Taking Stock

M&A activity is hot and getting hotter. Should you sell? Or should you consider an employee stock ownership plan?
By Patrick Fallon
August 4, 2022

The recently signed U.S. Infrastructure Investment and Jobs Act is expected to infuse $550 billion into the transportation, broadband, utilities and related sectors over the next five years. This year alone, federal highway and related infrastructure spending is anticipated to grow by 40%. On the residential side, new housing starts are at levels far above what they were only one year ago. Experts anticipate demand to remain high in a red-hot real-estate market.

Architecture, engineering and construction firms are looking to the future by actively assessing their staffing needs, as well as their ability to attract and retain top talent. But that’s not the only consideration they’re facing. In the first nine months of 2021, according to PwC’s “2022 Engineering and Construction Deals Outlook,” deal volume eclipsed pre-pandemic levels by 14%. The prospects for continued industry growth, coupled with favorable credit-market financing, should continue to fuel M&A activity in the months ahead.

If you’re wondering if this is a good time to sell your construction firm, you need to examine all your options carefully. Private-equity and third-party transactions aren’t always smooth sailing, as potential acquirers attempt to retrade deals during the arduous and drawn-out process; in fact, more deals fail than close. Meanwhile, certain alternatives are overlooked altogether—such as employee stock ownership plans (ESOP).

The ESOP Alternative

An ESOP is essentially two things: an employee benefit plan and a self-directed buy-out of your own company. The plan offers employees stock in their company, which they earn over time. Shareholders either contribute or sell equity to a trust that represents those employees. In doing so, owners can unlock some or all of their net worth that’s locked in the business. That means liquidity—with significant tax breaks—for themselves and their families.

Because an employee ownership transaction has one seller (the owner) and one buyer (the employees), companies don’t need to negotiate with or disclose confidential information to unknown third parties. It’s basically a closed-loop transaction between two known parties.

Sustaining legacies and rewarding loyalty: Partial ESOP sales are common, and companies remain independent post-transaction. Selling shareholders often maintain meaningful roles with their companies and potential upside after an ESOP is formed. That’s important for owners who are both deeply involved in day-to-day operations and have strong attachments to their companies.

ESOP stock offers employees a concrete path to wealth creation and incentivizes them to stay. As a result, companies preserve value and protect their most important, intangible assets: culture and identity. This also helps firms recruit top talent, which is essential in an industry dependent on human capital; employee-owned companies benefit from increased employee morale and satisfaction.

Offering tax benefits: An ESOP transaction can also yield tax benefits equivalent to the sale value. Those deductions should reduce or even eliminate a company’s annual income-tax burden for multiple years. If a company is 100% employee-owned, it will never pay federal or state income taxes, so long as it’s organized as an S corporation (with a few exceptions). That added cash flow can be a real advantage—especially in terms of project bidding, overall operational efficiency and growth capital.

There’s also a tax incentive for selling shareholders: the opportunity to defer or eliminate capital gains burdens on sale proceeds. Called a 1042 rollover, it’s a benefit that’s unique to ESOP sales.

Exploring Employee Ownership

Before planning a long-term succession strategy or diving into an M&A deal, you’ll want to consider an ESOP. It may not be the right fit for your firm, but you won’t know for certain until you talk to an experienced adviser, understand your options and run the numbers. From there, it’s a lot easier to determine the best path forward.

For many construction companies, the benefits offered by an ESOP can create value for all stakeholders. That’s especially true for owners seeking to gain liquidity and to reward employees for their help in building the business. In the end, employee ownership has the power to preserve brands and legacies built over years of hard work.

by Patrick Fallon

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