Succession Planning Best Practices: A Closer Look at the Construction Industry

By January 27, 2020 February 19th, 2020 Construction & Engineering, Tax
Succession Planning Best Practices for Construction

Regardless of industry or size, all businesses must transition ownership and leadership positions at some point in time. Change may come through retirement, resignation, dismissal or some other unplanned or opportunistic circumstances. This is when succession planning and succession management become critical components of your business plan.

Do you have the tools and strategies in place to ensure a smooth transition? Are you incorporating best practices to make sure your succession plan aligns with your business objectives?

What is succession planning?

Succession planning is providing guidance on how the company continues to operate after the incumbent leaders are no longer in control. It involves identifying and growing talent to fill critical business positions in the future. One of the key components of succession planning is the exit planning process that prepares owners to exit from a company with adequate financial resources for retirement and provides opportunities regarding the future direction of the company.

The main goals for succession planning include:

  • Preparing the owner(s)/leaders to exit
  • Ensuring adequate financial resources to sustain or support the plan
  • Determining the future outlook of the company
  • Determining the readiness of future successors

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Why is succession planning important?

Leadership is a key component of any business. So what happens when it comes time for the owner or leader to retire? What happens when there is an unexpected death in a leadership position? Would your business be able to handle the change?

Developing a plan to handle management or ownership succession can be a complex and sensitive issue, but facilitating a smooth transition is critical to the future success of the business – regardless of the industry or size of the company.

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Why is succession planning important for the construction industry?

While succession planning is key for any business in any industry, the construction industry, in particular, features the prevalence of an aging baby boomer generation of business owners and a growing need for transition planning. Yet, despite the trends, many construction businesses do not have a formal transition plan in place.

Many contractors, like most business owners, avoid important succession issues because they touch on sensitive areas. The result is often an inadequate estate plan that does little to fulfill the owner’s vision for both the future of the business and their family.

That’s why it’s important to build a comprehensive succession plan that accounts for the unique needs of your business and family. Being proactive about your succession plan empowers you to have a direct impact on your lasting legacy.

For large corporate construction companies with a larger pool of qualified candidates to consider, it is less of a challenge to appoint a successor. However, large corporate construction companies do not make up the majority of the industry. Rather most construction companies are family-owned/closely held businesses and when that is the case there tend to be fewer and less qualified leaders to choose from.

Therefore, when it comes time for these founding entrepreneurs to leave on their own terms – or in the wake of an unforeseen change – it is crucial to have a detailed succession plan in place to ensure the exit occurs in the most seamless, effective and tax efficient manner.

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How does tax reform come into play?

Recent tax reform generated additional incentives for carefully and deliberately instituting a succession plan – especially when it comes to family-owned businesses.

The Tax Cuts and Jobs Act (TCJA) significantly increased estate, gift and generation-skipping tax exemptions to $11.58 million for an individual and $23.16 million for a married couple in 2020. The exemptions are effective for tax years beginning Jan. 1, 2018, and provide annual increases for inflation through the sunset date of Dec. 31, 2025. This, among a number of other adjustments in the TCJA, creates an opportunity of flexibility for family-owned businesses preparing to transfer to the next generation.

With greater flexibility now available, there is greater incentive for family-owned businesses to assess the new opportunities and prepare the next generation for long term success.

For instance, business owners may now make considerable gifts to family members in an attempt to transfer more of the business to the next generation. This “gift” is now free of any gift or estate tax and effectively transfers twice as much business value (compared to 2017) to children or trusts without being included in the business owner’s estate.

This change may ease some of the complexity around succession planning for family-owned businesses, even eliminating the estate tax altogether in some cases.

Every business feels the impact of the TCJA differently. Some strategies such as retention of certain assets or gifting other types of assets may work for some entities and not for others. Either way it is important to get in front of a tax advisor to unearth some of the hidden opportunities as you work through your succession plan.

If your exit strategy and succession plan do not align, successful succession can be hindered or excessive taxes can be incurred.

Also of note, it is important to keep in mind that tax strategizing is only one aspect of succession planning. Instituting a competent and capable management team is vital for the success of these transitions.

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What are best practices for succession planning?

Too often contractors and other business owners and leaders overlook or delay the necessary discussions regarding succession planning. In most leaders’ eyes, preparing for a successor signifies a loss of control, planning for a sale of the business, or inherently placing trust of your most prized asset into the hands of another person.

However, construction company owners who have undergone successful ownership transitions recognize investing the time in succession planning is well worth it. Among a number of benefits, strong management succession will increase the business’ value and set the stage for the next generation of leadership.

Furthermore, consider other areas of a company: it is not uncommon to establish formal processes and plans to reduce cost and uncertainties while concurrently building value. Succession planning should be no different.

Generally, when it comes to succession planning you should consider the following best practices:

4 Succession Planning Best Practices1. Identify Key Players & Set Goals

It is important to identify key decision-makers and leaders and determine the primary goals of your succession plan. During this time you should consider the following questions:

  • When is the right time to sell or transfer the business? What is the transition timeline?
  • Does the succession plan accurately reflect your business goals?
  • Does the plan align with your personal objectives?
  • Who are the potential successors and do they have the requisite skills and interest needed to lead the company?
  • Can the designated successor afford the deal?
  • Does the plan correctly account for the successor’s financial capacity to acquire the company?
  • Will the customers stay with the new owner?

Common discussion topics regarding succession usually include future financial security, financial stability for dependents, maintaining family ownership and treating dependents equitably.

2. Communicate Objectives

Just as it is important to set your goals, it is equally important to communicate those objectives with key members of the organization. Failing to effectively communicate with other members of leadership or family members may cause costly disruptions and stress for external players, including suppliers, customers, lenders and advisors.

3.  Train a Successor

Once you have identified the key talent, it is up to you to groom them accordingly. You cannot expect a successor to effectively take over the business without any training or guidance. The succession plan as a whole stands to benefit greatly and have a higher chance of success if you dedicate the time and effort to work with your successor before handing over the business.

4. Transfer Ownership

Finally, you must determine how you want to transfer ownership. It is up to you and the succession management team to effectively plan for ownership transition. There are a number of considerations that you must take into account, some of those include:

  • How will the valuation of your business be determined?
  • Will the prospective acquirer or merger be a good fit?
  • What is included in the sale?

When it comes time to prepare for ownership transition, make sure you have your personal and professional goals in mind. There are other options beyond gifting that may suit your succession needs.

Understanding the options available to you helps to prevent unforeseen business or personal circumstances that may impact your plan. It is best to talk with an advisor who can guide you to the most optimal path for you, your business and your family.

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How can Squar Milner help?

The Squar Milner tax team is ready to work with you to prepare for the next phases of your personal and professional life. We can work with you throughout the succession planning process and help you implement the most effective tax strategies.

Beyond that, we have dedicated groups that deal extensively with the Construction and Real Estate industries, among others.

Succession planning involves a number of steps and key considerations. You need a partner by your side that values the success of your business as much as you do. Let Squar Milner be that partner for you.

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Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.