How Construction Companies Can Plan for Success, Failure, and Change

As a CPA specializing in construction accounting for over 15 years, I've seen firsthand how proper planning can mean the difference between thriving and merely surviving in our industry. One of my clients recently told me, "We had a great year, but I'm more worried about next year than ever." This sentiment echoes across the industry as we face unprecedented challenges and opportunities. At a recent construction industry webinar, several key themes emerged that I believe are critical for construction companies to consider as we approach 2024 and beyond.

Strategic Planning is More Critical Than Ever

Comprehensive strategic planning is essential for construction success. While many companies focus only on immediate projects, a proper strategic plan needs to address three key timeframes: the upcoming 12 months, the next 3-5 years, and your ultimate exit strategy.

For the immediate term, companies should develop a business plan for the next 12 months that outlines expected revenues, overhead costs, and profitability targets. By analyzing past 12-month activity, you can develop an informed budget and monitor actual results against it monthly or quarterly. This regular monitoring helps identify issues in real-time, allowing you to fix problems before they become severe.

Looking at the 3-5 year horizon requires careful consideration of various risks and challenges. Key factors to evaluate include whether revenue levels are sustainable, what profit levels are needed for bonding capacity, potential insurance increases, capital acquisition needs, labor shortages, union rates, equipment aging, and the political/environmental landscape. With an upcoming election in just two weeks, both sides have different tax laws they want to implement, which could significantly impact how companies pay taxes in the future.

Exit Strategy: The Often Overlooked Element

Exit strategy planning is crucial yet often overlooked. As the webinar noted, quoting the philosopher John "Hannibal" Smith of the A-Team, "I love it when a plan comes together." However, they also referenced Mike Tyson's famous quote, "Everyone has a plan till they get punched in the mouth," highlighting the importance of preparing for unexpected challenges.

There are several types of exit strategies to consider. Unscheduled exits - what the presenters called "the three Ds: death, disability, and divorce" - require careful advance planning. For death scenarios, key considerations include who can run the business, sign checks and contracts, handle surety bonds, and ensure operations continue. Cross-purchase agreements or buy-sell agreements, properly funded by life insurance, are essential tools for these situations.

For planned exits, options include:

• Liquidation (though this typically yields lower returns)
• Sale to other owners
• Sale to outsiders
• Sale to employees
• Passing to family members

The webinar survey revealed that 33.3% of respondents plan to pass their business to family members, 25.4% to employees, 20.6% to outside buyers, 19% to other owners, and only 1.6% plan complete liquidation. This reflects a strong preference for keeping businesses internal with family and employees.

Employee Stock Ownership Plans (ESOPs)

ESOPs represent a viable exit strategy for larger contractors, particularly those with annual revenues of $40 million or above. These plans are tax-qualified retirement plans similar to 401(k)s that allow employees to receive ownership over time. S corporations with 100% ESOP ownership are exempt from federal and most state income taxes.

For an ESOP to be suitable, companies should be profitable and stable with a proven track record of growth. They need at least 20-25 employees for cost-effectiveness and should have minimal debt since the ESOP transaction typically requires financing. The structure provides valuable retirement benefits for employees while incentivizing them to maximize company value.

Tax Planning in an Uncertain Environment

Looking ahead, significant tax changes loom with the Tax Cuts and Jobs Act provisions set to sunset after 2025. The top individual tax rate could increase from 37% to 39.6%, and the valuable Qualified Business Income deduction could disappear. For construction company owners, this means effective tax rates on business income could jump from 29.6% to 39.6%.

These pending changes affect traditional year-end tax planning strategies. Companies using cash-basis accounting or completed contract method may want to reconsider aggressive deferral strategies in 2024 and 2025, given the likelihood of higher future tax rates.

The Employee Retention Credit continues to present challenges, with many claims still in a "holding tank" awaiting processing. The statute has lapsed for 2020 returns, and 2021 returns will begin to expire in March 2025. The IRS has initiated 386 criminal cases worth almost $3 billion related to improper claims, emphasizing the importance of proper documentation and legitimate claims.

Looking Forward: Opportunities and Strategic Considerations

Construction companies have several opportunities to strengthen their positions through various tax incentives and credits. The 179D energy-efficient commercial building deduction now offers up to $5.65 per square foot for qualifying projects. State-specific programs like Virginia's Worker Training Credit can offset up to 35% of training costs, and the Work Opportunity Tax Credit provides incentives for hiring from targeted groups.

The construction industry faces both challenges and opportunities in the coming years. Success will require careful planning across multiple time horizons, from immediate operational concerns to long-term succession strategies. Companies that invest time in comprehensive planning now will be best positioned to navigate future changes.

While these insights provide a planning framework, every company's situation is unique. Working closely with financial advisors to develop tailored strategies for your specific circumstances and goals is essential. The time to start planning for tomorrow's challenges is today.