Why Your Construction Company Needs a Buy-Sell AgreementPosted by Erik Mueller
Has the topic of buy-sell agreements come up in discussions with your attorney, surety agent or accountant? Chances are someone who cares about the future of your business has been nudging you to have one drawn up.
In fact, without a business continuity plan, and the means to execute it, you may find yourself unable to get the bonding you need for your next project.
You’ve probably heard of contractors who suddenly pass away, leaving no clear succession plan. Sometimes there are legal battles over who will get the company. Maybe a surviving spouse without any construction experience takes over the business. Or the company is simply liquidated.
It doesn’t have to be that way if you have a plan. That’s where a buy-sell agreement comes in.
Buy-sells ensure bondability
A buy-sell agreement is a legal document that obligates the surviving business owners, a key employee or the business itself to purchase the interest of the deceased owner. It creates a planned and orderly transfer of ownership. And it avoids the pitfalls we too often see when an owner has failed to plan properly. It also helps maintain the bondability of the post-buyout company.
Life insurance is the logical choice to fund buy-sell agreements — because the death benefit will be available when it’s needed and the premium expense is relatively small compared to the face amount of the policy. The alternatives are not nearly as attractive from a surety’s perspective since they usually involve taking on debt, which can impact some key ratios on the balance sheet as well as the cash flow of the business.
At the very least, your company should have a plan for how it will complete its backlog if the business has to be wound down. This may involve paying incentives to key employees to finish projects.
In addition to a contingency plan to transfer ownership after you pass away, you should have a succession plan for when you retire. Surety underwriters like it when there is a planned transfer of stock from one generation to the next and the current owner is grooming a new owner to run the company.
An orderly succession gives your surety confidence that as the stock is transitioned, the new owner will be capable of leading the company and has the experience to keep the business going.
What not to do
Here are a few things we’ve seen that you should avoid:
- Don’t put off making a plan. As the saying goes, “If you fail to plan, you plan to fail.” Why put your company’s future at risk? Make a plan.
- Don’t finance your buyout with a bank loan. A bank note will show up on your balance sheet as a liability, and that could jeopardize your bond credit. Life insurance is the best way to fund a buyout if the owner passes away, but for a planned succession consider:
- Annual bonuses to the next generation coupled with an agreement holding that money in trust to purchase stock when the owner is ready to sell.
- A seller-financed sale where the new owner pays back the current owner on an agreed-upon schedule. Seller-financed debt doesn’t appear on the balance sheet. Also, there can be more flexibility than with a bank loan.
- A company-financed sale. The note would need to appear on the balance sheet, but it’s considered friendly debt or equity if the current owner can be flexible with the payments and there is a subordinated debt agreement.
- Don’t sell to a private equity firm. Private equity firms are looking for fast growth and will leverage your company to chase big revenue numbers. Sureties, on the other hand, prefer businesses to grow incrementally and at a sustainable pace. As a consequence, a surety may not be willing to bond the acquired company’s projects.
Get your surety’s opinion
When it comes to succession planning, there are three parties you should have at the table: your attorney, a construction-oriented CPA and your surety (the agent and/or underwriter). Always seek your surety’s opinion, so the post-buyout company qualifies for the same level of bonding you have now.
Remember, financing a buyout can negatively impact your company’s cash flow and some key ratios on the balance sheet. These are important factors sureties consider when underwriting a bond. That’s why buy-sell agreements funded by life insurance make sense for contingency planning.
For continuity planning, identify and groom your next-generation owner, and draw up a buyout plan that has minimal impact on your balance sheet. You’ll be giving your family, your employees and your surety peace of mind, and securing your company’s future for generations to come.
If you have any questions about a buy-sell agreement, or anything regarding surety, contact an appointed agent, or reach out to an Old Republic Surety branch nearest you.
Erik is the bond manager of the Minneapolis, Minnesota, contract branch office (located in Hudson, Wisconsin). He has been in the surety industry since 2007. Before joining Old Republic Surety Company, he was a surety risk advisor at Bearence Management Group and an account executive at Travelers. He has a bachelor's degree in history and social studies from Minnesota State University.