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It Figures Podcast: S4:E13 – Successful Transfer and Succession

It’s all about longevity! Join CRI Partners Robert Coker and Larry May, as they dive into identifying solid succession candidates and preparing the next generation of talent for your business.

Speaker 1:

From Carr Riggs & Ingram, this is It Figures, The CRI Podcast, an accounting, advisory and industry-focused podcast for business and organization leaders, entrepreneurs and anyone who is looking to go beyond the status quo.

Robert Coker:

I’d like to welcome you today to our podcast on transition and succession plans for It Figures. I’m Robert Coker. I’m out of the Birmingham office. I’ve practiced in the construction arena probably for 32 years, or maybe back to birth because my grandfather was a contractor, so I’ve been around it for quite a while.

Larry May:

Well, I’m Larry May. I’m out of the Jackson, Mississippi, office for CRI. I’ve been doing construction stuff for about 29 years and very involved with a lot of contractors and in the construction trade associations.

Today, we want to talk about the transition and succession plans because, Robert, I don’t know about you, but this is one thing that I see that people usually put off way too long to start thinking about, and it’s really something that needs to be thought about. Probably, if you haven’t started thinking about it and you’re listening to this today, you definitely need to start thinking about it today because there will come a time when you want to get out of business.

Unfortunately, most contractors, it’s very hard to sell their businesses because their competition would be the natural ones to buy them and they think, well, why would I buy you when you can just go out of business and I don’t compete against you anymore? I have not seen a lot of successful sales of contractors in all of my years of business. In fact, I think can think of two, one, two, a publicly traded company and one that was sold to a competitor because they were ruining the profit margins.

Robert, how about you?

Robert Coker:

Well, the real thing about that is think about what you’re buying in that you’re really buying talent. It’s an intangible you’re paying for, and so how are you going to transfer that intangible? You got all these customer contacts, these business relationships with GCs or subs or the subs having relationships with those, as well as workforce in place. Like you say, is it easier to go out and say, well, I’d rather just go out and start this from scratch or they’ll go and buy our competitor, and is there even chances of success because maybe that intangible that was so crucial in that business no longer exists?

Larry May:

Well, that’s right, and I think one of the big things that I see particularly with most of my contractors is the owner fulfills many roles, and they just don’t have the time to think about it. They’re sitting there, and they are the biggest talent. They’re the entrepreneurial mind that started the business. They’re often the estimator, project manager, personnel manager, HR. Well, when you have all that, it’s hard to sit there and think about, well, the future sometimes because, although it’s extremely important, it’s not critical, and the bid tomorrow is critical, the replace and find another project manager is critical, the fire and the employee that came in drunk or stoned is critical, but the thing that’s really important because most of the time this is really their biggest asset.

Robert Coker:

It is their asset in most cases, right?

Larry May:

That’s right.

Robert Coker:

Yeah. They’ve got a lot of toys outside of it, obviously, because all our contractors do, and I love them for it. They love to have those pieces of fun outside of it, but, like you said earlier, the transition piece of it, you get right down to it. That requires a lot of effort, a lot of time, like you say, and they’re not finding time to cut that out to say, okay, when do you even start this, how do you even start the process and, quite frankly, are they’re good at teaching other people about what they really do? It’s just a natural gift that they’ve had as far as what they’re doing, and they may not be the greatest of teachers, right?

Larry May:

That’s right.

Robert Coker:

Understanding that, at the end of the day, this asset goes away without you transitioning it is our job as CPAs to make sure we put that top of mind so that they do monetize that asset, and that’s our goal today is really talking about that.

Larry May:

That’s right. One thing that I find funny is, most of the times when somebody has approached some of my contractor clients, I always liken it to children. You never think that you have an ugly child, but there’s a lot of ugly people in the world. Well, they always think their business is worth way much more than on paper that anybody could justify paying for it. The expectation that they think that, hey, I’ve got a $2-million asset or a $10-million asset that I can sell, and then you start showing them when you look at the numbers and the ratios and say, “Nobody’s going to offer you anywhere near that for your business,” often because, the things that people do for tax strategies and other things or the toys that people buy where you have extra money instead of investing back in the company, you may invest in something fun for your family.

I think it is very important the earlier you start, and I think you brought up a valid point of a lot of the owners have never written down all that they do. They don’t even know what all that they do.

Robert Coker:

Do they even trust the other people surrounding them enough to even turn over the reins?

Larry May:

Well, and a lot of times, when you built this, you don’t want to relinquish any kind of control.

Robert Coker:

Well, they’re fearful in terms of, okay, wait a minute, if I give all this skillset to someone else, they walk out the door, and it is a risk, and it is dilution of ownership. They do have to give up something to get something. It’s just a fact. We experience it in the firm ourselves where we have retiring partners and we say, okay, well, the way that works is you monetize that cash flow over time so it’s not all a big hit so you can maintain working capital, bonding capacity. It’s a real challenge in terms of getting it there, but you have to be willing to play in the sandbox with others. It’s really what it comes down to.

Larry May:

In my mind, the first thing you need to do in thinking about transition is, if you have a family member that you know is in your succession plan, to start very early training them on what you do and the ways to run that business, so to identify the persons and make sure they’re interested because, all too often, your children or nephews, nieces may not be interested, and so what do you do then?

In my mind, getting to know that, if you have a child that’s interested and if they are and expressing interest, to get them interested early, to start showing them what you do and then allowing them to take more and more control, because I see even my contractors that have a very good succession planning in a child that is capable of taking over, they still don’t want to relinquish that control. A lot of times I think it’s because, being busy, they’ve never taken the time to. They don’t think that they’ve transferred all the knowledge that is needed there and just the hesitancy to put that at risk. I think that’s the first thing is, if you have a family member, to start identifying and training them.

Robert Coker:

Or key members of management, identifying who you want to groom for those well in advance, even a 10-year plan, but the key to that is, if you’re going to make those people who you assign to transfer the business to, you got to keep them.

Larry May:

You got to keep them in, and what I have seen over and over again is a lot of the younger people are more interested in cash today and aren’t good at thinking about the future. If you’re going to start selling them ownership, make sure that they see the reward at the light of the tunnel or, better yet, even identify people who you know are longsighted and not shortsighted, because I know even in my father’s own business, when he was transitioning and he identified the people and they started the process, well, they bought a little bit and then they just never would continue buying, and so they ended up he had to go to an outside buyer. He got very lucky in that, but in most situations I see that’s not the case. You need to start selling little pieces at amounts that these people are willing to pay and let them accumulate more and more.

Robert Coker:

You got to find a way to fund it. In other words, really what it comes down to a lot of times, what you’ll see in these transition plans is you’ve got a compensation program that’s designed to give them a bonus to allow them to go and purchase shares or membership interests in the business, and that’s the only way they’ll ever afford to do this. They’ve got to build up some wealth, and the only way you do that is taking some off the table. Again, it comes to playing in the sandbox well together and sharing.

Larry May:

Well, and thinking ahead enough to say, okay, well, yeah, I could take this off for myself, but if I do bonus and then let them use that to buy my percentages, long term, I’m making a better investment.

Robert Coker:

Sure, because they’ve got a way to fund it finally. The other challenge that you see in that is, these older owners, they’re really challenged with reconciling these younger generations and, “Wait a minute. Do they want to work this hard? Do they want to do all the things that need to be done here? Do they have the skillset to even transfer, and when in the heck am I going to have time to do that?” That piece, they have a problem with the work ethic, if you will, on some of the younger generations. Understanding that up close and personal is pretty important.

We talked about finding the mechanism of transfer is really a real strategy piece that we usually like to get involved with to say, okay, here’s some options of ways that you can help fund this process and get it in place. Taking time out to look forward ought to be something every business owner is willing to do. It’s making them do it, and we really are charged with that a lot of times to go, “Have you thought about retirement? Have you thought about how you’re getting out? Have you thought about succession, even a estate planning in the process?” because that can be an ugly monster as well, and also making sure you help them develop these surety relationships and banking relationships-

Larry May:

Well, surety, well, and the customer relationships, all those relationships

Robert Coker:

… and customer relationships.

Larry May:

That’s putting you at risk because then they could leave and go work for someone else, but at the same time, it’s necessary for you to have the trust and the faith in this person by giving people more responsibility and positive feedback and transferring that knowledge. You’re showing them that you’re putting trust in them, and your people who are your go-getters are going to want to take more responsibility. They’re going to want to know these people, and that will help you in this buyout if you’ve identified them internally whether family or key employees.

Robert Coker:

Having that conversation early to say, “What is your goal?” Maybe they may be really talented and they have no interest in owning a piece of the business. They don’t want to take on the responsibility or the financial burden that comes along with it to do the buyout piece. Maybe they want to see the cash, bird in hand theory. They’ll say, “Well, I don’t want to take my bonus and not ever see it. I want to make sure that I have some today,” so it’s hard for people to look out long term.

It’s expensive to live these days. We’re in this huge period of inflation, and it’s really difficult. You go to the grocery store and it’s $500 later and you got four sacks of groceries, so doing that is really something that’s crucial. I think educating them as much on the process and making sure you’ve identified people that are willing and able to stomach the process of going, “Well, I’ve got to take on some responsibilities.”

We talk about strategies. I know you’ve done it, and I’ve done it. We’ve got some things in place. Stock recapitalization may be an option, old-co-new-co type situations where you have a new co that you set up and then you transfer and let new jobs flow into that and give them a structure of ownership and then wind down the old co business.

Larry May:

… and cash out. I’ve seen that happen when you’ve identified family members as well as when you’re bringing in key members of employment where what that allows is for the owner of the original company to cash out, but at the same time you’re bonding with the surety company, the new company, until it’s able to stand on its own feet. I’ve seen that as being a very, very effective method.

Robert Coker:

I haven’t necessarily had that much exposure to it, but I know you have, Larry, and I’ll let you speak to that on ESOPs.

Larry May:

Yeah, ESOPs, they can be a really great thing. I think the key there is, generally speaking, the main thing in the construction world that the ESOPs create challenges with is your bonding capacity. You would never want to do a hundred percent ESOP sale at one time. Where I’ve seen it very effective is when owners have sold maybe 50% to the ESOP and, when that gets close to being paid off, maybe come back and sell another 25%.

Robert Coker:

In tranches.

Larry May:

Exactly, because that way, if you do a hundred percent ESOP sale, the way the accounting practices do, you wipe out your equity completely, so then you have no net worth even to get your contractor’s license.

Robert Coker:

… and even your working capital.

Larry May:

Your working capital, all of it, I mean, but-

Robert Coker:

Setting up debt.

Larry May:

… not just bonding, but if you don’t have a contractor’s license, you can’t do anything. It can be very effective. You just need to look at the mechanism and how you do it and not do a hundred percent transfer at one time. Also, that’s another one that you don’t want to wait till the day you are ready to retire to take on. You want to plan it early and start and realize the implications for what kind of control you’re giving up.

Robert Coker:

In our job, in terms of that, we’ve talked about different, as if they’re just standalones, but sometimes you have an amalgam of all of them, you have a blend of all these strategies. You might even have pieces of it in old co. You might do some other bonus programs intrinsically within your key management. Build up their wealth. Have it set aside. Have a profit sharing plan where you’ve got a nugget out there that they don’t see until later on, and then they use those moneys that are built up into those funds that are almost in escrow to use it to do a buyback or redemption of those shares to get you out of the business and do it over time and you make it work. Again, it comes down to having conversations and being open to the idea that you got to give up control eventually, and you got to find a way to, again, we said it earlier, monetize the biggest asset you got.

Larry May:

I think that’s definitely true. I think, then, if you don’t see a family member or some of your employees or ESOP is not going to work, if you’re going to set your company up to try to make it sellable to an outside party, then I think there are some things you’ve got to be able to put a team together that can run that business without you where it’s going to be attractive to a buyer where they’re going to say, “Oh, I’m set up.”

One thing that I’ve seen as an obstacle is, a lot of times, people’s family name is on the business. If you’re thinking ahead far enough, do a name change and get your name off of it, so if you sell it to someone who messes things up, they’re not ruining your family’s name, because I have seen that an obstacle to more than one where they decided to just close it down and auction it off, where you’re not going to get top value, rather than trying to sell it. To recognize that you need to create a company that, if you get hit by a bus, that it can run on its own is beneficial not only to your family if something horrible happens to you, but also is positioning your company to be attractive to outside buyers if you can identify another option.

Robert Coker:

… and then having existing shareholders buy-sell agreements, having those kinds of things in place where you do have some support and protection for your family in the event. You are the majority shareholder. Well, they’ve got to find a way to, again, monetize that asset for your family, having some things in place, cash value or something of that nature, plans that actually allow you to fund that redemption and think those are things that are in place. It all dovetails together. We touch on the transition, but it’s all about thinking about your workforce, giving them roles and responsibilities, pushing out these things, training them up, sharing your knowledge early, and then you have a way to actually exit in a reasonable manner.

Larry May:

Hopefully at a young-enough age to enjoy life. I think the one thing that we have is I have seen the private equity move into that for larger contractors, but I’ve not really seen that as a good option for most of the size of contractors that I’ve seen. How about you?

Robert Coker:

Really haven’t seen much in the way of activity in that space related to the contractors I work with.

Larry May:

I think, usually, the volume that any private equity is looking at is much, much, much higher. For most of my clients, that wouldn’t be an option, but I do know, for your larger businesses, that they are out there scooping up this and that of everything.

Robert Coker:

It might be a good idea to maybe examine who your competitors are. Maybe there’s a great strategic purchase out there that they’re looking for to say, okay, they don’t do exactly the same subset of work, but it is in their line of work, and it makes sense for them to actually look at your business, and again then you have to be really open because, again, you have to share financial data, and that’s pretty risky if you’re in the same market with your competitor that also has some overlap. Maybe there’s some synergies that occur. Maybe there’s workforce in place. Contractors are so desperate to get their hands on workforce and, if you’ve got a really solid, trained workforce, that may be what they’re buying.

Larry May:

It could be. That’s right, and sometimes they just want to move to a different location. I think one thing that needs to be mentioned is CRI does have a capital advisory group that oftentimes can help point buyers and sellers and link them up so that they are. If in your area there’s an electrical contractor that wants to get into my area and I happen to know one that might be interested in selling and Joel knows to reach out to me, I mean, that’s one resource that we do have within the firm that I think could potentially be helpful, but I have seen cases where somebody just wants to get a new marketplace, but they want to get in it with the name that’s already firmly established, so they might buy and have a wholly owned subsidiary.

Robert Coker:

Well, the other beauty of CRI is just like in our example. I’m in Birmingham. You’re in Jackson. We come across it all the time where we sell. We got owners that want sell their business. Maybe my Birmingham business says, “Wait a minute, I’m really in the market to look to expand my footprint in the southeast.” I can call you and others, people in Dallas, all over the southeast where we have connectivity. It’s all about communication and then starting early so you’ve got long start lead time, so that you’ve got the pieces in place to help you be successful and to really capture the best price for you.

Larry May:

Absolutely, starting early, can’t say that often enough. I don’t really have anything else, Robert. How about you?

Robert Coker:

I think that’s all we needed to share today. There’s so much to talk about in that area. I guess my best advice to the people who may be hearing this podcast, we are a resource and I think we’re invaluable in that space to really help you sit down and get a plan together and put together a good team that actually helps you be successful in transitioning business.

Larry May:

I agree with you a hundred percent. Thank you.

Speaker 1:

If you want more CRI insights or are interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures, The CRI Podcast. You can subscribe to It Figures on iTunes, Spotify or wherever you prefer to listen to your podcasts. If you liked what you heard today, please leave us a review.

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