How to Plan Your Exit

Sooner or later everyone retires. It is a simple fact of life. Ensuring that a remodeling business survives beyond this inevitability has become an important goal for many remodelers — whether they plan to retire next year, or 10 years down the road.

But in planning a succession, tough questions soon arise. Who will take over the company? Will there be enough money from the transaction to comfortably live on? Will a family member or employee purchase the company from you or will you have to sell it to an outsider? All of these questions can be managed with a well thought-out succession plan that lays out a smooth transition between you and the new owner(s).

Succession planning is a process, not a horse-race to the finish line, and should be carefully reviewed by the owner and a team of qualified financial, accounting and legal experts.

Within the remodeling industry the succession planning process can present special challanges as most successful remodeling companies rely on long-term, personal relationships — with employees, trade contractors and customers. How to maintain these relationships and keep your company’s hard-earned reputation at a high level is another important factor in this process. Addressing these considerations depends largely on the intended ownership. Different succession plans flow from the initial decision to a) pass on the business to a family member, b) sell the business to a current employee or multiple employees or c) put your company up for sale to the highest bidder.

All in the Family
According to Charles Schrader (see sidebar on pg. 19), 95 percent of all construction companies are family owned and only three out of 10 will succeed to the second generation. Among the 30 percent of companies that successfully pass to the next generation is Hobbs, Inc., of New Canaan, Conn.

Scott Hobbs is proudly the third generation to take over this full-service remodeling company. Hobbs Inc. has a unique way of phasing out the previous generation, a credit to a well-written succession recipe.

“Our strategy is that the current owner can work as long as they choose, however, when they decide to leave — they must completely leave,” explains Hobbs. “When the senior member chooses to stay around, they typically have a harder time letting go and this muddies the water for the next owner.”

This tactic has made the transition between two generations in the Hobbs family quite simple.

Starting the company in 1954, Theodore Hobbs began like many others — picking up general remodeling jobs around town and creating key business relationships along the way. These relationships, be it with employees, architects or clients, were his basis for business success and also ones that needed to be passed on to the next owner.

“It is incredibly important for the younger generation to establish their own relationships,” says Hobbs. “As soon as you have an idea that you might be the future of the company start developing these long-lasting relationships and get to know the company as much as you can — soak up as much information as you can.”

This ranges from the financials of the company to the ethics and procedures the company follows.

Dan Klappa, CR, second generation of JDJ Builders of Mukwonago, Wis., got to know his father’s company very well and when it was his turn to sit in the owner’s chair, he made a few changes to the way things were run in the past.

“My father had an ‘old school’ approach to the way he ran the business and when I came in,” says Dan Klappa. “I incorporated additional structure into many of the in-place procedures.”

Klappa, who took over the company at 27, allowed his dad to still be a big part of the business. “I love that my dad is still around and helping out,” says Klappa. “Although he does know that it’s my company now and I make the calls.”

Jim Klappa, CGR, CAPS, founder and CEO, is engaged in a buy-out plan with his son. “Our succession plan called for a time period for me to buy-out my father. During this time, he would still receive a salary plus the buy-out and when the company was fully mine, he would continue to work for me when I needed him and I would pay him accordingly.”

Another big decision that Klappa made was to flip their salaries. Since his father was no longer as involved in the business and Dan was running the show — he talked things over with his father and decided that he needed to be paid what he was worth and so the “flip” was enforced.

Both Hobbs and Klappa went to an outside source to appraise the value of their companies. From this, meetings with their accountants and legal teams led them to final contracts between fathers and sons for the buy-out.

“Based on his (appraisal) opinion, my father gifted the majority of the shares to my brother and me — he had to file and pay gift taxes because of this,” says Hobbs. “He retained 10 percent interest which we bought out years later and he also received a retainer for five years and a profit sharing allocation.”

Michael Hobbs, Scott’s father, remained non-executive chairman of the board and participated as an active board member and advisor to both Scott and Ian. He did not, though, have any specific day-to-day dealings within the business.

Trustworthy Employees
Many owners are not as fortunate as the Hobbs and Klappas. They lack ready and able family members to take over. And for many remodelers, the thought of putting a “For Sale” sign on their company is unbearable. So, the only other source of succession is an employee or group of employees who truly know the real value of your company.

In business since 1990, George Dunning and Tope Lala opened the doors of Homefix Corp. “selling everything we could sell,” says Dunning. “We sold windows, doors, room additions, kitchen remodels — you name it, we sold it.”

After the realization sank in that they were fighting two battles — full-service remodeling and specialty remodeling — Dunning and Lala focused all of their attention on the specialty side.

As the company grew into a successful firm with six branch offices, the partners were approached numerous times by employees with the idea of one day selling the branch offices to current managers. “About four years ago, Tope and I started seriously talking about the future of the company and the idea of a buy-out by our employees intriqued us,” says Dunning.

After a lot of discussion, they decided to sell one of the offices to two of the managers who were heading that operation. “These two guys have been around for a long time and were viewed very highly amongst the other employees and we knew they would do a good job with the business,” adds Dunning. “My view is that true value of a company is best known by those who have put ‘sweat equity’ into the business — the employees.”

That office, now known as Homefix of Gaithersburg, still carries the Homefix name but is no longer part of Homefix Corp. “The two owners of Homefix of Gaithersburg have a buy-out arrangement with us over a fixed time frame,” explains Dunning. The arrangement is such that both of the new owners will turn over profit and earnings to Dunning and Lala over an agreed upon time frame. If the buy-out is done prior to the deadline, a discount will be applied.

Also part of the contract, Homefix of Gaithersburg can advertise under the Homefix name, be part of the Homefix Corp. Web site and share sales leads. “One big difference is that Homefix Corp. has no liabilities for Homefix of Gaithersburg, even though they still are presumed to the general public as Homefix,” says Dunning.

Both Dunning and Lala plan on retiring when they turn 50 years old, however, with their plan for a successful succession — only time will tell if another office is sold to another gracious employee.

The Highest Bid Wins
Rick Pratt, CR, of Classic Homeworks, Denver, Colo., had a plan similar to the one executed by Dunning and Lala.

“About a year ago, I started thinking about my future and what I wanted to do with it. That’s when they idea came to me about possibly retiring from my 20-year business and giving the opportunity to one of my employees” says Pratt.

That plan went awry when Pratt let that employee go and he was left with no one to run his successful design/build firm.

“I’m not sure if I was a bad manager or what, but I was so frustrated with the hiring and firing process and my company, although successful, wasn’t growing — I thought there must be someone out there who could take this company to the next level.”

With his growing frustration and dreams of achieving other goals, Pratt was then prompted by numerous phone calls “that many of us business owners receive” saying that they have buyers ready to purchase their company for a great price. One day, Pratt took one of these calls “just to see what it was all about.”

Realizing that this was a scam, Pratt called upon an outside source to determine the value of Classic Homeworks. When those numbers came back a little low and with a 12 percent broker fee, Pratt began his own investigation.

Pratt then headed to the computer and stumbled upon three Web sites all geared towards helping current business owners, sell their business: businessbroker.net, sellerworks.com and bizbuysell.com.

“For a small fee of under $400, I listed my company on three sites, threw up a fairly high number of what I wanted my business to sell at and waited for responses,” says Pratt.

Shortly after the company was listed, Pratt began seeing numerous inquiries. “There were quite a few interested bidders, but only a few serious buyers that went to the next level,” says Pratt. “Ultimately, four buyers signed confidentiality contracts which included giving them my name and Web site address — two people moved forward.”

Two months after the ad was listed on the Web, the two bidders were given all financials of the company from the past four years. Each also met with Pratt at his office after hours to keep the sale under wraps.

Over a six-week period, both parties mulled the financials and put two offers on the table.

“The smaller bid was an all-cash offer and the other required approval for a small business loan and a $100,000 loan from me,” says Pratt. “In the end, the all-cash offer was less of a liability and I felt this buyer was better suited for this type of company.”

After a letter of intent was drafted, the new owner and Pratt called a meeting with the employees. “Everyone was happy for me because they knew all the stress I was under,” explains Pratt. “I assured them all that their jobs were all protected and that I felt good about the new owner.”

As for Pratt’s in-progress clientele, four of five stayed with the company with the assurance that Pratt would be on hand to complete their projects.

Pratt contracted to stay active in the business for the first two months with no pay, work the next three months at an agreed upon salary, followed by one month off and 500 hours over six months until the anniversary of the sale if the new buyer needs him.

“This makes the transition a lot easier for the new owner, the employees and our existing customers,” says Pratt. “I’ve also locked up seven months of work to keep the company going at its current pace.”

Asked his next step, Pratt says, “Over the next three years, I don’t plan on doing anything that involves collecting a paycheck!”



Keys for Effective Succession Planning

ByCharles R. Schrader

Studies show that over 95 percent of all construction companies are family-owned or closely held businesses. Studies also show that only three in 10 family businesses survive from the first to the second generation, and only one in 10 of those survive to the third generation. Furthermore, these businesses often fail for nonbusiness reasons. In fact, many experts believe that the biggest threat to the continuation of a closely held or family construction company business is not estate taxes, but is instead the inability of the next generation to effectively and cooperatively own and manage the business.

With this background, the following are 10 keys to an effective Succession Plan in the construction industry:

Start Early
Succession planning forces owners to make decisions about the future of their businesses, and gets harder the longer you wait.

Be Conservative
Move slowly into new territories, whether it be a new aspect of the business, or massive changes in organization structure. If it doesn’t work, don’t be afraid to go back, re-think, and start again.

Invest in People
Hire and train the best people you can get.

Give them a chance, and reward them appropriately.

Have meetings with potential successors (family businesses should set up a Family Council) to allow them to learn and understand your business, and where you want it to go.

Give the Next Generation a Chance
In a family business, if later generations indicate an interest, let them work in real jobs, with real expectations.

Don’t be too easy on them, and don’t be unreasonably hard.

Let them do a variety of jobs, and work themselves up; broad experience is often the key to success when your name is on the door.

If they can’t cut it, give them a way out.

Listen to Professional Advisers
Hire attorneys and other advisers who understand the construction business and are experienced in succession planning — not just estate planning.

Follow the advice of your professionals, or fire them and hire new ones (and then follow their advice).

Put it in Writing
Make sure the company’s mission, goals and succession plans are in writing for all to see.

Pay Now or Pay Even More Later
The cost of succession planning is more than just paying advisers.

If a workable succession plan requires restructuring, or bringing in outside managers, or setting aside funds, do it.

If there is an emotional cost, bear it.

Litigation, or a failed business, is much more expensive.

Provide Liquidity
Stock in the business may be worth millions on paper, but if it produces no cash, you have a recipe for dissension and disaster.

Develop a mechanism for owners to sell their interests, including a valuation and funding process.

Don’t ignore estate planning — but don’t confuse it with succession planning.

Provide for Retirement
If the current generation of owners has insufficient retirement funds to exist without a company paycheck, they will never quit.

Providing for sale of company ownership is not enough — setup and fund a retirement plan.

Know “When to Say When” and “Just Do It”
There can be no succession if the predecessors won’t let the successors have a chance.

Set aside egos, take a risk and facilitate a legacy.

In addition to these keystones, the unspoken rule, and perhaps the one that most closely held and family businesses owners misunderstand, is that estate planning and succession planning are not the same thing. Estate plans are designed to minimize taxes and transfer wealth. Succession plans are designed to minimize disruption and transfer knowledge and experience. Both are vitally important to the survival of the closely held and family-owned construction companies.

For more than 25 years, Chuck Schrader has advised businesses operating in Oregon and throughout the United States on organizational, transactional, labor, employment, succession planning, and litigation matters including contracting, acquisitions, divestitures, commercial law and resolution of disputes. Chuck is a shareholder in Jordan Schrader PC and can be reached at 503.598.5512 or by email at chuck.schrader@jordanschrader.com .

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