Voiceover:
From Carr, Riggs & Ingram, this is It Figures: The CRI Podcast, an accounting, advisory and industry-focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.
Dan Sellers:
All right. I am Dan Sellers. I’m with Carr, Riggs & Ingram in the Birmingham office, and I’m joined by Robert Coker, also a partner in the Birmingham office. And today, we’re going to be talking about transition and succession planning, the issues and difficulties that businesses face when that situation arises and specifically how it relates to contractors, Robert, because that’s where we spend most of our time.
Robert Coker:
It is in fact, Dan, and it’s probably one of the biggest challenges we face. And I think it’s true in every industry, not just contractors, but it is specifically difficult with some of the nuances that contractors have to deal with, bonding and such as that.
Dan Sellers:
Yeah. And this is a situation that’s pretty widespread across all businesses just because of the demographic setup that we’re in where I think we have an estimate of like 11,500 people a day turning 65. So across all industries, you’re just seeing a brain drain where experienced leaders of companies are at retirement age, nearing retirement age, or like we’ve seen many of our clients, Robert, working well past retirement age to make things continue to work.
Robert Coker:
Too far past retirement age in some cases.
Dan Sellers:
I think when you start looking at some of the issues and difficulties that businesses face when they encounter this situation, to me, I think you can really sum it up in three buckets. You’ve got what I call people difficulties, which really, to me, are the hardest ones. And then there’s some operational difficulties and then control and financial difficulties, which have the most impact in where we come in. But I think before we get into some of those, the people difficulties, to me, is really the most important because if you have not identified that successor, your key senior leadership to step into the shoes when the owner walks away, I mean, that’s a major problem. And that’s the hardest problem to solve because you haven’t identified that person or you don’t have that person, you can’t solve the operational and financial problems that come with it and you’re led to other ways to solve it.
Robert Coker:
The interesting part about that, we went to a recent local chapter of an association, a contractor’s association meeting, and we were the presenters. And we had sort of a small roundtable discussion, and some of which were really just dabbling in the very beginning of it, whereas others had a pretty robust plan already identified looking five, 10 years and three years as far as really getting that on target, and it already sort of identified key players in that process. But if you don’t have them, it’s even a bigger challenge. Right? In other words, it’s hard to solve for X when you’re trying to solve for Y, too. So two unknowns, you can’t solve that equation.
Dan Sellers:
That’s exactly right. And I think that’s a good example of one of the problems you see is as we’re solving the day-to-day problems of the business, of running the operation, it’s easy to kick the can down the road on finding the success or finding the next round of leaders. You mentioned at that association we were at, we had a couple of folks there that were on that three and five-year plan. They started early, and that’s really a best practice. If you can start early identifying your future leaders, then you can develop that mid-range and long-range plan to bring them in and you don’t have these shocks to the business. That’s really a best practice. But too often we see where we procrastinate on finding those future round of leaders, whether they don’t exist in the company, whether we haven’t invested in them from a mentorship perspective to grow them to be those next leaders. And so that’s where we’ve seen time and time again, that can create issues in identifying those people.
Robert Coker:
The generational issue that comes up in that, Dan, is really, I think so many of the older owners really, really struggle in this area and that they can’t reconcile the work ethic and the operational mentality. And it really just keeps them from going forward as far as actually coming up with that plan.
Dan Sellers:
That’s exactly right. And we’ve never seen anyone, certainly an owner, that would have control issues, right? And so-
Robert Coker:
Never. Never.
Dan Sellers:
[inaudible 00:05:27].
Robert Coker:
We even have a [inaudible 00:05:28] in the CPA firm, I know that’s hard to imagine.
Dan Sellers:
But having to cede control is hard, especially when you’ve been successful, when you’ve built a really good business doing it your way, and maybe you have someone from a different generation saying, “Maybe we should do something a different way.” And there’s plenty of leaders out there who are willing to adapt, but it’s hard, certainly if you’ve been set in your ways and been successful doing something for multi-decades.
Robert Coker:
But the thing is on that, and we caution our clients all the time on it, what worked yesterday may not work in the future because everything is changing so rapidly. AI and the like is changing the whole environment. And we have to look at that in a different light, and certainly, we don’t want to see our clients do anything but be successful, but when they’re really stubborn and stuck in their ways, mule-headed as I like to call them, it really poses some challenges out there for us.
Dan Sellers:
That’s exactly right. And I think as we focus specifically on contractors, one thing that is true certainly of small and medium-sized contractors, most of these businesses are family-owned or certainly closely held entities. And when you’re operating an entity like that, the relationships with the customers, the relationships with the subcontractors and vendors, the key stakeholders across the entity, a lot of times, those relationships have been controlled and developed by the owner, by the key employee over decades. And transitioning that relationship piece, you kind of get back maybe to the control aspect of, if I transition this customer, if I transition this subcontractor relationship, can this future leader, can they handle it the way I did?
Robert Coker:
And there’s the piece that’s key, can they handle it the way I did instead of the way they should? And you just got to give them a long leash in that, and really, oversight is important, I agree. You just can’t divest yourself with the whole idea of going, “I still got to maintain my relationship.” But sort of bringing them to the table more often is really the key in that process. I mean, it really is a challenge though. And the family members, it’s really more difficult because they already suffer from different dynamics altogether because they’re family.
Dan Sellers:
Absolutely. Yeah, I think the summary there is whether it’s a family member that’s being transitioned to or just a key employee that’s not in the family, there’s going to be some friction. There’s going to be some pain points during this process. So it’s not going to be a quick process. So that’s why when we say start early in identifying and implementing the plan, because it’s not going to go smoothly. We can all sit in a conference room and come up with a beautiful plan that might be a two-year transition plan to transition this owner out, but we all know it really may take four years or five years because we’re going to hit some speed bumps along the way, whether it be with our relationships, with our customers and vendors as we talked about, or whether it be with operations, financial analysis. Everybody’s got different strengths, and you got to leave yourself enough lead time to make sure that all of those different aspects of the business are covered in this transition.
Robert Coker:
One of the key pieces in this people issue, and I think it raised its ugly head worse than ever, was COVID, which took some people out of the mix that you didn’t expect to leave and they did, and it left holes in that organization that others had to fill. So it makes it even more difficult. You’re saying, “Look, I’m just still trying to recover from the loss of those key people, and now, you’re wanting me to add another layer of extra work.” And it is work to get it done, right? To do that transition requires an investment, and the most valuable commodity we have is time.
Dan Sellers:
Absolutely. And I think so often that as business owners, you can be so focused on the day-to-day, on completing the job, on obtaining the new job, on handling problems of jobs to keep them moving forward, that we don’t invest the time as a leader and an owner to mentor. Right? And that’s where you get that disruption to operations. If you’re not investing that time to mentor, to bring them up, and then you have a situation like COVID where unexpectedly people are leaving the workforce, people are taking different jobs, getting out of changing industries, whatever it may be, and all of a sudden, the plan you thought you had that you hadn’t invested in is now not even on the table.
Robert Coker:
Correct. Because those key people are gone and you’re in a scramble. And they’re really asking the questions like we do every day – “Well, who’s going to do the work?” Yeah, I know it’s important to go out and do selling, but today, I got to get the job done so I don’t lose money on this job that I’m currently working on. So pulling away from it, it is a struggle and we understand it better because we have the beauty of sort of what I call economic voyeurism, if you will, because we see the problems that these owners face, and then while we don’t have to face it ideally the same way, we’re in the same boat they are. We have the same thing happening in our industry that’s happening in theirs.
Dan Sellers:
So we’ve touched on the people difficulties that can pop up and also some of the operational difficulties. Where I think certainly specific to contractors where you have to have some planning involved is there are some unique difficulties you can encounter as you’re structuring a transition of ownership that could have adverse financial consequences if you don’t plan through what it means for your balance sheet, what it means for your liquidity as you structure a buyout or a transition of ownership, because as we know, there’s so many different ways that you could structure it – outside financing, inside financing. There’s so many different ways that could look and how you structure that could increase your debt load, it could impact your working capital, it could reduce your equity. And all of those things, if you haven’t thought through the financial implications of the post-buyout structure, could impact your bonding capacity, if you’ve got working capital liquidity, equity issues, licensure, bonding capacity, all sorts of things.
Robert Coker:
You know what, dovetail with that, I guess, and this is something that I know I have conversations with these owners all the time, they’re wearing three hats. They’re doing the marketing, they’re doing the oversight of the finances, and they’re also looking at operational issues. And they realize, well, somebody coming in may not necessarily be able to do all that, and worse yet, how do you transfer that relationship that you’ve spent years developing and get that other person in place? And it may take three people to do the same job that you’ve got one person doing. And that in itself is a rub for some of the older generation to go, “I don’t understand why I got to have three people to do what I did all these years.” Well, that’s because they were at the office 78 hours a week. They lived there on the weekends to just get caught up on all the stuff they didn’t do during the week. And honestly, it’s a sea change generationally speaking, and honestly, I think the younger generation’s getting it right. They understand quality time outside of the office, and they understand that family and spending time with others really is meaningful and sometime the dollar didn’t fix it for them. So that’s another piece in this proposition that raises its ugly head.
Dan Sellers:
Yep, 100% right. Kind of going back to the financial piece, Robert, from your experience, is there some structures that you’ve seen where a buyout is structured into new ownership where it was done maybe improperly or maybe not done the best way and it created some liquidity or equity bonding issues?
Robert Coker:
A great example of that is ESOPs. While some people think that is the way to say, “Okay, well, we’re going to have the employees take it over,” well, in order to do that, you just decimated the equity and you also loaded it up with a piece of debt in the process that you get into that really hamstrings the contractor. You got to take in mind, and that’s the beauty of what Dan and I do. We do audit and tax simultaneously, which is a unique animal in itself, but we always have to manage, what is this going to do to our bonding capacity? What’s it going to do to our covenants as far as meeting that? And God forbid, is it going to generate some income tax? Because we all hate that.
And so our owners are keeping an eye on all of that and they expect the one that gives them the best answer, and that’s the key because you can walk out the door, again, having that idea of having enough time to transition. Especially if you’re going to basically have the business retire the owners, they can’t leave the building all at one time. If they’re buying out their equity at one pop, well, you’re stripping that balance sheet of that equity and converting that into a note. Well, what does that do to your working capital? Now, you got a big current portion sitting there that didn’t used to exist and you got some debt, does some stuff to your debt covenants, also hurts your bonding capacity because now you’ve affected working capital. And in that same process, you got contractor’s licenses as well as bonding. They’re looking at the overall equity, and you just took a hit immediately.
So the cash flow is also a piece in that that you have to manage. It can’t be gone over a two-year period because the business basically couldn’t stomach it. Right? And the bonding company, the sureties, they want to know what’s the plan. That’s really our biggest… I guess our biggest challenge is making sure they’re happy with the program and they want to know what’s going to happen, because they’re bonding something that they may have to step in later and take care of. But you got to have the financial wherewithal to continue on in your business. So I think that’s the real key is it’s not an overnight process and you can’t just wreck the balance sheet and income statement in the process.
Dan Sellers:
Correct. It takes a lot of planning, again, not just the people and the operational challenges, but as you structure that, the first idea that’s thrown out, it may not be the one that winds up winning the day. And so you’ve got to sort of think through the scenarios of the different buyout structures and transition structures and how that’s going to impact the company.
Another thing I know that pops up in this is certainly if you’re transitioning this to non-family members to let’s say key employees. Well, what if they don’t have the financial ability as an individual to buy out the stock or buy out the owner? So what have you seen in that regard and is that something that we should be thinking about?
Robert Coker:
That piece really comes down to one concept. You just can’t be greedy. If you’re expecting those key employees to buy you out, a piece of your compensation package, basically sort of an LTIP like you and I have seen, a long-term incentive plan that sets aside monies that are owed back to that employee, but they vest over time to give them the financial ability to then convert that balance over to equity. And in other words, it’s becoming their money so they have something to buy you out with. You can’t pay them $75,000 a year forever and go, “I’m expecting them to buy me out in the end.” Then you got to look outside of the company itself, and that’s typically not a great answer either, especially with contractors because so much, just like our business is relationships, and it really is those people that have built your business. So you got to share the love. I mean, you got to start sharing it early because you got to have that in place, sometimes, it’s five, 10 years that you got to give them the ability to build up some working capital. Oldco/Newco, like we’ve seen as well, Dan.
Dan Sellers:
Sure.
Robert Coker:
I’ll let you talk about that for a minute, and that’s been a great way for transition that we’ve seen.
Dan Sellers:
Yeah. The Oldco/Newco structure, what you have is you have a group of new owners that take over Newco, and the jobs in process, existing projects stay in Oldco and are sort of, I guess, novated over, right, Robert?
Robert Coker:
Correct, correct. You can novate those contracts and then say, “We’re going to give the old owners a piece of that profit, but we’re going to keep a portion to build that balance sheet, build the equity and the cash reserves that are necessary to get that where it’s a standalone.” In other words, what you’re trying to do is build the castle on the other moat or across the moat so that they’ve got the ability to do this.
Dan Sellers:
So I mean, I think those are the real key aspects of it from my perspective. And again, I think with any business, as you’re approaching this transition and succession problem, you’ve really got to take care of all three facets. You got to have the people in place that you trust to hand over the business to. You got to make sure you’ve trained them on all the aspects of the business that they can make the decisions as you walk out the door with all of that knowledge. And that’s where the operational comes in and making sure that you’ve taken the time to show them all facets of the business. That’s time away from getting work done on a day-to-day basis, but it’s important to be able to walk out of the building and still see the success of the company that you helped built to invest that time and come up with a plan for those people.
And then I think finally, the control and the financial problems that come with it that we talked about are in order to make it successful, you’re going to have to get okay giving up some control, and like you said, Robert, can’t be greedy. You’re going to have to share in the profits. You’re going to have to create some incentives to get the key employees on board to be able to see the business continue on so you can see your legacy continue.
Robert Coker:
One of the key pieces in that that I think I’ll interject and add, you got to keep them. You can have all these great plans and say, “Okay, X, this person’s going to take over.” Well, if you don’t maintain the ability to keep that person in place, i.e., make that carrot big enough where they don’t want to walk away and they have an environment that’s very conducive. You can’t sit there and micromanage these people and expect them to enjoy it. I know I don’t. I mean, I never enjoyed that idea of having someone stand over me. Give me some leash and let me succeed or fail. If I need you, I’m going to call you and hopefully, you’re going to see it early. But you can’t just abandon them either, right, Dan? You got to really be there for those people in the process.
Dan Sellers:
That’s right. And like you said, in our job, we have the beauty of this economic voyeurism. So we have seen it. We’ve seen this transition plan go really well. We’ve seen companies that had long range strategic thinking and implemented those plans very well. We’ve seen others that have not gone so well, whether it was just for… Lots of things can happen suddenly, and all of a sudden there’s no plan to deal with a sudden event and it creates a spiral that’s hard to dig out of. So we’ve seen ways that it’s done well. We’ve seen ways that it’s not done well. And so I think there are companies, there are great examples out there. It just takes time and planning to set something up to succeed in the future.
Robert Coker:
One of the paradigm shifts that I think we need to convey to our owners, this is in many cases the largest asset they have, yet they’re not thinking about, how do I monetize the asset? And this is a piece of that program. Yeah, you could liquidate, but you may get pennies on the dollar, but if you can keep the business going and sell it to your existing employees or key people, or even maybe a piece of outside investors, maybe you’ve got to dovetail it in that manner, sort of have a marriage of the two, right? Bringing in an outside investor that’s got some deep pockets and have your key people take ownership interest as well, but the idea that they don’t want to sign up to take care of this asset that they’ve created, this tremendous wealth that’s sitting there is foolish. They don’t not look at their investment statements every month or their 401(k). They monitor that, and they do all that they can to make sure that it succeeds and they redistribute assets as needed. Same thing’s true in this business, and it’s a difficult process, much more difficult than 401(k)s and investing. But it comes with its challenges like Dan outlined earlier. Those three key areas is something we have to evaluate.
Dan Sellers:
Okay. Well, I think we can put a bow on it there. I think that was a good discussion and had a lot of good topics. And I think just, there’s a way to do it, and if we implement a plan and a strategy, you can get to a good result, but it takes a lot of planning to get there.
Voiceover:
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