The Pros and Cons of Common Exit Options for Construction Owners: ESOPs, PE, Third-Party Sales

ESOPs

In an ESOP sale, the owner sells company stock, in whole or part, to a trust that holds shares for the benefit of employees. Gradually or in one transaction, the company becomes employee owned. The benefits of ESOPs include:

Tax advantages, as the sale can be structured to enable tax relief with owners deferring or even avoiding capital gains tax on the sale of the business;

The nature of ESOPs also allow the business to preserve its culture and legacy inclusive of established names, values, and practices. In addition, financing structures often remain intact so, assuming the transaction is communicated effectively, relationships with customers, bankers, and bonding agents are not necessarily disrupted;

Similarly, the business’ employees are incentivized to stay with the business which they now have an ownership stake in. As a result, many ESOPs increase moral, productivity, and longevity as key staff are rewarded by remaining with the company for longer.

Because owners can phase out gradually, they are able to remain involved to the extend necessary to support through the transition period;

The sales process is simplified with the trust acting as the sole “buyer” of ownership shares. The process is private and straightforward, so can be much smoother than alternative exits. A feasibility study is carried out to confirm that an ESOP transaction is viable and valuations are accurate. Typically, ESOP transactions cause fewer disruptions and carry less risk than other transactions.

PE

PE firms use their funds along with debt to buy controlling shares from owners. They generally plan to grow the business before reselling it or taking the business public in the future. Depending on the structure of the deal, some transactions involving PE allow owners to retain a minority share or continue in a management role, usually on a short-term basis. The benefits of selling to a PE entity include:

Large payouts at closing, with PE buyers known for offering competitive valuations that are often among the highest immediate cash offers on the market;

When they involve the owner taking a minority stake, sales to PE firms can represent an opportunity for a “second bite of the apple” as the resale event is a near ubiquitous goal of PE deals. If the PE firm is successful in growing the business prior to that sale, the rewards to the previous owner can be significant.

PE partners are typically well connected and may inject capital to fund expansions, technological advancements, and other improvement efforts. The expertise within PE firms can be instrumental in helping acquired businesses scale or enter new markets, accelerating growth;

Transactions are second-nature to PE firms, so they are generally organized with concrete timelines. They may also be equipped to work with owners to offer flexibility in terms of the owner’s ongoing involvement, structuring a quick exit or transitioning slowly with the owner remaining involved as a consultant or executive.

Sale to a Third Party

In third-party sales, the owner typically fully steps away to allow the business to be integrated into the buyer’s operation. The advantages of selling to a third-party include:

High valuations, as strategic buyers are most likely to pay a premium for the business. In competitive bidding situations involving multiple prospective buyers, owners are well positioned to achieve the highest possible value for their business;

Third-party buyers often enable fast exits. Because third-party buyers have their own management capabilities, the owner is often expected to exit swiftly post-close, which some owners may prefer to a transition period;

Owners in sales of this kind often receive proceeds in cash at closing with no financing requirements. That means owners can walk away with immediate liquidity and without any risk associated with the business’ future performance;

When a business is acquired by a larger company, employees may enjoy access to better benefits and new career opportunities, while clients of the acquired company might gain access to expanded services and resources.

ESOPs

ESOPs pay owners a fair market value determined by an independent appraiser. That may be lower than what a motivated strategic or financial buyer would otherwise offer;

Only a portion of an ESOP sale is paid up front and that amount may be financed via a loan. The remainder is then paid over time from future earnings. That means the payout is deferred and subject to the company continuing to perform;

ESOPs involve legal and administrative effort, are based on independent valuations, and subject to meeting compliance requirements. As a result, they are a comparatively complex option that involve ongoing costs, including for running the plan;

The ESOP’s purchases are usually funded by company earnings or a loan, so can put the business under financial strain if not structured carefully. Stable cash flow is critical to avoid jeopardizing the business;

ESOPs work best when the company’s management team is capable and the business is steady and predictable. Cyclical businesses and those requiring outside capital to drive growth may be less suitable for this type of exit.

PE

PE acquisitions are often associated with major decisions, like asset sales or workforce reductions. Owners may find it difficult to relinquish control to a PE buyer;

Similarly, PE firms may impose new practices and targets that affect corporate culture or even conflict with established corporate values. Under new PE ownership, clients and employees alike could face substantial change in the established ways they do business;

PE ownership is temporary, with resales typically occurring within 3-7 years of the acquisition. That exposes the company, its clients, and employees to further upheaval;

Analysts at PE firms typically seek out a corporate profile of a certain size and growth trajectory. Those criteria might preclude PE opportunities for smaller companies. In addition, the due diligence process PE firms employ is deep and negotiations can be complex, stressful, and time consuming;

Unlike ESOP sales, direct sales do not offer tax deferral opportunities. Owners will owe capital gains taxes on sale proceeds in the year of the sale, reducing the net cash the seller keeps from the deal.

Sale to a Third Party

In mergers, the independent identity of the acquired company is lost, with the company’s name and culture changing shortly post-close;

Outside acquisitions typically lead to reductions in staff or changes to roles. Buyers often consolidate teams with overlapping responsibilities resulting in reassignments and layoffs;

Sales to third parties typically involve divesting 100% of owner equity, precluding gains from the business’ future growth;

As mentioned, direct sales to third-parties do not offer tax deferral opportunities, meaning the tax impact of a sale will reduce the seller’s net cash with capital gains taxes owed in the year of the sale;

Mergers and acquisition are lengthy and demanding processes requiring time spent reporting, communicating with buyers, and undergoing due diligence. There is also the risk that an involved pre-sale process may not result in a deal closing, which can be disruptive and demoralizing.