Type-A. Entrepreneurial. Driven. Innovative. Tireless. Sound familiar? Contractors are planners by nature. Most company principals have worked their entire professional lives to build and grow their firms, yet for many, the idea of perpetuating their business is always years away. In an era of record valuations, it’s easy to make the assumption that a willing buyer will always be there to take the reins.
The key to successful ownership transition is simply to have a plan! While the main reason behind a transition strategy is to blueprint the future transfer of ownership, it also will respond to pitfalls such as the unexpected death of a key employee or an economic downturn (making those willing buyers much harder to find). Having a plan in place could be the difference between successfully transitioning ownership to a new generation or closing the doors permanently.
A strong perpetuation plan will identify the successor or purchaser (key employees, family or friends, sale to an outside firm/investment company, or merger with another company), the method of conversion, and how that transition will be funded. Important elements of the plan can include, but are not limited to, the following:
- Buy-Sell Agreement – in the event of the sudden death of an owner, this agreement will outline the operational and financial transition to the new ownership group. The buy-sell agreement should have a pre-established funding source such as life insurance and be structured to take income and estate tax needs into account.
- Life Insurance – A vital part of the Buy-Sell Agreement that is often overlooked is how the transition will be funded. Life Insurance can provide much needed capital to the owner’s family or next in line to ensure the company will survive the transition.
- Limited Liability Company – Many perpetuation plans establish a holding company for business interests and other assets. The ownership team can gradually transition ownership interest in the new LLC to the future ownership group, while allowing the primary owner to retain operating control of the business.
- Shared Responsibility and Indemnity – Often times, companies will have a single owner who has been responsible for providing personal guarantees or indemnity to banks and surety companies. These guarantees provide operating capital and credit vital to the company. Any perpetuation plan should educate and prepare the next generation of ownership to share these financial responsibilities.
The first step to a solid transition plan is determining your ideal outcome and sharing it with key stakeholders and advisors. Even if you plan on running your business for decades to come, share your desires and ideas with those around you! Making sure your team members are aware of and understand your plan is critical, yet often overlooked. Accounting, Legal, Insurance and Surety representatives can all provide valuable insight and help to avoid common pitfalls. They can also assist with starting internal conversations with key employees and future leadership. Like most major business endeavors, the hardest part is getting started!