Warning: Don’t forget to plan for ownership and leadership transition, whether for growth or an exit from the business.
For the past few years, the construction industry has been booming. Businesses have been hustling to keep up while experiencing record-revenue years. However, there are now concerns about headwinds such as an economic slowdown and rising financing costs. According to results of the 2023 AGC Construction Outlook National Survey, construction companies are also concerned with material costs, project delays, rising labor costs and other costs, insufficient workers, inadequate worker quality and training, safety issues, increased regulations, and increased competition for projects. Given these concerns, it is easy to defer planning. But now is the time to review and reflect on ownership and leadership transitions, which are essential for business continuity.
National and regional surveys show that about 51% of businesses are owned by baby boomers, and about 53% of those businesses expect to go to market, with about 47% transitioning to internal buyers, like employees. Nationally, about 83% of those businesses either do not have a transition plan or the plan is not documented and communicated. Some regional industry sectors tend to be more proactive than others in planning. In addition, companies with higher revenues tend to have plans and shorter windows to transition, and companies with smaller revenues don’t have plans and have longer windows.
With these concerns and statistics in mind, there are two situations for owners to consider:
In both situations, the following factors should be considered for a smooth strategy and transition.
The 2023 market is different from the past few years. There are fewer large transactions, more caution, a slower pace to close, dropping valuations and buyers requiring more rigorous due diligence and alternative financing arrangements. On the other side, there is also uninvested capital in private equity funds and a strong cash position of strategic buyers, coupled with a pipeline of sellers, sell-side private-equity firm activity and carve-outs. The M&A landscape is changing and may be an opportunity or a challenge for a buyer or a seller depending on one’s outlook and expectations.
In 2023, buyers are demanding more due diligence and assurances, covering contractor licensing and compliance; bonding, guaranties and surety requirements; material contracts and project compliance; customer and supply chain relationships; quantity and quality of assets and equipment; employees and employee benefits; union relationships; employee restrictive covenants; governmental contracting status and requirements; legal claims and litigation; warranties; insurance; financial verifications such as the quality of earnings reports and audited financials; cybersecurity; immigration and I-9s; real estate; environmental compliance; trademark and other intellectual property; corporate records (even in asset deals); accounts receivable collectability; inventory valuation; taxes and tax impacts (both for the company and the owner). Sellers need to be prepared for this type of review, which requires advanced preparation and resources, especially if tax and estate planning are critical. Being prepared as a seller, buyer or joint venture is essential for certainty and closure.
Buyers and sellers need to articulate a defensible and realistic valuation methodology and valuation in both internal and external transitions. Good financial information, including normalized cash flow, is essential, and a third-party valuation expert may be helpful. Valuation includes the company’s operational structure, whether a stand-alone business or a family enterprise, and whether real estate is included. Understanding the company’s value is essential to evaluating and acting quickly on offers or opportunities that arise.
Taxes may drive many transactions and need to be analyzed from the perspective of the company, the owner personally, and the buyer. The structure of the transaction will likely depend heavily on the tax implications, including state tax. Advanced planning, including good estate and gift planning, is often vital.
Will the owner continue after a transaction? Does the buyer have the employees to integrate and grow the target? If the deal is contingent on the seller’s team staying, what protections have been put in place or are needed? These questions need to be addressed early on in planning for either a growth strategy or an exit strategy.
To be prepared, companies need to have the right team in place, including internal management, family and external experts, like accountants, lawyers, valuation experts and, in some cases, investment bankers, family consultants, etc. This team should understand the business and the owners’ goals.
These considerations are important for any plan. Planning is essential for growth, an interim transition, or an exit. The construction industry is no exception.