June 10, 2022 •CSG Partners Staff
M&A volume across the construction industry has soared in recent years. Despite potential economic headwinds, sustained activity is likely, spurred by increased infrastructure spending and a growing population of retirement-age owners.
Private equity's impact is undeniable. Since the early 2000s, when PE firms first turned their attention to builders and contractors, platform and add-on transactions have steadily gained favor. But the PE model isn't always a best-fit – especially when companies prioritize business independence and legacy preservation. Under these circumstances, employee stock ownership plans offer a meaningful shareholder liquidity alternative.
Why do built environment firms consider ESOPs?Lawrence Kaplan, CSG's Founder and Managing Partner, addressed this central question at a recent Vistage Networks webinar. In a lively Q&A with members of the construction, architectural, and engineering community, Kaplan shared the basics and benefits of leveraged ESOPs while highlighting a number of key considerations, including:
- Using ESOPs to Phase Out Ownership
- Comparing Employee Ownership and Other M&A Strategies
- Securing Third-Party Financing
- Bonding and Employee-Owned Companies
- Incentivizing Key Managers
Fair Market Value, Tax-Efficiency, and Continuity
"Most business owners have a lot of eggs in a single basket: their companies... In an ESOP, you're selling equity to an employee trust and taking cash off the table in a tax-advantaged transaction."
"It's very difficult to hire and retain people, and your competitors may poach your staff. By putting an ESOP in place and communicating the value to your employees, you create a benefit that can help them build significant equity value. When they retire, the company buys that equity from them."
Enables Gradual Transition of Ownership
"The majority of the companies we work with have owners that aren't retiring tomorrow. They might have a five or 10-year time horizon... They'll usually do an ESOP in stages, where they'll sell 30% today, but still retain majority interest."
"We have a few clients in the construction industry that have said to their employees: 'We're going to put in an ESOP on a minority basis. If you show that can help run this company and take it to the next level, then our intention is to sell the balance of the company to the employee trust.'"
Unique Advantages vs. Other M&A Strategies
"A strategic buyer could potentially pay the most for your company... but most construction companies don't like opening their books to competitors."
"A leveraged ESOP is like a private equity deal, but your own company borrows money from the capital markets instead of the private equity firm... Additionally, in an employee ownership transaction, selling shareholders can defer capital gains taxes, companies can deleverage at a faster clip (thanks to tax deductions), and equity is going to your employees - instead of a third-party investor."
Ample Third-Party Financing Available
"When I started doing ESOPs over 22 years ago, it was difficult to raise money for construction companies in terms of doing a leveraged transaction. That marketplace has completely shifted. There are so many different banks that are actively looking to finance transactions."
"Banks found that construction companies have been good credits. And while we're not getting the same type of leverage as for manufacturing ESOPs, we are getting leverage. And there are multiple banks (and non-bank lenders) financing transactions."
Compatible with Bonding Obligations
"We've seen a dramatic loosening of bonding standards. Before they would not allow leveraged transactions on a construction firm's balance sheet, and now they do."
"If you simply asked your bonding company to borrow money and take it out of your business, they would say, 'No.' But if you run an ESOP process, and you involve multiple bonding companies, you'll find partners that want to do the transaction... It comes down to communication and negotiation."
Additional Incentives for Key Managers
"A lot of times, business owners want to get more stock flowing to their key management team because they believe these employees will be major drivers of business in the future."
"A significant synthetic equity plan can be negotiated for the company's top managers, as part of an ESOP transaction... It's a way of helping the management team, who could not afford to buy the company outright, to help them buy a portion of the company, in conjunction with the ESOP."
Additional Employee Ownership Topics Covered:
- Plan Participation Rules
- Trustee's Role
- ESOP Formation Process
- Seller vs. Third-Party Financing
- Deleveraging After a Transaction
- Annual Valuations
- Transaction Options Post-ESOP
- Roll-up Strategies
- Estate Planning Considerations