What do Bechtel and Kiewet — two of the largest and most successful global contractors — have in common with your company? Chances are there is at least one thing: Your business is privately held, just like these two companies. In the U.S. construction industry, the number of companies that have remained private is overwhelmingly higher than those that have accessed the public markets.
It is likely that these mega-contractors have at least one more characteristic in common with your company — they face succession issues. Regardless of the company size, all privately held contractors will address the succession issue, ineffectively or effectively, now or in the future.
This article will attempt to persuade you that succession planning, regardless of the age of owners or management, is not an event, but an ongoing process that needs to begin now. There are critical decisions that need to be addressed (but not necessarily resolved today) about the future of your business, including big-picture questions like:
- How long does the current leadership of the company want to work?
- What is the exit strategy of the current owners?
- Is retirement for owners and key management adequately funded?
There are no easy answers to these questions. In fact, in our opinion there normally are no answers for the typical contractor for one reason: These questions have not been addressed or discussed before. The current day-to-day activities of business owners consume all their available time.
In order to successfully plan for the future of your construction company, you need to allocate time and resources, which may seem overwhelming, but it really is not. Following are easy-to-follow, logical steps that will help you put effective plans in place.
The 10 steps of an effective succession plan
1. Set an action plan with broad outlines for timing
The process of founding and growing a company is all-consuming and it’s easy to put off thinking about long-range issues such as succession planning. Chances are good, however, that the owner has given thought to who should run the business when he or she is gone. Take the time to put those thoughts into an action plan that contemplates broad ranges of implementation.
It’s tempting as a parent to think about giving the business to your child or children; don’t do it! A business should always be sold, even to the next generation.
Start by determining what your business is worth — a range will do. That value, by the way, is different than the amount of money you need for retirement. Understanding whether your business is worth $2 million or $20 million will simplify the process as it will help you to understand what options are available. For example, if you have one or more key employees that you would like to consider selling the business to, ask yourself, can they afford it? Do they have outside resources or are they looking only to their compensation for funding? If it’s the latter, consider how you feel about your employees essentially buying your company with your money. This may be a viable and good alternative, but understanding those dynamics will help you make the best decision for you and your family.
Having family, especially children, in the business introduces new layers of complexity. It’s tempting as a parent to think about giving the business to your child or children; don’t do it! A business should always be sold, even to the next generation. Be sure to think critically and impassionately about the characteristics and attributes of your children and use those to match them up with the appropriate position in your company. This will maximize their chances for success and your chances for a successful transition.
2. Take a hard look at your compensation strategy
The Great Recession of 2008 and 2009 dramatically changed the landscape for talent acquisition and retention. Many skilled workers and project managers left construction for other industries and will probably not return. The severe down-cycles that contractors routinely experience make it difficult for employees to feel long-term security.
As a result, the traditional methods of compensation will not be sufficient to retain your employees or attract new talent. By traditional, we mean a salary or wage plus an annual bonus tied principally to project performance. It could also mean a totally discretionary bonus that is not directly tied to any discernible performance metric (i.e., the ‘Santa Claus’ bonus).
Instead, contractors need to design motivating and understandable compensation programs for key employees. And, for key employees, those programs need to include some type of long-term financial reward, such as a deferred compensation arrangement. You should also look at including noncompete and nonsolicitation terms in those long-term arrangements to ensure that you are not funding your key employee’s start-up business when and if they depart.
In the context of family employees, it’s critical to separate the roles of employee and owner — and to compensate each role on a fair and competitive basis. No one should be paid more — or less — because they share your last name.
Over the years, we’ve found the most success with owners who have a carefully planned transition from one leader to the next. And creating an immediate sense of accountability for everyone can certainly smooth the way through the transition for the next generation of leadership talent.
At some point in the life of the closely held business, you may not have the right kind of talent in the partnership or family to staff critical management or staff positions. Attracting, training and retaining good people can be a challenge in these situations. The design of compensation plans, opportunity for an equity stake and long-term incentives to retain good talent are all considerations when hiring. Having said that, we often see family members who get a ‘premium’ in compensation just because they are family members; we think that is a mistake. There are other ways to compensate family members/shareholders beyond what they get paid to do their job.
In our experience, it’s difficult for the partners/family members who founded the company to let go when bringing in outside talent, especially executive talent. Likewise, the new hires often feel like they don’t really have control over their areas of responsibility because ownership can’t give them control. Over the years, we’ve found the most success with owners who have a carefully planned transition from one leader to the next. And creating an immediate sense of accountability for everyone can certainly smooth the way through the transition for the next generation of leadership talent.
3. Determine who should have equity ownership
The process of determining who should own an equity stake in your business needs to consider two possible scenarios: a plan to deal with the issues arising from the sudden death or incapacitation of a principal owner or owners, and a long-term plan identifying the next owners of your business. Each of these is its own separate plan and should be shared with the significant credit providers as well as the appropriate individuals inside your organization, as details emerge and become final.
Upon the sudden death or incapacitation of a principal owner, you need to be able to identify financial resources that are available to bridge management and project gaps (for example, life insurance or a corporate disability policy) as well as the immediate changes in roles. Specificity is crucial; the business and your business partners will need to know who its leaders are.
'Sprinkling’ ownership among a wide group of employees or family, no matter how key they are to the success of the company, creates difficulties for the next generation of transfer.
The long-term plan identifying who will own your business should first address a significant issue — ownership is not a right and in many cases is instead a burden. Favored employees or family should not receive actual ownership (as opposed to synthetic ownership — see following) in your company due to their long-term tenure, friendship or family relationship. That choice must consider instead who is best poised to lead the company into the future.
Many times there is no apparent successor owner. This is not necessarily a cause for concern; it just points to a different ownership strategy, such as shopping the company to outside buyers.
In our view and experience, ‘sprinkling’ ownership among a wide group of employees or family, no matter how key they are to the success of the company, creates difficulties for the next generation of transfer. Consider instead the use of synthetic equity — phantom stock plans, restricted stock plans or some similar tool that will reward key employees or family in a similar fashion. These options amount to actual ownership but without the difficulties of reclaiming those shares in the future.
4. Managing multiple roles in the business
As is the case in most privately-held companies, family members and business partners have multiple roles. In the case of a partnership, we often see the partners bring in friends and professional colleagues to help run the business. Parents will often want their children to be part of the business.
Family members who are employees should behave, perform and, as already noted, be compensated just like any other employee.
As a general rule, we like to categorize the partners or the family members into three groups: owners, management and employees. On any given day, the owners may wear their ‘management’ hats as well as their ‘ownership’ hat. And, as you might guess, knowing what ‘hat’ you are wearing and when is an important part of running a closely-held company. Too often we see ownership trying to manage the company on a day-to-day basis when it’s really management’s job to do that.
Take the case of a family member who is an owner and plays a role as an employee. In one case, we found an owner, who also happened to be the shop foreman, insist on firing the CFO for some mistakes she made in payroll planning. Even though the CFO reported to the shop foreman’s older brother, who also happened to be the CEO of the company, the shop foreman felt his ownership entitled him to fire the CFO.
The point is this: Any owner should be clear about their role as an employee, even though they have an ownership stake in the company. Family members who are employees should behave, perform and, as already noted, be compensated just like any other employee. The same goes for those who are part of the management team, which brings with it additional rights and responsibilities, and consequently, better pay. Finally, ownership brings with it the most responsibility and the highest return. We think it’s very important to consider the pros and cons of granting ownership to family members.
5. Get started on retirement and estate planning
Those retiring from a family construction business often worry, will I be comfortable in retirement? Are my wills effective? Are my assets at risk?
Far too many closely held businesses have most of their wealth tied up in the business. This could spell disaster should anything unforeseen occur in the future. With its assets often extending far beyond the company structure, owners should speak to their advisers as to how to protect their family homes, their investments and ultimately, the assets of the business.
Similarly, too few business owners have relied upon retirement planning to build wealth in a tax-efficient and risk-protected environment. These are ideal opportunities for business owners to develop a separate wealth stream outside the business. Of course, an important part of this equation is to make sure your will is up to date. If you have not revised your will in recent years, it may be ineffective or may not reflect the latest taxation and asset protection measures available.
Far too many closely held businesses have most of their wealth tied up in the business. This could spell disaster should anything unforeseen occur in the future.
One final point here: In our work with many closely held companies, the ‘senior’ generation sometimes depart from active engagement from the company with a plan for their retirement to be actively funded from company resources. In our experience, when that happens, the succeeding generations feel obligated to a ‘mortgage’ to the previous owner and often get resentful about losing their income/equity to an inactive owners retirement plan. This sort of arrangement can work well for some closely held companies, but we advise caution in the design of such a plan.
6. If appropriate, explore the best ways to bring family members into the business
Closely held businesses are often multigenerational family businesses. Yet studies have shown that fewer and fewer children are going into the closely-held family business. It’s not hard to understand why. In a changing world that brings with it more career options, the closely-held business often becomes a less attractive option for many children. But for those who do choose to follow in their family’s footsteps, what is the best way to teach them the ins and outs of the business? And, if they do not have an aptitude for it, what is the best way to let them go?
Even more important is the conversation we recommend that families/partners have with their potential successors. In our experience, owners sometimes have an unrealistic expectation that their kids will have the same passion for the business as they do. This initial conversation is a critical success factor in bringing family members into the business.
We recommend the next generation talent enter the business only after they have first gained experience elsewhere — preferably in an established business where they can learn through trial and error. When they do join the business, they bring more experience, perspective and confidence to the table.
Most entrepreneurs view their business as they do their family members. They will do whatever it takes to keep them safe and healthy. That very ‘parental’ attitude often hinders the transition from one generation to the next and creates roadblocks to the transition for the next generation. We believe a disciplined planning process can mitigate many of the problems that come up in the transition from one generation of the family/partnership to the next.
7. Lay out a strategic plan
Planning ahead does not have to be complicated. Following are tips for getting started:
- Involve your key people — their participation ensures their commitment to the plan.
- Keep it brief and to the point — identify the issues and priorities and don’t try to do everything.
- Plan off-site — leave the office behind and hire an external facilitator.
- Avoid complex financial analysis — instead, look at the big picture; cash flows and forecasts can always be added later.
- Create an open environment — your people should feel free to raise important issues with impunity.
8. Develop a wealth-preserving strategy
As mentioned earlier, too many business owners tie up their wealth in the business. This makes sense to a point — capital is needed to grow a business and, together with the considerable effort on behalf of the owner, the return on capital is usually very high. But a business is inherently risky. Even the most stable business can go through periods of uncertainty due to competition, insolvent clients, changing markets, litigation and workplace accidents. Such unpredictability puts the owner’s personal wealth at tremendous risk.
We’ve seen many partnerships refuse to give control to the next generation because they worry about the risk to their current lifestyle and future retirement.
In our experience, over-reliance on the business for preservation of personal wealth can also be a big roadblock for current ownership. We’ve seen many partnerships refuse to give control to the next generation because they worry about the risk to their current lifestyle and future retirement.
By developing a strategy that focuses on building wealth away from the business in a lower risk and return environment, and in a secure and protected manner where the highest rates of taxes do not apply, business owners can build and preserve wealth regardless of the fortunes of the family business.
9. Resolve conflicts
Is the closely held business a blessing or a burden? Unresolved conflicts related to family or the partnership are key reasons it can quickly become a burden. One risk is the potential for conflict to hold back or destroy the business due to the personal and emotional relationships among members. Over the years we’ve seen too many companies sold because ownership didn’t have a way to successfully navigate the conflicts that arise in any company.
However, by designing structures, systems, procedures and guidelines that distinguish between family and business concerns, it is possible to either avoid conflict or build in a process for managing conflict that is acceptable to all parties.
10. Draft a set of operating rules specific to the partnership/family
How do families work and play together? How do partnerships whose beginnings were created by authentic friendships retain the quality of the relationships while owning and managing a business?
To spell this out, you might want to consider drafting a set of ‘agreements’ that addresses the expectations in matters, such as:
- Obligations of the business to offer employment to friends and family
- Who is entitled to special compensation or equity agreements
- Do friends and family get employment entitlements that are different from other employees
- How friends and family fit into the management structure of the business
- Whether friends and family are ‘cut’ for management roles
- How they are assessed for promotion
Such a document is reserved for the family/partners alone and provides a business-like approach to the partners’/family members’ future in the business.
It requires a certain amount of initiative and change to begin the succession planning process for a closely-held construction business. These 10 steps are tools to give you a head start on managing potential problems before they occur, which will lead to a better, clearer, more profitable and less conflicted future for everyone.
The day-to-day demands of business make it difficult to pull back and focus on the future, but it is critical to do so. You want your closely-held business to survive, whether under its current or new ownership, so that it can continue to provide for employees and stakeholders. Take the time to begin!