Exit Planning Strategies for Construction Owners—Selling Internally

If you plan on retiring from your construction or contracting business, it’s crucial to have a clear exit strategy for how you will sell and transfer the company to others. Otherwise, according to Exit Planning Institute data, you could become one of the 76% of business owners who feel profound regret within a year of their sale. 

A major decision is whether you want to sell to an external buyer, or to those who are already part of your construction firm. Here, we’ll discuss why you might want to sell internally—and how. 

When you sell internally, you sell to someone already working at your business. This could be a buyout from your business partners and other existing owners who want to keep working, and it could also be a transfer to your family members. 

If you have key employees you want to keep loyal to your firm, you could set up a buyout agreement where they will eventually take over your contracting/construction business, either through a direct purchase or through an Employee Stock Ownership Plan (or “ESOP,” a type of workplace retirement plan). 

Selling internally is usually a more straightforward exit plan for contractors. You’re dealing with people already working for your company, and they know your employees, clients, and business plan. This means you don’t have to search for a prospective buyer. It can also cut down on your transaction costs because you don’t need to hire a broker to find prospective buyers, you don’t need to get out and market your business, etc. 

Most construction businesses aren’t a good fit to sell externally because so much value is based on internal employees, with their knowledge and relationships. However, you might have no choice but to sell internally, especially if trying another approach could mean losing your best employees, a vital part of your company’s value. 

On the other hand, with selling internally, you don’t have the same opportunity to maximize your price, as you aren’t collecting multiple bids. Internal buyers usually have fewer financial assets, and it can feel uncomfortable to push tough negotiations with people you know personally. It also usually takes longer for you to receive all your money from this type of sale, as internal buyers would likely need to fund your buyout using future company revenues. 

Lastly, internal buyers might be convenient but aren’t always the best people to lead your company. This could especially be true if you sell to family members, as most family businesses struggle after passing to the second and third generations. 

When you sell to family members and other owners, they most likely won’t have the cash on hand to complete the purchase right away. They also would not be able to take out a loan to cash you out immediately. Lenders don’t provide this type of financing because there isn’t enough remaining equity to back up the loan after paying you out. 

Instead, you structure these deals as a long-term buyout where the new owners pay you out of future revenues. These deals take time, as you get paid out of future cash flows. It could take 8-to-12 years to complete your buyout, and there’s also the risk that the new owners might not correctly manage your business, and never complete the buyout. 

To protect yourself and your future payments, you could set up a stock sale where the new owners agree to purchase 40% of the company while you retain 60% to stay in control. That way, you’re protected. 

Over time, the new owners pay off the agreed purchase price for those shares. At the end of the payment term, they could then have enough equity to qualify for a loan to buy out your remainder. Or, if you aren’t happy, you could then sell the remainder to another investor or external buyer.  

If you have key employees who you don’t want to lose, you could also propose that they buy out your company in the future. This way, they stay loyal to your firm and won’t be tempted to leave for a competitor or start their own firm.  

To keep these non-owner employees satisfied, you could propose gradual equity transfers over time, so they receive some ownership and stake in the company’s future while you’re still there. Then, once you’re ready to retire, you could set up a formal buyout. 

Another way to transfer ownership to your employees is through an Employee Stock Ownership Plan. You would sell your shares to the ESOP as part of your exit. If your company doesn’t have enough cash to complete your buyout, you would accept a promissory note for the unpaid amount. Over time, future company cash flows pay off your business loan to the ESOP, thus funding your buyout. 

Your employees also gradually earn shares of your company through the ESOP. The number of shares is based on compensation and commitment. The plan has a vesting schedule with a minimum number of years required to earn shares. Employees who leave early forfeit their unvested shares. When an employee retires or quits, they sell back their vested shares to the company for fair market value. 

There are tax advantages to selling through an ESOP as you can delay the taxes on your sale proceeds. It also keeps your employees loyal. The drawback is that you need to pay to set up and manage this retirement plan, which is an extra cost. You also end up selling shares to all employees of your company versus targeting the key players under a standard buyout. 

If you feel comfortable financially, and your top priority is to transfer it to family members so they can succeed, you can give them the business—then they take over without the burden of having to finance your buyout with future cash flow. 

While this helps your family members, it means making a substantial financial sacrifice. Be sure your retirement plan is strong enough to support this decision. 

As part of the transfer, you may want to start by transferring over nonvoting shares of your business, with the option to repurchase them should you change your mind. Only when you’re sure of your financial position and happy with how the next generation is handling the business would you complete the gift of your voting ownership shares.  

Giving away a valuable construction business could lead to you owing gift taxes or a tax on property transfer. Work with an estate planning expert to figure out how to structure the transfer while minimizing taxes.  

As you weigh your options, consider speaking with one of Aldrich’s construction experts. Our deep industry knowledge and experience help you navigate exit planning while achieving your financial goals.