Throughout the next decade, numerous baby boomers who own construction businesses will retire and exit the marketplace. For many, a good portion of their personal wealth is tied up in the business. To maximize financial gain upon retirement, owners will benefit from a well-planned transition strategy. 

There are four common paths for changing ownership of a business: employee stock ownership plan (ESOP), sale to a third party, initial public offering and transition to family members or an existing management team. Just as each business is unique, the transition strategy that may work for one company may not work for another. Understanding the alternatives and selecting one carefully will go a long way toward making a smooth transition to retirement.

Employee Stock Ownership Plan 
An ESOP essentially is a tax-qualified retirement plan that owns or invests in the company’s stock. An ESOP differs from other tax-qualified retirement plans in three main ways: The ESOP must invest primarily in the company’s stock, it can borrow money to finance the purchase of company stock, and it offers additional tax advantages not available using other ownership succession strategies. 

Some main benefits include: 
  • A company that is owned by an ESOP and that elects S corporation status for tax purposes pays no federal or state income tax on the portion of the company owned by the ESOP, greatly enhancing cash flow. 
  • An ESOP generally is a sustainable form of ownership because beneficial ownership is spread over all employees, which, for the most part, prevents a large buyout or redemption obligation in the future because of employee group demographics. 
  • The company’s exiting owner generally can stay involved for a time after the sale and exert influence over business matters.
Sale to a Third Party 
Sale to an unrelated third party, such as a private equity firm or other strategic buyer, is another common business transition path. The main benefit is that it often results in the highest value for the seller. A sale process with several interested third-party buyers has the potential to yield a greater return for the seller versus negotiation with a single buyer. 

However, sellers may want to consider the emotional side of such a transaction and be prepared for what a third-party buyer might do after acquiring the business, including changing the organizational culture, terminating employees or moving the headquarters. Often some of the selling price is in the form of contingent consideration based on future earnings. 

Initial Public Offering 
Another way for a business owner to transition a business and realize its cash value is by taking the company public in an initial public offering (IPO). With a traditional IPO, a private company issues new equity shares that are listed on an exchange and made available to the general public to buy and sell. 

The most prominent benefit to establishing an IPO is the access to liquid capital that results from opening the company up to a wider pool of investors. However, an IPO comes with a host of complexities, including regulations, legal costs, increased public scrutiny, and other factors that call for careful research and consideration. 

Transition to Family Members or The Management Team 
Transitioning the company to family members can be a comforting option for owners who wish to continue the legacy and tradition of the business, especially if the family’s name is attached to it. 

One potential pitfall of a family transition is balancing ownership among multiple family members, which can create conflict. The most successful transitions to family members are those in which the successors spend several years working in the organization, learning the business and building respect among employees.

Various options exist for selling ownership to family members. The transfer method chosen depends on numerous factors and circumstances. 

If an owner is financially secure, transfer options include a grantor-retained annuity trust sale, a straight gift or an intentionally defective irrevocable trust sale. These options primarily use a form of gifting, which is designed to reduce the estate tax the family will owe upon the passing of the parent or parents. If the owner is seeking value from the business, then a sale of stock would be an appropriate option. 

Selling the business to members of the current management team is another common transition path for business owners. This option can be rewarding, with business owners putting their faith in the people with whom they have worked and developed the company. 

Options for selling the business to members of the management team include: 
  • selling directly to the managers (generally for a promissory note funded by the earnings from the business in the future);
  • granting stock to the employees as a bonus, followed by the company redeeming the exiting owner’s stock; and
  • selling multiple blocks of shares each year for a period of years (known as a serial redemption).
With these arrangements,the company’s earnings essentially fund the purchase, which makes it a good option for employees who generally would not have the money to directly purchase the business. 

Likewise, these arrangements offer benefits to the seller, including being able to leave behind the stress, challenges and risks of running the business while still gaining financially from it. 

Larry Mackowiak is a partner at Crowe Horwath LLP. For more information, email larry.mackowiak@crowehorwath.com.