Psst — wanna buy my construction company? ESOPs offer another retirement option

Target Audience: Construction Companies, Construction Accounting Interest, Retirees, Employee Benefits Coordinators, Mature Construction Companies, large Non-Union Workforces, Companies with Growing but Stable Earnings and Consistent Revenue Sources, Construction Company Owners

As many contractors near retirement, they begin to wonder what to do with their businesses. In many cases, the answer is to sell to a third party, transfer ownership to family or key employees, or liquidate. There is, however, another option worth considering — the employee stock ownership plan (ESOP).

What’s the deal?

An ESOP is an employer-sponsored, qualified retirement benefit plan that allows a company’s ownership to sell some or all of the business to its employees — without bringing in outside buyers.

Despite the name, however, you don’t sell shares in your construction company directly to employees. Rather, a trust buys as much of the business as you want to sell. Employees make no direct contributions; instead, the trust pays into their individual ESOP accounts.

Why do it?

In part because sureties take a dim view of anything that ties up cash over the long term, contractors haven’t used ESOPs as frequently as business owners in other industries. Properly structured, however, an ESOP may actually enhance a construction company’s bonding capacity.

With labor shortages being all too common in the construction industry, your surety may view an ESOP as an effective means of retaining employees and, thus, promoting operational stability. Why? Because ESOP accounts grow in value over time, employees may think twice about leaving your company.

ESOPs can provide significant tax advantages, too. In a “leveraged” ESOP, the trust borrows money from a bank to buy up to 100% of the stock in your company. You can claim a tax deduction for all contributions used to pay interest on the loan, and you may deduct amounts used to make payments on the loan principal up to 25% of the covered payroll expense.

In a “nonleveraged” ESOP, you contribute up to 25% of eligible payroll funds to the plan, which then uses these tax-deductible contributions to buy company stock, either from existing shareholders or directly from your construction business. This is a simpler option, but it doesn’t provide substantial amounts of immediate cash to shareholders or your company.

Last, because the value of each ESOP account is directly related to the company’s overall profitability, the arrangement may improve productivity. The key here is making sure employees fully understand how the ESOP works.

What about risks?

Of course, there are risks to an ESOP. If your company borrows money and then lends it to the ESOP to buy stock, you must record the bank loan as a liability and debit the same amount to the equity account. That effectively reduces your net worth by the amount of the debt.

And if the stock value soars, the ESOP may not have enough cash to buy it back when someone retires. This means a portion of the trust fund should be in liquid investments.

Last, banks typically get first priority on assets if the unthinkable happens and you have to liquidate. Sureties may be uneasy about this as well.

Are there other, similar options?

ESOPs tend to be most beneficial for mature construction companies with large nonunion workforces, growing but stable earnings and consistent revenue sources. If your business doesn’t fit those criteria, you may have other, similar options.

You might, for example, choose to use private equity interest in an ESOP. In this arrangement, investors as well as banks provide funding. Your company will have less debt, but investors will share in the returns.

You might also combine an ESOP with a management incentive plan or a select manager buy-in, which would allow key personnel to buy stock out-of-pocket. Or you could create a performance-based award that allows selected managers to earn equity if business appreciation hits a target goal for the year.

Who can help?

An ESOP, in one form or another, may be a good way to transition out of an ownership role as you head toward retirement — or it may not. Your CPA can help you weigh the risks vs. the benefits and decide for sure.

To contact Feeley & Driscoll, please click here or call us at 1 (800) 392-6192.