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FMI Quarterly/September 2013/September 1, 2013

Tenets of Transfer

workingplans10_imageThe size and breadth of the construction market dictate that it is always undergoing constant change. The trends and realities of ownership transfer are not immune to this constancy of change.

In fact, FMI’s recent survey of construction company owners (2012) illustrates a dramatic shift in ownership issues. Some themes that FMI garnered from this survey include:

  • Baby boomers own more than 84% of the firms we surveyed. And these owners are working longer. Fifty-two percent of owners responding to the survey were 47 to 60 years old, and 32% were older than 60. This latter group represents an increase of more than 20% from five years ago.
  • Most construction company owners plan to transition the ownership oftheir firm internally to their employees, but it is taking longer. Sixty-six percent of respondents indicated that their company’s return on equity declined since 2008. More than 33% saw declines of more than 20%. With lower levels of profitability, transitioning businesses internally takes more time.
  • Talent is vital. More than half of the owners (52%) indicated that they do not have a team of managers that could easily replace them in their absence. Fifty-six percent of owners do not have a formal plan to transition themselves out of managing the business.
  • Owners are increasing their reliance on third-party sales, and many will not find a buyer. Seventeen percent of respondents are relying on a third-party sale as part of their exit strategy. This is up nearly 50% from FMI’s 2007 study. When combined with the aforementioned lack of depth at the management level — a key factor for many buyers — many of these companies will find that a third-party sale will be problematic.

FMI’s Investment Banking Group has assisted thousands of contractors in planning and executing the transfer of their businesses. While each of these transactions is different, the fundamental tenets of ownership transfer and succession planning remain the same. Whether a company is contemplating an immediate internal sale of the shares of its construction business, or has the luxury to plan orderly for such succession, these tenets can be helpful to avoid the pitfalls that have tested others. Here is a broad treatment of important issues to consider:

Align future ownership with future management responsibility.
The most successful internal sales occur to those individuals who have a meaningful and direct impact on the day-to-day operations and profitability of the firm. Business owners understand the direct correlation between ownership and accountability within a privately held business, and any ownership transfer plan should seek to create and harness this powerful link.

Shared leadership and business philosophies lead to successful outcomes.
Alignment around management philosophy and objectives is crucial. Ensure that future owners and leaders of the firm are in agreement with current ownership on key issues, such as operating objectives, a shared focus on similar key financial metrics and culture/people management. Once this foundation has been laid, the company and its advisors can select the proper structure to meet the objectives and needs of the organization and plan participants. The internal transfer process must serve the company and its shared values — do not try to fit a sale process that has worked in other situations into a transaction structure just because that is the most familiar or most easily understood method. Internal sales are much more likely to succeed when shared goals drive the process and transaction structure, rather than the other way around.

Prepare for the unexpected.
Just like in a construction project, internal sale plans invariably encounter unanticipated bumps in the road, both bad and good. Bad jobs, unforeseen market conditions, personnel departures— none of these can be planned for with precision, but variations will likely occur at some point. Build flexibility into your plan to accommodate necessary course corrections.

Profitability is essential.
Employees typically do not have the financial resources to purchase the company’s stock, so the buyout money will be funded by the future profits of the business. If a company is profitable, almost any internal transfer technique will work. If the company does not make money, ownership transition will not occur unless the owners are willing to give the firm away. Indeed, if the company is not profitable, where is the incentive to acquire future ownership?

Approach strategic initiatives involving the use of capital cautiously.
A timely ownership transition will impose cash-flow constraints upon the company, which will, by definition, limit strategic objectives. Before any transition begins, ensure that all key participants in the business agree to the long-term strategy, and that the strategic objectives can be accommodated in conjunction with the adopted ownership transfer plan.

The earnings capability of the business and the owner’s time frame for exit drive the value.
By assuming a closed-loop process where employees are only able to contribute a limited amount of the purchase price, the buyout will be funded overwhelmingly by earnings. Therefore, the value a selling shareholder can receive is simply a function of the amount of time allotted for the buyout and the amount of earnings generated during that time. Theoretical valuations and a seller’s monetary desires are important, but they are just that — theories and desires. Stay grounded in reality and manage expectations accordingly.

Internal sales to key employees or family require hard work and can be time-consuming. However, they prove to be a rewarding alternative for many construction companies. With the condition of the current construction economy, planning for and developing an internal ownership transfer plan is a more important alternative than ever.


Tim Sznewajs is a senior managing director at FMI Corporation. He may be reached at 303.398.7214 or via email at tsznewajs@fminet.com.

 

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