Navigating a Clear Path to Successful Ownership Transfer
While there are no cookie-cutter solutions for ownership transfer, there are some viable strategies to consider when it’s time to successfully hand over your company’s ownership to the next generation.
As baby boomers move into retirement and millennials continue to make their way into the workforce, the issue of ownership has become acute among many of the nation’s engineering and construction firms. If owners cannot find the talent to manage their firms following their (eventual) retirement, they will lose the ability to dictate how ownership will be transitioned.
With these dynamics in play, it is increasingly important for owners to start planning early and focus on the long-term development of the next generation of leaders.
Handing Over the Reins
At its core, succession planning involves the transfer of ownership and control of a firm to new management. In most cases, this might entail transferring ownership to a family member or key employee(s), selling the business to a third party, management buyout or voluntary liquidation. FMI estimates that about 50% of construction firms will change ownership in the next 10 years.
Given this estimate, the question is, when and how will these transfers take place. Only 47% of respondents to FMI’s most recent “Ownership Transfer and Management Succession Survey” believe they have capable, strong managers who could run the company in their absence. Furthermore, 44% said they have a formal plan in place to transition themselves out of managing the business; just 64% have a formal plan in place to ensure continuity of operations in the event of their death.
The harsh reality is that only a small percentage of construction firms are saleable to other companies at a so-called “reasonable” price. Because the sale option is not on the table for the majority of firms in our industry, we have to look more carefully at internal sales and succession—a prospect that’s not always easy to tackle when owners assume that their firms are worth more than the market will pay. Most employees can’t afford to pay even a market price to acquire a company. In fact, the only way to get fair value in cash is by selling to outside acquirers.
A good example of this would be a sole company owner in his or her late 60s. One morning he or she wakes up and says, “Well, I think it’s time for me to get out and take my money off the table and turn this business over to someone else.” Unfortunately, the individuals working for that business probably lack the financial resources necessary to buy the company. The inability to sell the company to employees becomes a major hurdle for construction firms looking to successfully transition to a new generation of ownership.
Here are other key considerations to take into account when developing an ownership transfer initiative:
Both money and people have to be factored into the equation
As construction firms consider their business continuity options, there are two sides of the equation to evaluate: money and people. Both sides have to be taken into consideration if the business is to survive from one generation to the next. I’ve spent much of my career focused on the money side, which in most cases is the easier part. The people side is more complex. Consider this: The construction business is very much an entrepreneurially driven and risk-oriented business, which requires a certain personality type to succeed. It’s often challenging to find those people, and we frequently hear company leaders say, “We’ve got one really strong founder, but that person’s leaving, so we’re going to replace that person with five or six other people.” This kind of transition can be challenging because it often takes a single strong leader to make things work.
Your second lieutenant probably isn’t the best choice
Even though he or she may have helped you shepherd your company through good and bad times over the last few decades, that right-hand person doesn’t necessarily have the instincts needed to lead the company into the future and take it to new levels. Besides, he or she may not even want to be in that top job. Knowing this, we often encourage people to move down a generation into the 30-something age group to find their successors. This goes against the common sentiment that someone who is in his or her 20s or 30s lacks the experience to lead. The reality is that someone with 10 years of the right kind of experience in construction—a very difficult business—is probably well-equipped to take over.
Bonding and banking issues can be a hurdle for any construction firm
In our industry, bonding and banking both present significant hurdles for any firm looking to transition to a new generation of ownership. Put simply, the bonding companies and the banks are not going to provide you with credit unless the company has a meaningful equity. If you start taking equity out, your bonding and banking credit levels go down. So it becomes an issue of how to get your money out and maintain bonding capacity. In short, you have to be able to make enough money to replenish the funds that you're taking out. That’s a tough pill for some people to swallow.
Employee ownership can be a challenging route to take
Looking at the current demographic landscape in engineering and construction, we see a lot of companies in an interesting position right now—particularly those that are working through long-term plans for employee ownership. A firm that plans to sell stock to its employees over a 10-year period, for example, will probably start by selling just 10% of that stock (meaning, the owner still benefits from 90% of the firm’s growth). By the end of the 10-year period, the employees own the company entirely. This type of slow buyout is necessary to allow the business to fund the buyout through profits.
The cycle of ownership transitions happens every 25-30 years for every business
Every construction firm in America that’s not publicly traded goes through ownership transition. This transition process is currently being fueled by the high level of baby-boomer retirements. As a result, more people are trying to figure out how to exit their companies and leave those entities intact and on a growth path as they move into retirement. This isn’t any easy task for firms—particularly those 95% or so that aren’t candidates for sale to a third party. This can be difficult to accept, particularly for someone who has spent 30 to 40 years of his or her life creating and building the business.
Winning a Difficult Chess Game
When we talk about ownership transfer, there is no clear-cut guide to the question, “How can I successfully transfer my company to a new owner or owners?” In fact, ownership transfer is a lot like a chess game in that it involves a lot of moving parts and some very focused concentration to navigate successfully. It’s not simply a financial problem nor is it an organizational or family problem. It’s also not just a bonding and banking problem. It’s a combination of all of these elements, and that’s why there is no cookie-cutter solution that applies to all construction firms. Each entity is different, and making all pieces fit together is an extremely important step that’s contingent upon the company’s individual nuances, traits, successes and failures.
To construction firms looking for the best possible ownership transfer solution for their individual situations, the best approach is to consider the pros and cons for all options that lie before them. Understand that it really depends on the individual circumstances, the preferences of current and future owners and what approach “feels right.” By taking the time to understand your company’s current situation, assessing the options and planning well in advance, you’ll be well-braced to handle the transition when the time comes to do so.
Hugh Rice is the Senior Chairman of FMI Corporation.
His thoughts and opinions are part of our new series “Industry Icons” in which we share insights from FMI partners and industry thought leaders. For further information, please contact Sabine Hoover, FMI’s content director, at [email protected].
