By Brad Eriksen
Construction and development firms face unique challenges when planning, structuring, and implementing a succession plan. Successful succession planning is the art of transferring the control, ownership, and management of the business. While each of these elements (control, ownership, and management) requires careful consideration when structuring any successful succession plan, there are a number of considerations unique to construction and development firms.
Many agreements the company is party to, such as leases, construction contracts, etcetera, likely contain provisions prohibiting the assignment or transfer of the agreement. Broadly written, non-assignment provisions can expressly prohibit transfer of the ownership of the company as well. Inadvertent violation of these non-assignment provisions while transferring ownership can put the company in breach of the agreement and liable for default damages. Since ownership is but one element of a succession plan, proper use of the other elements (i.e., transition of control and/or management) can help navigate around the non-assignment restrictions and allow implementation of the succession plan without violating the non-assignment provisions of leases and contracts.
Financing and bonding needs for future projects may also be an impediment to implementing a succession plan. The new owners of the company may not have a strong financial statement necessary to obtain required financing and bonding. Much of the new owners’ resources and cash flow may of necessity be needed to pay for their interest in the business, leaving little financial support to back the financing and bonding needs of the company. Creative structuring, such as continued participation by the departing owners or silent participation by a strong financial partner, may be necessary so the company can continue to operate as it has historically. In order to assure that the financial backer is adequately protected, security and collateral must be put in place in such a way that allows the company to continue to operate while still protecting the financial backer.
Because of the real property and heavy equipment nature of development and construction companies, there are both possible tax benefits and tax pitfalls when structuring succession plans for the company. On the positive side, deferred taxation is possible for both real property and equipment sales. By lowering the tax cost of a transaction, it may be easier to finance the succession plan and bring in new owners. On the negative side, depreciation recapture can drive the tax cost of a succession plan unreasonably high, endangering the success of the plan. Careful analysis of the company’s financial statements, tax returns, and depreciation schedules, along with proper structuring and allocation of purchase price, greatly increases the likelihood of a successful plan.
Unfunded Pension Liabilities
Even when a company has faithfully made all of its required contributions to the pension/union trust fund administering its retirement plan, the company may still find itself in a position of having unfunded pension liabilities. Implementation of an improperly designed succession plan can trigger significant withdrawl liability for the company and potentially its departing owners. New owners are reluctant to assume responsibility for this uncertain liability. This can often bring implementation of a succession plan to a standstill. However, creative use and structuring of each element of a succession plan (again, ownership, control, management) can allow partial implementation of the succession plan and defer or decrease any underfunded pension liability.
Even in the best of times, it is a challenge to successfully implement a succession plan. For construction and development companies the challenge can be even greater. However, with proper planning, the likelihood for success can be increased and allow the departing owners to enjoy the fruits of their labors.