Exiting a business requires advanced planning by owners
INSIGHT ARTICLE |
With a strong economy at their disposal, baby boomers who own construction companies are increasingly looking for ways to either sell their businesses or pass them to the next generation. The siren song of retirement is compelling and, for those who have worked hard for many years, a deserved gift.
However, pulling off business succession, particularly if it hasn’t been planned in advance, can take longer and require more effort than many business owners expect. The considerations are many, starting with whether to sell the business to an outsider, a partner or employees; to pass it to family members; or to simply liquidate the assets. Each choice has distinctive requirements.
But before any direction can be selected, a business owner has to know what the business is worth.
The process must begin with a formal valuation.
Valuations can be obtained from a number of sources, ranging from accountants to business brokers to investment banking firms. In seeking an appraiser, it is important that a contractor consider only qualified and experienced professionals who understand the local construction market. When it comes to setting a price, national and regional economic conditions are the chief influences, and they ebb and flow on a regular basis. However, according to Pratt’s Stats, construction-related businesses generally sell for four-to-five times earnings before interest, taxes, depreciation and amortization. For a typical, profitable business, this number will be in the range of one-third to one-fifth of annual sales.
For those who intend to pass their business to family members, a formal succession plan needs to be in place well before the transition begins. According to PCE Investment Bankers, only 30 percent of construction companies survive through the second generation of ownership, and only 20 percent survive the third generation. The reason, many who study the issue say, is a lack of a viable succession planning.
One of the simplest ways to transfer ownership is through gifting, using the annual exclusion and estate tax credit. These techniques work through the use of lifetime gifts―gifting shares of the business to the next generation using annual exclusion―and bequeathing the remainder of the shares to the children after death using a will or trust. Gifts can be made using a variety of trusts, limited liability corporations and family limited partnerships.
Although gifting is the simplest and least expensive ownership transfer method, it may not be the best way to achieve the owner’s goals. Usually there is no exchange of money to help finance retirement needs.
Life insurance is another good tool to use in shifting ownership. It can provide money to the beneficiary to pay estate taxes or debts and to fund a buy-sell agreement.
Selling to a partner
When an owner is ready to sell to a partner, as opposed to family members, a formal buy-sell agreement is critical. Without one, the death of a partner, a divorce or even the desire by one partner to leave the business can force liquidation or a sale to an outsider. All this stress, as well as unexpected tax liabilities, can be avoided by means of a simple buy-sell agreement.
Effective buy-sell agreements establish that an owner’s interest must be sold to the company, the remaining owners or a combination of the two. It also establishes that once a triggering event occurs, owners are guaranteed their interest in the business will be purchased, and establishes a methodology of computing the purchase and sales price of the ownership interest. The agreement also provides a funding source and payment terms that will allow the company to maintain its financial viability.
Selling to an outsider
For owners who intend to sell to an outsider, the first step should be strengthening the financial bottom line. The process should begin by eliminating extraneous perks and expenses. Buyers must be able to see how they can pay the debt service payments and pull out a reasonable salary and/or return on the investment. More cash flow means buyers can afford more debt service, which translates into a higher purchase price.
Owners also need to get their books in order, and the first focus should be on their financial statements, including the balance sheet and income statement. Because a contracting business must pay taxes based on its income tax return, when the financial statements match the tax return it is a strong indicator that the company’s books must be accurate; this creates comfort for the buyer.
Along with this, the key line items within the balance sheet and income statement should align with other company records, including accounts receivable, bank accounts, inventory, fixed assets, revenue from sales, expenses related to vendors, contract files and insurance policies.
It should be pointed out that first-time sellers often have unrealistic expectations. Many of them believe their businesses are worth more than actual market value. That’s why they should study recent sales of similar construction businesses in their area.
Whether an owner intends to sell to outsiders, partners, family member or even employees, succession planning must begin well in advance of the transaction. The first step owners should take is seeking advice from accountants, attorneys and their bankers. For their part, accountants can review all tax and income implications of any sell scenarios that are available to the owner, and help owners choose the most profitable path to the golf course.
Published In: June 2017 Texas Contractor.