Lessons from the Field: Why Business Continuity Planning Is EssentialPosted by Wayne Messick, AFSB
Like it or not, ownership and management changes are a certainty in construction. According to FMI, every construction company that isn’t publicly traded will go through an ownership transition — usually every 25 to 30 years. With baby-boomer retirements on the rise, those changes are occurring with greater frequency.
A business continuity plan can ensure a smooth transition when a company changes hands. This is especially the case if an owner dies suddenly. A formal plan gives the company’s family, employees, and customers — as well as the surety company — assurances that the company will be able to stay in business and continue its work program.
A previous post by Scott Albrinck, “Expect the Unexpected: The Importance of a Solid Continuity Plan,” explains why you need a plan and what to include when writing one. In this post, we’ll look at lessons learned from firms that have gone through an ownership change.
Why Surety Companies Place Importance on Continuity
First, let’s review why surety companies have an interest in continuity and succession. Remember, it’s the surety’s job to guarantee that a contractor’s bonded work will be completed. The death of an owner or the loss of a key employee — if not adequately planned for — could significantly reduce the contractor’s capacity to complete its backlog, potentially leading to default.
In addition, a transfer in ownership can impact the capitalization and liquidity of a company. The increased debt from financing a buyout can reduce a company’s cash flow and deplete its working capital, important factors sureties consider when underwriting a bond.
If a contractor doesn’t have a continuity plan, the surety may require that it provide a completion agreement. This is a simple, one-page document that states who will complete the work if the owner becomes disabled or dies. The completion agreement isn’t a substitute for a formal plan, but it at least provides some degree of continuity.
As you can imagine, sureties have seen all kinds of situations arise when ownership changes occur. Here are some examples and lessons learned:
The Greedy Siblings
The situation: When the owner of a family-owned company passed away, a son was already running the business and wanted to buy out his brother and sister. The owner had provided funds for a buyout through life insurance proceeds and the sale of several properties. However, the brother and sister wanted twice the company’s worth — well beyond what the owner had left. They are currently fighting over how to value the company.
The lesson: A continuity plan should provide for an orderly transfer of ownership. Who will buy the company when the owner retires or dies? How will the price be set? Decide ahead of time how the company will be valued. Will it be based on the most recent CPA-prepared financial statement or some other valuation?
The Vengeful Wife
The situation: The owner of a company was found dead in his home. He left behind $17 million in bonded backlog. Luckily, he had life insurance payable to the company, and the firm was able to complete its work. As it turned out, the wife had arranged for her husband’s murder!
The lesson: Prepare for the unexpected. Who will manage the company if the owner suddenly dies or is incapacitated? Where will the funds come from to transfer ownership? We strongly recommend the purchase of key-person life insurance on the lives of the owner(s) and top managers. The policy’s death benefits should almost always be payable to the company, not a spouse or individual.
The Careful Controller
The situation: The controller of a company died in an accident. He was known for being conservative in his approach to business, the perfect counterbalance to his more aggressive owner. After the controller’s death, the owner began making rash decisions that harmed the company’s reputation and hurt its quality of work. Competitors began hiring away top employees, further compounding the problem.
The lesson: Key employees can be as important to a company’s success as the owner. Make sure you have a succession plan that includes your top employees. Competitors will try to take advantage of any weaknesses they perceive in your organization. They may play on employee fears about job security and attempt to lure away your top talent — all the more reason to have a continuity plan.
The Complicated Buyout
Seven employees wanted to buy out the company’s two majority partners when they retired. The deal was complicated, and the employees paid more than they probably should have for the company. The good news is that these new owners are now doing quite well.
The lesson: Many owners today are selling to employees rather than family members. Don’t make it hard for your employees to buy the company. Keep in mind that most employees won’t have the capital to purchase your business outright, so consider allowing them to buy the firm over a period of five to 10 years. If you’re thinking about an employee stock ownership plan (ESOP), be sure to enlist the help of a firm that specializes in these plans.
For every ownership transfer and management succession, there’s a different story to tell. What doesn’t change, though, is the need for continuity planning. The more you plan, the easier the transition will be for everyone involved. According to FMI, firms with a clear vision and strategy for the future are more likely to have a formal continuity plan. They’ve identified successors with the right skills and experience to move their companies forward.
Wayne Messick is the Bond Manager for Old Republic Surety's Birmingham Branch. He has over 40 years of surety industry experience. He worked at Continental Insurance Companies, Lawyers Surety and CNA Surety before joining Old Republic Surety in June, 2011.