Business Succession Planning

Junior is not always the best person to manage the business—even if he or she wants to run the business. The person running the company doesn’t always have to be the owner, and vice versa.

Avoid Family Ties That Bind Your Business

By RICHARD E. GAVIN, CPA, CCIFP

The construction industry is comprised of many closely held or family-owned businesses. Over time we have heard plenty of business owners question the need for succession planning. Some feel they will just sell the company at some point, others feel that a plan inhibits their ability to decide to continue their management of the company.

We have seen many cases where a family business is no longer run by the family that started the business. Is it absolutely necessary that Junior run the business? The simple answer is no. The more important question is whether the family wants to retain ownership of the business or divest itself of all ownership. Depending on the family structure, you might consider the idea of retaining majority ownership, but allowing successors (who might be individuals who currently work with the business owner) to have partial ownership and run the day-to-day operations. Junior is not always the best person to manage the business—even if he or she wants to run the business. The person running the company doesn’t always have to be the owner, and vice versa.

In a recent client situation, we had a family who built a construction business from the ground up. They were very successful, earning profits even during difficult economic times. The chief principals and owners, a man and a woman in their 60s, had one child who never wanted to be involved in the business. Both parents tried to pique the child’s interest over the years, but nothing ever caught her attention. Their daughter wanted to start her own business, an interior design business, focusing on residential homes. Her goals in life and views on the world were different. How could we help this family figure out the most beneficial way to transfer ownership of the business and identify a true succession plan? How could they choose a successor that would allow their daughter to continue to reap some of the benefits of her parents’ hard work?

The owners had invested a great deal of time building their business, but were now at a crossroads in their professional lives. They could sell the business they worked so hard to develop or they could create a succession plan featuring some of their most talented protégés and structure a deal to benefit their entire family. Their nephew John, was interested in joining the business, but wanted to manage projects—not manage the company. He was interested in being a project manager and keeping the family involvement alive.

Here are some facts: the company, with more than $120 million in annual revenues and 10 percent net income, has substantial value. They carry 20 months of backlog at any given time. The company’s balance sheet is healthy, their line of credit is solid, and their jobs are all bonded with full indemnity agreements, both for the business and the owners. There are a number of talented potential successors. The Chief Financial Officer, Ed, is an extremely bright individual and he has worked with the owners for more than 15 years. A number of project managers are business savvy and looking to advance in their careers.

There were a number of options for the owners: they could retain majority ownership (including the daughter and the nephew as part owners, while transferring more ownership rights over time) and sell some of the shares of stock to a minority ownership, allowing the owners and their family to enjoy the fruits of their labor. They could do this through traditional methods, such as selling shares of stock in the company, or they could create an alternative ownership structure, replicating certain ESOP-like ownership rights. When choosing successors, they could incentivize the young leaders with stock options. The owners also realized that if they chose certain individuals, they might lose others who envisioned their own evolution to those roles. The owners had to contemplate many considerations.

They needed to make an informed decision. We worked with the client to establish new roles within the organization—advisory roles in which they could still be involved with the direction of the company (including board involvement). Beyond their new roles, 45 percent of the company would either be sold (25 percent) or used for incentivizing successors (20 percent). Specific management employment contracts were worked out with the successors (they chose the CFO and two of the other management team members), where they would obtain certain percentages of stock as they took on more responsibility over a five-year period (specifically drawn out and based on completion of projects, goals, etc.). At the end of the five years, the owners were still involved with the board, but had no involvement in the day-to-day operations. Additionally, the daughter and nephew of the owners were added as board members as they would each be part owners one day. We also established an estate plan for the owners, which detailed the ownership transfer to the daughter and nephew.

We also designated a Board of Advisors for our client. This is a key component to a succession plan. If a disaster occurred, this Board of Advisors, made up of the owners’ accountant, attorney, and banker, would oversee the management, along with the daughter and nephew and make sure any outstanding projects were completed. They were given the power to enter into contracts, terminate or hire management, and can advise the next generation on future business issues, including the idea of a complete sale of the business.

Ultimately, your failure to plan can be poisonous to the company’s existence. With proper planning, you can ensure that your family retains your investment for generations to come.

About the author: Mr. Gavin, CPA, CCIFP is a Partner at Grassi & Co., CPAs where he heads up the Construction Practice Group. Grassi & Co., CPAs is headquartered in Jericho, NY and has additional offices in Manhattan, New Jersey, North Carolina, and worldwide through Moore Stephens International Limited. He can be reached at (516) 336-2440 or via email at rgavin@grassicpas.com.

This is part of the June 1, 2010 online edition of Construction News.

Have an opinion on this matter? We'd like to hear from you. Click here.