington working for his dad, a contractor.