The most common contractor exit is a management buyout (MBO) as fewer than 10% of contractors that go to market ever sell. The odds improve if your revenues exceed $10 million.

The lack of recurring revenue and the connection to cyclic economic conditions make construction companies a risky investment by outsiders (consolidators or private equity).

This means a roofing contractor’s most probable opportunity for monetizing the business will come from senior managers and family who understand how to manage this risk.

I still hear this over and over again from owners: “My managers don’t make enough money to buy the company!”

I get it. The largest obstacle in executing an MBO is that managers often do not have the financial ability to pay for the business. This requires the business owner to structure a plan that will allow the business to pay for the transition over time.

Therefore, advisers should educate owners to the many tools available to help achieve the best tax yield for the buyer, seller, and the business. Remember, the business pays for everything.

The adviser should also educate the owner with several tax efficient plans to pre-save for the exit on their path to retirement.

Another major obstacle for the seller of an MBO is the financial risk. The risk of an MBO is the owner not being paid. The senior management team performance is tied to the cash flow that will pay you. This is why succession is a key factor in an MBO.

The good news is that an MBO exit has a lot of flexibility and, if properly structured, can have significant tax advantages. In certain situations, a properly structured MBO will reap a better bottom line result than an outside sale because of the tax savings and still being paid during the process.

Remember, it is not how much you get, but how much you keep.

Utilizing the ideal balance and coordination of various tools should create a result of dollar maximization with risk minimization.

Key considerations include:

• Know the value of your company (valuation) and tax mitigation strategies.
• Sales price can be negotiated as opposed to a computed amount in accordance with IRS ruling 59-60.
• Create strategies to eliminate the various tax liabilities (which can exceed 55%) with bottom line after tax illustrations of each path.
• Structure the deal so the owner stays in control until the last check is in the bank.
• Implement “asset management” tools to protect the company, to protect what you have built.
• Begin preparing the managers for succession ASAP because it takes time. You will know when they have traction when you can take a care-free, two-week vacation.
• Future cash flow pays for everything, and your managers will drive the profits that buy the stock.
• Time is your best friend, so start early and implement slowly.

Below are several business and key risk-management concepts for your exit via a management buyout.

Business

Visualize Your Financial Future: Owners cannot commit to retirement until they can visualize their financial future with an exit plan. The plan calculates the value of the company, before and after taxes, so the proceeds can create the income to maintain the owner’s present lifestyle in retirement. Only then will the owner be motivated to pick and lead the team into the MBO and succession process.

Outside Savings: While the owner is still in control, he or she should contribute as much as possible to many tax efficient savings and retirement accounts for the company and owner. This will take the pressure off the price of the company during the sale that are outlined in the exit plan.

Benefits: The owner can still receive benefits during the sale and have those benefits phased out over time depending on the sales agreement. This is all determined in the exit plan and understood before the sales agreement.

Win-Win: An MBO is a win-win for the buyer (management) and seller (owner/s). Management has the opportunity to build significant personal wealth, and the owner benefits by cashing in on the investment built in the company. Sellers also leave a legacy with trusted stewards who bring a new energy to the company.

The Company Pays for Everything: I remember in the late 1980s when our company’s owner asked me if I would like to buy the company and I said, “Dick, I cannot afford to buy the company.” He said, “Kevin, just keep the company growing and profitable, and the company will buy my stock and give it to you.” In other words, if you generate profits, the company will pay for everything.

Ownership: Multiple ownership has become an increasing trend in the industry. A study conducted by FMI on the distribution of ownership in construction companies illustrates the following composition of multiple owners:

• 67%: multiple owners with one shareholder in control
• 27%: multiple owners with no control
• 6%: one owner with all the stock

Shareholders: The new shareholders must understand that their stock ownership does not necessarily make them the boss. There can only be one boss/authority. Yes, you are a senior manager and work collectively for the company’s success, but you are an employee/associate first and a shareholder second. As a shareholder, you benefit directly from the success of the company.

Risk Management

Risk: With an MBO there is a risk of the owner(s) not being paid by the managers. That is why it is critical to find the right person(s) who have demonstrated the broad capability to run the company and who show the leadership ability to take the company to the next level.

Buy-Sell Agreement: The shareholder agreement must address the four D’s of death, disability, divorce and departure and how they trigger the buy-sell. The agreement should leave little ambiguity for the reader. Remember, in most cases, the document will be referred to by the existing owners, the deceased shareholders spouse, and legal counsel. The agreement should consider valuation formulas, funding and transfer of ownership.

The Golden Egg: The company is the goose that lays the golden eggs. The company must remain fiscally healthy during the buyout and endure the economic cycles. During our buyout we kept the payments flexible even though I had annual notes from the buyers. Why? Because the company came first. Our company buyout paid out early over two recessions.

Financing: The sale is many times funded by seller financing, the redemption of the owner’s share over time or by outside financing via a leveraged buyout.

Financial Partners: Be transparent with your key financial partners, including your bank and bonding company, as they should be kept in the loop with your transition plan. The company still needs to keep healthy financial ratios and the necessary working capital, but it will look different as money is transferred to the owner in the buyout. Your financial partners will understand and benefit from a well-thought out transition plan.

Personal Guarantees: Get the new management and especially the comptroller engaged with your financial partners. Banks and bonding companies depend on the owner’s personal guarantees, which will have to be transferred to the new owners near the end of the buyout.

Character Matters: The company associates are your key asset. Promote the best people into the right chairs for the company to perform.The empty chair must be replaced with a person of integrity. Leaders put the company, customers and associates first, not themselves.

Succession: Succession is key as the owner is being paid by the management’s performance. First the managers need to get to the next stage by growing and performing as champions. During this time, they must begin to think like owners and always put the company first. Then move into leadership by dealing with their blind spots and lead the company into the next generation.

Continuous Process: Succession takes time. It is a continuous process, not a single event. The process is about the development of talent and not the typical replacement of talent. Your best players are developed in your internal culture, and owners must provide the curriculum, training, and leadership development.

The process is designed to lift off around the third year and continues to improve.

In conclusion, the process of exiting your business should not be taken lightly as there is much at stake. For many owners, the business can be their largest single asset (more than 70%) and the primary source of retirement funds.

With so many moving parts and the government as the greatest source of sales price erosion, a carefully designed exit plan should help overcome many of the barriers that owners will confront.

In this process, time can be your best friend, so start early and implement slowly.

Tax laws are complex and subject to change. Contact your professionals for tax or legal advice. IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.