Owners of construction companies are great at completing construction projects on time and on budget, but many struggle or fail to build a succession plan for themselves or their business. Like most construction projects, a succession plan is based on your objectives; it should accommodate your goals for yourself and your business, including considerations of wealth, family, and legacy. It’s a complex process involving a multitude of financial as well as personal considerations and the contributions of a variety of financial and other professionals. In my work with contractors spearheading their succession planning, I serve not only as their accountant and trusted advisor, but as point person, coordinating multiple internal experts from our multi-disciplinary firm—financial planners and investment managers from our wealth advisory, our tax and audit professionals, and members of our Valuation and Transaction Advisory teams—as well as other professionals they will need to properly execute a transition, such as attorneys practiced in the legal aspects of selling a business and other business succession strategies.
Because planning a contractor’s eventual exit from their business is a complex and multi-faceted process, we encourage you to start early. Even if you don’t plan to sell your business or transfer it to employees or a next generation for many years, it’s advisable to gain an understanding of the value of your business so that you can start doing things now to ensure that when it is time to sell, you’ll get the best possible return on what is surely the biggest investment of your life. Besides, who knows when the opportunity will come? A suitor could appear at your door any day. But no matter when it comes, you want to be ready—and as my HBK colleague and business valuation expert Robert Zahner says, “If you stay ready, you don’t need to get ready.”
So how do you start? Let’s examine the details by organizing our approach around the three questions you as a contractor must consider as you develop your exit plan and plan your transition:
How much is my business worth?
It’s typically the first question someone asks themselves when they consider selling their business. Of course, you need to know what your business is worth prior to making a decision to transition or sell. Knowing the likely price allows you to improve or enhance the value of the business if it is not currently worth what you think it should be. To increase your company’s value, you first need to understand what drives value in your business so you can focus your time and resources on maximizing that. Consider your strengths, the type of jobs you do best, and the financial and operational metrics a prospective buyer is likely to focus on. You also need to identify your areas of weakness, so you can implement a plan to convert weaknesses to strengths prior to putting your business up for sale.
“The first step in a construction business valuation is ensuring you have up-to-date accounting information that addresses the most important KPIs (key performance indicators) for contractors,” Zahner pointed out. “Percent of completion accounting is more involved than completed contract accounting, but it also provides deeper level, more sophisticated accounting information, more of what buyers want to see doing their due diligence.
“It’s not just top-line profitability that a buyer will look at. You have to track a variety of KPIs, such as percentage of jobs completed on time, percentage completed on budget, and data on labor productivity.” Zahner provided the following list of construction firm KPIs:
- Labor productivity – work hours per unit installed
- Schedule performance – percentage of projects completed on time
- Cost performance – percentage of projects completed within budget
- Equipment utilization
- Safety incident rates
- Client satisfaction scores
- Change orders
- Rework rate
- Employee turnover, training completion rate
- Bid win rate
- Financial ratios: liquidity, leverage, and profitability
- Work-in-progress schedule accuracy
- Backlog-to-revenue ratio
- Accounts received greater than accounts payable
- Return on investment
“When contractors begin their succession planning early, they have time to address weaknesses, to improve areas of performance as they approach the time when they are ready to sell,” HBK Valuation’s Zachary Politsky said. “For example, negotiated contracts tend to have higher margins than competitively bid contracts, and higher margins are a high-priority KPI for potential suitors.
“Markets matter as well. Areas with strong, long-term upward economic trends are obviously more attractive to buyers, but particularly attractive to builders and subcontractors. So timing is an issue; if your local economy is slowing, it’s not going to be the best time to put your business up for sale.” Other areas contractors can work on to improve the value of their companies, according to Politsky:
- Goodwill value (for subcontractors): Particularly in heavy construction, subcontracting can be extremely capital intensive, so it is important that subcontractors build goodwill value through a reputation for quality work and service, timeliness, and by staying on budget.
- Recurring customers: Repeat business can mitigate ebbs and flows typical in the industry.
- Skilled labor: Shortages are risky. Buyers know that contractors who can attract and retain skilled workers tend to flourish.
- Poor safety: A history of poor safety can have a negative impact on insurance availability and rates, as well as on recruiting and maintaining a quality workforce.
- Bonding relationships: Strong bonding relationships reduce risk and thereby increase value.
- Employee turnover and percentage of employees who complete training: These are also KPIs that are closely examined by a savvy buyer.
“Use customer satisfaction surveys to identify areas for improvement, then pick five to ten KPIs that resonate with what drives you competitively and what you can improve on,” Zahner advises. “Identifying and tracking your progress over time is important, and the sooner you start the more you can measure and improve.”
Who am I selling to and how?
Whether you are selling to a third party, a next generation family member, or transferring the business to your employees, understanding the buyer and structure of the sale are just as important as the sales price. You need to know how a particular buyer will pay you: a lump sum payment, payments over time, or perhaps with part of the purchase price tied to the future performance of the business.
My colleague Keith Veres is the National Director of HBK Transaction Advisory Services. He and his team work closely with clients looking to sell or buy a business, overseeing and coordinating the process from start to finish.
“We make sure a seller understands all their options,” Veres explained. “Often they come in wanting to sell internally, but when they examine their options, they might decide to sell externally.”
Selling to an employee or employees generally means, “you’ll be the banker,” Veres said. “It’s an installment sale, and your employees will likely pay you from the business’s ongoing profits over a period of years. In essence, you haven’t sold the business, and you might be back inside running the business again if they aren’t able to make the payments. You’re also still on the hook for liability in an industry where there is more potential for lawsuits than most other businesses.”
If you’re going to use an employee stock option plan (ESOP) to transfer ownership to a management team or all your employees, “you might be able to get 60 to 70 percent of the value upfront,” Veres noted. “We work as a professional go-between for the management team with bankers or investors to get as much financial support as possible for the employees and the best possible deal for the seller.
“Often sales to an outside party, including a private equity firm, will net the seller a large percentage of the sales price upfront, 70, 80, even 90 percent. But you need to stay in the business during a period of transition to help the new owner. If the business grows, the value of your remaining ownership grows with it. You might be able to get the full amount of the sale price from someone in your industry who doesn’t need your help in transition, and you can truly move on.
“Or you could sell a minority interest and continue to run your business with a partner who can help you grow the business beyond what you might have been able to do yourself.”
Veres employs a four-step process in a first meeting with a client looking to sell their business:
- “Everything starts with a realistic market-based valuation. A contractor might have an idea of what the business is worth, but every business is unique: different customer bases, different specializations, different community involvement. A realistic valuation that thoroughly understands your business is the critical first step. You don’t want to be making decisions in a vacuum.
“The valuation identifies what drives the value and what subtracts from the value of your business. A buyer wants to find reasons to put downward pressure on your selling price based on what they discover. We identify those issues, work first on the low-hanging fruit, then prioritize other items that will take longer to resolve or improve. It’s a comprehensive process to get to the true value, including accounting for what you’re taking out of the business in addition to W-2 income, like cars, insurance, cell phones; we can normalize these benefits in a way that explains it to the buyer. Then we can collaborate with the accountant on the team to estimate what you’re actually going to take home from the sale after taxes and other expenses. - “Does the seller have a financial planner? If not, we can introduce them to a professional who can work with them to develop their retirement financial plan. A retirement plan is distinctly different from a pre-retirement financial plan because you’re no longer saving for retirement, you’re spending those savings. How will you monetize your business, which typically represents the majority of a business owner’s wealth? Will the proceeds from the sale be sufficient, or is there a gap? Will you need to reduce your expenses in retirement or do you need to fill that gap before you sell?
- “We ask the seller to allow us to be candid, that is to examine their business from the buyer’s perspective. We don’t want the seller to be surprised by a prospective buyer’s questions.
- “There are two transitions. A seller must consider their personal transition, what they want to do next. As to transitioning the business, beyond the valuation, we consider everything required to run the business, the operations, the relationships. For example, we have seen landlords kill deals because they weren’t confident in the buyers. A thorough understanding of what will be required of the new owners will help the seller decide how to sell the business as well as if the time is right. ”
Contractors need to understand the structure of the sale or transition and how that aligns with how they operate their business. An asset sale and a stock sale can have widely different impacts on both buyer and seller. Any sale or transition will have its own set of variables and considerations, but understanding who you are selling or transitioning to and how will help you decide how to operate your business leading up to the sale or transition.
Will the sale produce enough wealth to fund my retirement plans?
Most contractors spend their lives building their businesses’ balance sheets and keeping them strong, but don’t have a personal balance sheet or a “what’s next” plan. Like succession planning for your business, a personal succession plan, or financial plan, addresses what you want your life to look like after business, in retirement. Maybe you want to pay for your grandkids’ college educations or travel extensively. Whatever your retirement goals might be, it’s important to establish them prior to selling your business in order to determine if your selling price will support them. Creating and maintaining a personal financial plan will help you determine whether the sale of your business will produce sufficient capital to support your goals and lifestyle as you transition to retirement or another venture.
I asked Brittany Taylor, a senior financial advisor with HBKS Wealth Advisors, to share her approach to developing financial plans for retirees.
“What you have to consider to determine if you have enough to retire depends on who you are and how you want to live in retirement,” she began. “Some of my retiree clients live on $100,000 a year; others need more than $500,000.
“We start with your expenses, but also what additional you want to do with the money, such as travelling, buying new cars every couple of years, paying for your kids’ weddings or college educations, or contributing to charitable organizations. We look beyond current expenses, like future healthcare costs, such as in-home nursing if someone were to get sick. You have to account for unanticipated costs like replacing household appliances, maintenance and repairs, or moving to a new house. All those expenses will be impacted by inflation. And there’s your legacy: your retirement financial plan should accommodate your estate plan.
“If you’re selling your business in your mid 60s, current research says you have a 50 percent chance of living to age 93 and a 25 percent chance of living to age 97. So you’ll need money for 35 years. We look at the client’s existing resources: Social Security, a 401k or defined-benefit pension plan, their savings and investments. The rest will come from the sale of the business, and for most business owners, that’s where most of their money is tied up. If we can start working with a business owner early on, we can help them build wealth outside their business, like through a company benefit plan or another tax-advantaged way to build savings.”
Taylor pointed out that a comprehensive financial plan will tell you whether or not you’re ready to sell.
“You might need some time for a runway to get your business to the point the sale will generate sufficient money for you to retire without the risk of running out of money in retirement,” Taylor said.
Developing a succession plan is a continuous and collaborative process. HBK Constructions Solutions, in collaboration with HBK Transaction Services, HBK Valuation, HBKS Wealth Advisors, and the professionals of HBK CPAs & Consultants, America’s 46th largest accounting firm, is uniquely positioned to help you improve your business’s appeal to prospective buyers, determine the value of your business, and develop a financial plan for using the proceeds of your sale to accommodate your personal financial goals. For more information, contact me email at kmelewski@hbkcpa.com; or call HBK Construction Solutions at 330-758-8613.
Contributors to this article:
Kyle Melewski, CPA
Principal | Regional Director, HBK Construction Solutions, Ohio Region
Kyle is the Ohio Regional Director of HBK Construction Solutions, a team of industry-savvy professionals serving the unique business needs of more than 600 construction firms. Kyle provides traditional accounting and tax services, but also services that help contractors improve their financial performance and maximize returns to their shareholders. He uses benchmarking tools to identify areas of strength and weakness, then helps management develop and implement plans to improve areas of weakness. He also helps contractors develop training for their management teams designed to improve internal communication, cash flow, and profitability; assists contractors in the evaluation, development, and application of proper overhead rates; and projects cash flows and develops financial statements that support contractors seeking increases in their credit facility.
Robert J. Zahner, CPA, ABV, CVA, ASA
Principal, HBK Valuation Group
Bob’s public accounting experience includes extensive involvement with businesses and individuals planning for and complying with federal, state, and local tax filing requirements, as well as financial statement analysis for attest. He leverages his years of experience and skills as a Certified Public Accountant to perform valuations of closely held businesses, pass-through entities, C-corporations, professional practices, intangible assets, family limited partnerships, and other entities in various industries.
Keith A. Veres, CPA, CGMA, CEPA
Principal and National Director, HBK Transaction Advisory Services
Keith is a Principal in the Fort Myers, Florida office of HBK, and the National Director of HBK Transaction Advisory Services. He began his accounting career with HBK in 1991. Keith spends the majority of his time helping clients, friends, and associates throughout the HBK family of companies work through their exit strategies.
Brittany Taylor, CFP
Principal, Senior Financial Advisor, HBKS Wealth Advisors
Brittany helps her clients achieve their financial goals by establishing and overseeing a plan of action specific to their unique economic and life situation. She applies a holistic approach to their financial well-being, helping them preserve and grow wealth, developing investment and wealth protection plans that help them attain their families’ objectives. Her client base consists mainly of people in or near retirement and their families. She serves clients in many states from her office in Erie, Pennsylvania
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