When it comes to the construction industry, where so many businesses are either family owned or closely held, formal plans for a successor are a must, but can be a major challenge for business owners who are busy with managing daily operations and planning for the next big project.

Succession planning, however, is becoming a significant issue for the construction industry and the great unknown of what may happen when the business’s founder is no longer able or willing to be in charge can lead to much concern and uncertainty. Yet, currently 70 percent of businesses die with the founder. If the owner desires to keep the business going for years to come, a succession plan is essential. Many construction owners have similar challenges when they start the succession process such as:

• How to avoid selling to a third party and provide for the welfare of the owner’s trusted managers and employees;

• Creating a buy-sell agreement under which the company purchases shares from the owner’s heirs;

• Possible incentives that the owner can give key employees to remain with the company through an ownership and management transition.

All family owned and closely held businesses should have buy-sell agreements to plan for dealing with problems that arise upon the death or disability of the owner. These agreements provide for the purchase of an owner’s interest in the business following his or her death or disability, and in some cases, following retirement.

The purchaser may be the deceased party’s partner or co-shareholder, an employee of the business, or the business itself. Buy-sell agreements generally have two basic goals: (1) the conversion of a deceased owner’s interest into liquid assets; and (2) the prevention of the transfer of the decedent’s stock to outside interests.

While transferring ownership to the next generation, selling the business to a third party or liquidating are options for some companies, another option that may produce greater benefits is an employee stock option plan (ESOP). These plans are especially appealing in today’s economic climate, where many construction owners are finding it is difficult to find qualified buyers. An ESOP effectively creates a market for a company’s shares that might not have previously existed.

While ESOPs are tax-qualified retirement plans like 401(k) and profit-sharing plans, they differ from other tax-qualified retirement plans by investing primarily in the company’s stock. If properly structured, an ESOP may enhance a contractor’s bonding capacity since sureties often view ESOPs as a means of retaining top employees, and therefore, promoting stability for the company. Since ESOPs grow in value over time, employees are less likely to leave the company. Construction companies may also combine an ESOP with a management incentive plan or allow its key personnel to buy stock out of pocket.

An ESOP may be a risky proposition for some construction companies. For example, when a company borrows money and lends it to the ESOP to buy stock, the company must record the loan as a liability and debit it from the company’s equity account, thereby effectively reducing the company’s net worth by the amount of the debt. Therefore, if the company’s stock price rises in value, the ESOP may not have enough cash to buy it back at the time an employee retires from the company.

Some lenders look with disfavor to ESOPs because they view them as reducing equity, while increasing debt. Another risk inherent in ESOPs is if the owner does not properly train his successors, the company could collapse or suffer financial losses reducing the amount the owner receives in a buyout when he retires from the company.

Overall, an ESOP is advantageous for many closely held construction companies. Besides offering succession planning benefits, an ESOP also offers several retirement, tax, financing, and management benefits, which are particularly advantageous in the construction industry. This explains the fact that 91 of the largest 100 employee-owned companies in the United States have ESOPs, with almost one-third of those companies in the construction industry.

Frederick E. Hedberg is a partner at Halloran & Sage law firm in Hartford.