5 Reasons Contractors Should Consider an ESOP

By Franco Silva

Oftentimes, owners of specialty contracting firms wish to access some of the value they have built up in the business, while others may be approaching retirement and looking to move on. Many business owners view a third-party sale as the main way to accomplish these goals. However, there is an alternative that may be a more preferable option for unlocking the value of a specialty contracting firm: an Employee Stock Ownership Plan (“ESOP”).

What it is - How it Works

Fundamentally, an ESOP is a retirement plan that, like a profit-sharing plan, allows employee participants to share in the company’s success. More specifically, an ESOP is a trust set up by a company into which the company contributes its stock—or, alternatively, cash to buy its stock. Shares of stock are allocated to the company’s employees over time; as employees accumulate seniority, they become increasingly vested in their ESOP account. (For further information about ESOPs, see  this video, https://www.prairiecap.com/videos-and-podcasts/what-is-an-esop.)

As opposed to a third-party sale, an ESOP allows contractors in specialties such as plumbing, HVAC, electrical and fire protection systems to ensure their company will continue on 1) in a manner consistent with the values and history they have established and 2) in a way that rewards the hard work and dedication of their staff—both present and future. Recently, Manhattan Mechanical Services transferred ownership to their employees by implementing an ESOP, joining other specialty contractors, including MJW Consolidated, H2I Group, Tri-City Electrical Contractors, Votaw Electric and Commonwealth Electric Company of the Midwest.

Advantages

Outlined below are five main reasons that an ESOP is an attractive ownership transition strategy for specialty contractors:

1.    Attract & Retain Employees – Since the onset of the COVID-19 pandemic, companies throughout the U.S. have begun recruiting and retaining staff by offering a work-from-home option. However, generally, this is not an option for specialty contractors since they need their staff on-site. In response to this fact, a special report by Engineering News-Record suggests that one way for construction companies to increase engagement and loyalty is to offer an ESOP to employees. Additionally,  Prairie’s 2^nd Annual Construction Survey, “ESOPs: Insights into 2021 and Beyond,” published January 11, 2022, (https://www.prairiecap.com/articles/prairies-2021-esop-construction-survey) found that, overall, employee-owned construction companies anticipate that having an ESOP will not only continue to drive the company’s growth during 2022 but also increase employee retention, even in a difficult labor market.

2.     Culture – Many specialty construction firms have employees that already understand how their day-to-day contributions can have a direct impact on the company. Offering an ESOP will often further increase employees’ commitment to the company and foster an ownership culture. This can, in turn, benefit the company’s valuation and, thus, the appraised value of the company’s ESOP stock. Employees who are educated as to how an ESOP can increase their own personal wealth are often very engaged.

3.     Legacy – Owners who have worked diligently to build and grow their business often hope to preserve their legacy both in the community and the larger construction industry, even after they eventually retire. However, if they choose to sell their business to a third party, the likelihood of this occurring fades. Fortunately, since implementing an ESOP means the firm will remain in the hands of the individuals that helped to build it, this also helps ensure that the values espoused by the original owner(s) are carried on over the long-term so that the positive impact the firm has had on the community will continue.

4.     Independence – Some believe that if a specialty contracting firm is sold to another construction firm or even to private equity, it may damage the company’s reputation and diminish the brand’s appeal. While an ESOP does require the company’s management team to consider the impact of their actions on the ESOP, the company nevertheless maintains its independence as a corporation and the ESOP becomes a vehicle for transitioning ownership to employees in a tax advantaged way.

5.     Liquidity – An ESOP can be structured to meet a variety of liquidity events. For example, depending on the owner’s goals and timeline, the sale of 100% of the company‘s stock to an ESOP may not be practical or desired. Still, an ESOP can be structured to provide partial liquidity to one or more shareholders. Indeed, an ESOP is an excellent option for multi-shareholder situations where one owner is seeking liquidity while others wish to retain control. In fact, the ESOP can be set up to initially give the ESOP a minority share in the business—thus providing some liquidity—with plans to sell the remainder of the company’s stock to the ESOP or even a strategic buyer at some point in the future. In other words, an ESOP presents the owners of a specialty contracting firm with many options for transitioning their shares.

Conclusion

In summary, ESOPs offer a host of advantages to owners of specialty construction firms, and they can be a highly effective tool for ownership transition. It comes as no surprise, then, that the National Center for Employee Ownership, a nonprofit organization that supports the employee ownership community, indicates that privately-owned construction companies are currently one of the top three U.S. industries with ESOPs.

Franco Silva is a Director at Prairie Capital Advisors, Inc. He specializes in advising middle-market companies on mergers and acquisitions (M&A), employee stock ownership plan (ESOP) advisory, fairness opinions and other investment banking advisory services. He can be contacted at 312/445-9213 or by email: [email protected].