(Published in Construction Accounting and Taxation, May/June 2017 issue)
As 70 million baby boomers reach retirement age, it is estimated that 12 million privately owned businesses will sell or bequeath assets worth $10 trillion over the next two decades.1 Proper succession planning is just as crucial for the boomers’ employees as it is for the exiting business owners. Our firm has seen a steadily growing number of contractor clients enter into business transactions over the past two years, and there are many more working on plans for that day. Business owners have several different paths they can take to transfer ownership of their businesses, including:
- sale to a competitor or customer;
- sale or gift to a family member or group of family members;
- sale to a key employee or group of key employees;
- sale to a private equity company or other investor;
- sale to an employee stock ownership plan (ESOP); and
- closing the business.
Deciding on the path best suited for the business and its owner can be a long process. Regardless of the path that a business owner ultimately takes, we see that those who transition their businesses effectively have a number of key elements in common.
It is never too early to start succession planning. Business owners should begin the process five to ten years before they anticipate exiting the business. Some start even sooner, but most business owners postpone the process, waiting until the projected exit date is far too close. Those who make succession planning a longer and more thoughtful process transition their companies most successfully. As part of their planning, it is crucial for business owners to envision a strategic path and work toward that goal.
Business owners who take steps to surround themselves with a great management team and the best and brightest employees are ultimately the most successful when it comes to transitioning their businesses. They look to fill key positions that the business needs, even if the company has not historically had those positions. They also have plans in place to replace key talent as those individuals near retirement. Best-in-class companies build a talented management team that can operate the business even if the owner is away for an extended period of time.
Strong balance sheets
Companies with the strongest balance sheets, especially with regard to cash, working capital, and debt-to-equity ratios, have the best opportunities to sell their companies effectively. A plan to strengthen the balance sheet in a way that drives up company quality takes knowledge, best-in-class benchmarks, and strong goal setting. Cash-heavy companies with little leverage are typically in a position to command a strong valuation.
Business owners who hope to transition their companies effectively should have streamlined, efficient processes, including proper internal controls, in place and documented. A buyer of a company, through its due diligence phase, is going to hone in on these processes and controls, expecting them to be established and appropriate. The focus will not only be on accounting-related processes, but also processes surrounding job selection, estimation, job tracking, and job close-out.
External board members
Even though this strategy is more common in larger organizations, external board members with appropriate skill sets and industry experience can help take a company of any size to the next level. By integrating one or two individuals into a company’s board, business owners can gain a different perspective and knowledge base that may ultimately help maximize the company’s potential at the time of sale. It is important, however, to ensure that the company selects the ideal individuals for these positions.
Budgets and projections
The most successful companies have a structured annual budgeting process and continually forecast their income statement, balance sheet, and cash flow. Any potential buyer — individual or company — will insist on reviewing this information prior to a transaction. In addition, consistent and reliable cash flow will maximize any company’s value. As noted earlier concerning the balance sheet, it is much easier to plan for a strong report when the company is budgeting and forecasting. Having this process in place also allows the management team to head off potential job issues before they become problems for the company.
Excellent service providers
Business owners who successfully transition their companies surround themselves with great talent not only inside their organizations, but in their external relationships as well. A talented team of service providers includes attorneys, bankers, and certified public accountants. These service providers should understand the industry, the business, and most importantly, the individual owner’s goals and intentions for a successful transition. The business owner should regularly consult the team, heeding its advice to help strengthen the framework of the company over time. When it comes time to transition, a talented group of service providers can also help find a buyer that is the right fit for the company.
Working with the best service providers should also help business owners effectively plan for transition from a tax standpoint. When selling a business, the type and structure of the sale can have a significant impact on how much cash business owners end up putting into their pockets. When looking to maximize the transaction, it is very important for business owners to focus on the after-tax amount of cash that they will realize on the transaction.
Training and mentoring
People are the greatest assets of most companies. Especially for contractors, the pool of workers available has continued to shrink as an aging workforce retires and fewer people are coming into the trades. Companies that implement effective training and mentoring programs throughout their organizations tend to be the most successful in attracting and retaining the best talent.
Key performance indicator (KPI) transparency
Many private companies utilize some form of open book management with the employees in their organization. Typically, the most successful companies measure results in several key performance areas and share those results with employees. For many contractors, simple measurements such as overall budget-to-actual on projects, compliance with proper planning procedures, and safety compliance are common. Some contractors share information such as budgeted gross margin, total revenues, and profit, even if each number is provided only as a percentage. In striving to achieve the desired results, companies can set budgeted metrics and share these results with employees, encouraging buy-in from employees across their organizations.
Knowing what a business is actually worth is a key component of any succession plan. Once business owners have a realistic business value in mind, they can make educated decisions regarding their overall succession and estate planning. Additionally, reviewing the value drivers within a company’s valuation can help a business owner make informed decisions about the company’s future that could drive overall value up.
In preparation for a business transition, it is imperative to consider the company’s culture and how well that culture might, or might not, fit with the potential acquirer. Business owners should ask:
- What is the culture of the organization today?
- How might the culture need to change in order have a successful transition of leadership?
- How might the company be impacted by its sale to a competitor with an incongruent culture?
As boomer business owners begin turning the corner toward retirement, they have many things to consider when looking to transition a business effectively. Ultimately, however, the number one element to consider is the first point noted — timing. It is never too early to start thinking about a succession plan. The more time business owners have to plan and implement the strategies outlined previously, the more likely they are to have effective and successful business transitions.
1“Baby boomers: Incredible numbers are buying and selling businesses,” California Association of Business Brokers (accessed April 5, 2017). Available at: https://cabb.org/news/baby-boomers-incredible-numbers-are-buying-and-selling-businesses-part-1-2.