Navigating Succession Planning and Risk Management in Construction
Published by
Eddie Thompson
on
As a construction CPA with over 25 years of experience, I've observed numerous transitions in business ownership and risk management strategies. Recently, I had the opportunity to discuss these critical topics with Kevin Birch, Regional AVP and Territorial Underwriting Officer at CNA Surety. Here are the key insights that every construction business owner should consider.
The ESOP Advantage
Employee Stock Ownership Plans (ESOPs) continue to gain traction as a viable succession planning option. However, not every construction company is an ideal candidate. The strongest ESOP candidates typically generate $100 million or more in annual revenue and maintain consistent bottom-line profits of at least $1 million annually. These companies should have approximately 20+ years of operational history, with an established management team and robust cash flow to service both bank and seller debt.
Understanding the ESOP Timeline
It's crucial to understand that an ESOP is not a quick exit strategy. The typical implementation spans a decade or more, with bank debt repayment taking 5-7 years and seller debt retirement requiring an additional 5-7 years. When including warrants and stock appreciation rights, the total transaction timeline often extends to 15 years or more.
Private Equity Considerations
While private equity offers another succession option, it presents unique challenges for construction companies. The transition often shifts from relationship-driven to transaction-focused operations, potentially leading to the exodus of key employees and changed management priorities. From a surety perspective, private equity ownership frequently requires additional collateral through irrevocable letters of credit, with limited relationship continuity and increased scrutiny of financial stability.
Risk Management in Current Market Conditions
The construction industry is experiencing unprecedented work volume, but this brings its own challenges. Contract review has become increasingly critical, with particular attention needed for consequential damages clauses, notice requirements, maintenance and warranty obligations, and performance guarantees. With abundant work opportunities, contractors should be selective with projects, carefully evaluate owner relationships, and assess both labor availability and risk-reward ratios before bidding.
Looking Ahead
While current market conditions are favorable, it's essential to maintain discipline. Young professionals in the industry should note that these robust conditions won't last indefinitely. Smart contractors are implementing strong financial controls, building cash reserves, maintaining selective bidding practices, and investing in workforce development while strengthening subcontractor relationships.
From my perspective as a construction CPA, I've seen how proper planning and risk management can make or break a company's long-term success. Whether you're considering an ESOP, entertaining private equity offers, or simply working to strengthen your company's position in the market, it's crucial to engage with experienced advisors who understand the construction industry's unique challenges.
The surety industry remains healthy and competitive, with approximately $7 billion in premium volume. However, recent reinsurance losses have led to increased scrutiny in underwriting processes. This reinforces the importance of maintaining strong financial statements and working with construction-savvy CPAs who understand surety requirements.
By staying informed and proactive in addressing these challenges, construction companies can better position themselves for long-term success and sustainable growth. While we can't predict when market conditions will change, we can help ensure your company is prepared when they do.