Supply chain issues. A tight labor market. Profound shifts in expectations of younger generations and the explosive growth of remote work. The ongoing impact of Covid. Newly emerging tax legislation. How do you execute construction business succession in the midst of such unsettled times?
“Yes, there are significant new factors, but dynamics and uncertainty have always been part of the business landscape,” says Carol Butler, president, the Goering Center for Family and Private Business, part of the Carl H. Lindner College of Business, University of Cincinnati, Ohio. She says the fundamentals of succession planning are unchanged despite the arrival of new hurdles. “Communication and trust are key. It’s said the number one reason wealth does not carry through to successive generations is the lack of these two components.” Another fundamental is time. “Ideally you want a 2- to 10-year period of succession planning. Sometimes unexpected hardships, such as the death of a principal, prevent this.”
Nicole Menkhaus, marketing director at the Goering Center, offers this warning: “These are trying times, but don’t let the complexity and challenges of day-to-day operations completely remove your attention from succession planning. It still needs to be done.” She also notes that while family and private businesses are contending with these distractions, business entities who specialize in succession planning remain focused on that topic.
One such firm is Maxim Consulting Group of Englewood, Colorado. Michael McLin, managing director at Maxim, says “Transfer is tax inefficient. It is important to reduce the tax burden.” There are many vehicles for accomplishing this. “One solution is to pull out PPE, which is property, plant, and equipment, into separate business entities to reduce the value of the operating business. Another is to sell intellectual property separately as part of transferring the business.” Other options include intentionally defective grantor trusts and grantor retained annuity trusts. “Also consider an ESOP, an employee stock ownership plan. This doesn’t reduce the total tax liability but it distributes it among a larger group and it is realized over time, making that tax burden more manageable.”
Because of the many options and the complexities of each, McLin advises using a specialty firm to help with succession. “You need an expert, and it probably won’t be the CPA or other current resource you use for your business. They’ll likely lack the necessary specific expertise and will also be too closely tied to you and your business to provide truly objective insights.”
McLin says there are two parts of succession: ownership succession and management succession. The first is the financial agreement and is necessary for the succession to proceed efficiently. The second ensures the ongoing viability of the operation through due diligence and “is an oft-neglected part of succession.”
Butler lists the human essentials for successful succession from G1 to G2 (generation 1 to generation 2; many firms are now moving from G2 to G3 and the same essentials apply). “When G1 stays too long, havoc can result. This can happen because if what you do is who you are, who are you when you no longer do that which defines you?” The fear of being undefined keeps some owners in their positions long past the point where it’s healthy for them, for succeeding generations, and for the business.
Butler offers a cascade of questions to help with succession. The entire process should begin with, “What do you want? For yourself? For your family? For your employees? What are your objectives, what are your goals, beyond simply the smooth transition of ownership?” Having defined the desired outcomes, Butler says G1 should ask two more questions to determine whether to exit the business. “One is, do you have enough? That is, do have enough cash reserves, income and other assets to sustain your desired lifestyle? Two is, have you had enough? Enough of the demands, long hours and frustrations of running a business?” After first answering these questions, development of a succession strategy can commence.
Part of grooming G2 to take over is leadership training, says Butler, “not just how to run the business, but how to lead the people.” Financial fluency should also be part of that grooming process. Too often G1 is secretive about the books; as a result G2 comes in with little knowledge of the financial health of the company or any skill in managing the finances.
The work ethic and life expectations of younger generations, starting with Millennials, can be a challenge. “Millennials are not driven by the same desires as earlier generations,” says Menkhaus. “They are driven largely by purpose and are not shy about it.” What is emerging from this shift, says Butler, is that while many businesses moved successfully from G1 to G2, it’s not clear the same will be true from G2 to G3. “G3 is the make-or-break generation,” says Butler. Younger workers are also more likely to demand the ability to work remotely, at least part of the time. “Remote used to be a perk,” says Butler. “Now it’s expected.” Remote work is fine for some positions but probably not for principals assuming ownership.
How long will Covid remain a factor? That’s anybody’s guess, but McLin says Federal mandates will cause adjustments to be made by construction companies that may affect business succession. “Backlog, cash flow and company size—the number of employees—are affected as contractors seek ways to circumvent these rulings,” says McLin.
Butler says there’s great value in outside expertise. “A peer group is helpful. Adding in a board of advisors providing you with expert advice, diverse perspectives and insight can take your business to the next level. You may also want to consider a board of directors with fiduciary responsibility depending on your circumstances.” She and Menkhaus point out that while the Goering Center, established in 1989, is the largest of such university-affiliated organizations, there are more than 50 of these across the country ready to provide valuable guidance and insight.
McLin offers three final tips. One, identify a tax-efficient way of making succession happen. Doing so will greatly enhance the likelihood of the ongoing success of the business. Two, get a true evaluation of the management and operations. Is the business sufficiently stable and evolved to withstand the disruption of ownership change? Three, get a qualified assessment of the business’s worth. Seller and buyer may be miles apart in their assessments and this will help narrow that gap. All three questions require the services of an expert outside the company.
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