Over time, entrepreneurs who own their businesses must navigate between blue-collar and white-collar tasks. They must know how to build this detail. They must understand the logistics. They must be able to put on their bags and perform a multitude of tasks. They need to understand financing, cash flow and payroll. However, no one can be the master of all matters. The most successful entrepreneurs often have the best teams of professionals — blue and white collar — surrounding them.
Many entrepreneurs I know struggle with three issues. They haven’t defined what retirement looks like and don’t know how to get there. Their tax bill seems high and it’s hard to keep the right people.
retirement planning
Let’s start our conversation with retirement. Do you know what your retirement looks like? Are you just going to sit on your couch? Are you going to do non-profit work? Are you going fishing?
Retirement is very similar to a job offer. You have to make estimates, give yourself buffers and identify margins. Next, if you’re hoping to sell your business, a contracting/construction business is notoriously hard to sell. Private equity is probably not an option (bonding requirements and the cyclical nature of the business create issues that limit PE interest).
Third-party buyers are harder to find than with California Coastal Commission approval. Unsurprisingly, most entrepreneurs are aware of the above. The logic is quite simple, no one else is quite in the same position as the owner to benefit from all the relationships the property has built. Who knows your customers, employees and suppliers as well as you? Who stands to benefit from the relationships and trust you have built over the years? Your employees are a great option; except that often they don’t have any money. You can help them overcome this obstacle and benefit from it alongside them.
Looking at data from the US Bureau of Labor Statistics for many industries, construction has a high turnover rate. How to stem this tide? Give employees a chance in your business. If you plan to leave in the next 5-10 years, your employees will stay if they have something to gain and, more importantly, something to lose if they leave.
A job and a bid start with a set of plans (or defined specifications); a release requires a set of plans/docs. You should not take a buyer or bid without a set of plans. Why? A good plan addresses taxes before the buyer and the auction. The Internal Revenue Service (IRS) frowns on people who avoid taxes. The IRS, however, does not frown upon people who structure how they pay their taxes. Additionally, the government encourages responsible corporate governance and provides benefits when business owners choose to elevate their rank and record.
Employee Stock Ownership Plan (ESOP)
The best exit planning tools bring people, planning, and funding together. An example of this tool is an ESOP (Employee Stock Ownership Plan). A tool is only as good as the job it is designed for. ESOPs aren’t the only tools available. Installment sale trusts, phantom stocks, stock appreciation rights (SARs), stock options, etc. must also be taken into account. Each tool has different applications depending on your needs.
Our first recommendation, determine what you want from your outing. An advisor shouldn’t have your solution from day one. While an ESOP is often a good fit for entrepreneurs, a professional should start with the intention of writing plans, not selling a product. An advisor needs to get to know you, your goals and your business.
Let’s go through the process of creating an ESOP while understanding that this process is similar to other tools that could be used. This can serve as a good roadmap if you’re looking to create a Gantt chart or similar.
First, assess whether all owners are on board. You don’t want to go through all the other steps just to find out that a minority owner is going to create headaches. Obviously, this is easier for some companies than for others. All owners should be, at a minimum, open to discussion.
Second, create a feasibility study. We need to confirm everything planned and prepared for the process. The finances will support the structure to come. You can try to do this in-house, we recommend finding an advisory firm that specializes in buyout and M&A strategies. This company should be able to compare and contrast different types of plans and identify the best fit. We want advisors, not salespeople. The analysis should identify sufficient cash flows to support the ESOP’s stated objectives. Finally, you will need to confirm that the company’s payroll is sufficient for ESOP contributions to be deductible for participants and redemption obligations can be met.
Third, you will need to value the shares of the company. The buyer and seller must agree on a price. You must assess the business before implementing a plan. Importantly, the ESOP trustee should be the party to select and hire the appraiser. This eliminates conflict of interest arguments by regulators. An appraiser will look at cash flow, earnings, assets, goodwill, market conditions, values of comparative companies, etc.
Fourth, write a plan. You have identified what you want from the process and confirmed that you can afford the process. The counselor helping you with the assessment should be able to refer you to a lawyer. You will need to hire an ESOP attorney to draft the plan. Lawyers have errors and omissions insurance in case they make a mistake on your plan documents. This is not where you want to go cheap.
Fifth, fund your plan. Funding can be through a traditional bank, private parties, ongoing company contributions and/or employee benefits. Make sure the financing matches the property’s long-term goals.
Sixth, you must maintain the plan. ESOPs require monitoring, compliance, and reporting to maintain preferential tax treatment. Plan to communicate with employees who become owners, this represents a new, unexplored chapter in their lives.
Finally, let’s review some simple guidelines for those considering these structures.
These minimums represent the starting point. Your business has been in operation for more than three years, has more than 15 employees, is profitable, an EBITDA of $1.5 million and a capable management team can succeed the owner. As a business owner, you realize that what you receive from the sale of your business is more important than the initial selling price. Taxes take their bite. You want to maximize the value you retain. Additionally, you are looking for a gradual sale/handover of your business, cash flow (or the ability to take a few chips off the table), and a desire to reward your key people.
Reasons to be cautious
If you see the following, it may not be a good tool: your employees are not interested in the success of the company, your company culture is toxic, you lack a strong management team , the property is unwilling to help its key employees into an ownership position or if the business is in financial difficulty.
Be honest about the last paragraph. You don’t want to make the above problems worse. It can cause more problems than it solves. These structures are complex, requiring expertise, time, compliance and management.
The benefit is that the structure provides incredible flexibility and tax benefits for the person selling and while the business is operating.
Selling a construction company is not for the faint of heart. Fortunately, your buyer can be seated across from you. Take the time to talk with a good advisor. We want to understand your goals before making recommendations. Although it may take some time, it will likely result in better long-term value for you.
Disclosure: Standing Oak Advisors and Centaurus Financial, Inc. do not provide tax or legal advice.
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