Retaining key staff – those crucial to your organization’s ongoing success, even survival – is a critical, yet over-looked, aspect of transferring ownership of a company. Losing top employees can disrupt operations, impact current and future revenue and often causes a loss of morale, thereby lowering the appeal and value of your business.
So, retaining your best employees can help ensure the highest enterprise value, which in turn provides the funds needed to facilitate your business succession and estate planning, both of which can be challenging. Read our blog to learn about five ways you can retain employees in the real estate and construction businesses.
Value Your Staff
No matter what industry you work in, businesses need to retain staff. However, there are few industries that are as complex and demanding as real estate and construction. You and your key employees have specialized knowledge that is unique to your company and possess an understanding of the industry at large that comes with experience and relationships. Those capabilities constitute the high enterprise value that you, along with your top employees, have built. It is critical to your own retirement, succession and estate planning to protect and even increase, that value.
This is no easy task! In this business, how quickly and easily can you replace development talent, or top construction managers and executives who are wizards with the trades, or those who ensure both your exceptional on-site workmanship and commercial performance, every time? Don’t ignore the critical talent and wisdom that years of focus on such a complex industry brought to your organization. You must retain those worthy and valuable people. While strong earnings, efficient operations, intellectual property and buyer synergies often drive mergers and acquisitions, your top talent could make or break a deal. Also remember that transferring ownership of your business is a large, complicated process that will require the expertise and active involvement of your key people.
Set Reasonable Business Values
Expected future earnings, adjusted for time and risk, ultimately determine business value. So, the lower you can reduce buyer risk, the higher your business value and eventual selling price. Apart from the purchase price, human capital management is either an asset, or a cost, that can enhance value, or destroy it. So, subcontractors might want to consider just how valuable their top people are. Those who know your services, but also must understand the overall construction process in order to integrate the specific tasks and timetables of general contractors and all the other trades – all while preserving thin margins. Without them, would your company survive, ultimately? Developers rely on general contractors for quality builds, but what about your own top development people who also understand construction, and the individual contractors so well? Are they easily replaced?
Implement Retention Plans
Retirement plans are common ways for businesses to attract and retain employees. Most business owners and employees participate in a qualified retirement plan, like a 401(k) or profit-sharing. Contributions to qualified plans are tax deductible but all distributions are fully taxable.
In addition, qualified plans are subject to strict regulations, known as ERISA, which limit both the size of contributions and the ability to discriminate in favor of the key people who are most important to retain. On the other hand, non-qualified plans are free from onerous ERISA contribution and discrimination regulations. Although contributions to non-qualified plans are not tax-deductible, they can grow tax-deferred and be distributed tax-free, similar to a Roth IRA, simply by using life insurance as the plan’s funding mechanism. Plus, the life insurance death benefit provides a “self-completing” feature, should the employee die unexpectedly.
Provide Non-Qualified Plan Flexibility
All varieties of non-qualified plans are, essentially, individual legal agreements that promise to pay a benefit to an employee, at a future date. The conditions for employee participation usually vary, and often depend on an employee’s position.
For example, the CFO of a construction company may be required to stay five years beyond the business sale, or a commercial concrete salesperson may have to increase sales each year for 10 years. Therefore, non-qualified plans are powerful and attractive tools you can use to incentivize your key people to both stay and to keep performing into the future, without giving up equity in your company. If your executive leaves, or fails to meet required conditions, you can retain and/or redirect the benefits. Benefit payments are flexible, but the agreements usually provide your employee with a stream of annual retirement income, based on a percentage of salary, for a defined period of years. It is critical for employers in the real estate trades to begin setting aside assets now to meet future retirement obligations because once triggered, employee benefit payments can put too much stress on company cash flow.
Businesses can fund non-qualified plans with just about any type of asset. In fact, 75% of Fortune 1000 companies and 43 of the top 50 bank and thrift institutions in the U.S. utilize Corporate Owned Life Insurance (COLI) to fund supplemental executive retirement obligations. They do so because life insurance is the most cost-effective and tax-efficient funding option, by far. It is also unique in its flexibility, providing economic benefits at the right time, for every situation. Employers retain ownership of COLI policies, which insure the lives of one or more employees. These policies serve a wide array of functions that may not rise to the anticipated financial loss to the employer even upon a participant’s passing. If the employee performs well, the policy pays a retirement benefit from cash value, which grows tax-deferred. The company can access the cash value, tax-free, by taking policy loans and/or withdrawals and deducting the benefit payment to the retired executive.
If the participant dies while employed, the policy pays a pre-retirement death benefit to the company, tax-free. The participant’s family could also get a portion, which could also be tax-free if arranged properly ahead of time and structured as an added benefit of employment. If the participant dies in retirement, the company still receives a meaningful tax-free death benefit. You’ll find that the value created by retaining key personnel dwarfs the insurance premiums and legal fees for drafting non-qualified plan documents.
Reviewing Net Benefits
Retaining key people is a powerful way to increase your company’s value and bring premium bids. Non-qualified retirement plans help accomplish this with minimal reporting, and without the added complications of including rank-and-file employees. Using permanent life insurance as the funding vehicle allows you to maintain both flexibility and tax-efficiency without offering any equity. It is appropriate to recognize these arrangements as “transaction insurance” because the range of outcomes in large-scale transactions is quite wide. Motivated employees are an additional attraction for buyers, and if you satisfy concerns about their retention and performance, you dramatically decrease the risk of transaction failure, while simultaneously increasing the likelihood of a premium valuation. Planning pays off. Realizing the full value of your life’s work can be complicated, and not all business owners are aware of the full range of structures and techniques that bring the highest bids. So be sure to invest the necessary time, up front, in arrangements that will not only retain, but also motivate, key personnel, thereby maximizing value to you and your family. Non-qualified plans are ideal choices to do exactly that.
Even as you just begin to consider such a major step, and well before you place your business on the market, contact a reputable broker who is not only able to analyze business value, but also to advise you on a targeted mix of strategies proven to prepare your company for sale and increase its purchase price. The further benefit is that a higher price makes more funds available, making the other challenges of business succession and estate planning far easier.
Applying These Key Learnings
Suppose that after 25 years of growing your business, you are ready to sell and retire and need effective succession and estate planning. Your key employee, Edward, is an indispensable construction executive, who came up through on-site management and knows how to select, manage and groom junior level staff. He easily manages the myriad complexities of the trades and both the technical and commercial aspects of projects, earning you a lot of revenue. Non-qualified plans ensure that critical employees like Edward remain with the company, especially during sensitive periods such as major transitions. Such plans are called “golden handcuffs” for good reasons. They incentivize key talent to stay, and to perform to metrics that you specify, in exchange for generous future benefits, regardless the owner – you, or new ownership. A buyer will not offer you nearly as much for your company if Edward leaves, complicating your succession and estate planning and diminishing your personal retirement substantially. So before entertaining offers, you agree to a non-qualified arrangement with Edward that requires him to continue performing to project metrics and to stay on for five or 10 years after any ownership change. In exchange, for example, he will receive a $100,000 benefit each year from ages 60 to 85, as well as a $500,000 pre-retirement death benefit for his family. This generous benefit will strongly incentivize him to both stay with the company and to keep performing at his usual level. Your company owns and pays the premiums on a permanent policy insuring Edward’s life for “key-person” purposes. The arrangement earmarks the cash value as a source of his future retirement benefit. When he retires, the new owners use tax-fee loans and withdrawals from the cash value to pay the $100,000 annual benefit. The distributions are taxable to Edward, but tax-deductible to the company. If he passes away before retiring, the company receives a tax-free death benefit to compensate for lost revenue and to find a replacement. The company can agree to provide a fraction of the total death benefit, $500,000 in this example, to Edward’s family. That figure can be tax-free also, if he recognizes a small amount of additional income tax each year. If Edward fails to meet the plan stipulations, he does not receive a retirement benefit, and the company does what it pleases with the life insurance policy: keep it, sell it, borrow against it, cancel it, or use the cash value for a different employee. Note that this strategy offers far more flexibility and retention power than a one-time “retention bonus;” plus, the company can recover all its costs over time.
Overall, retaining key employees is a powerful way to increase your company’s value and bring premium bids. Valuing your employees, setting reasonable business values, setting qualified plans, providing non-qualified plan flexibility and reviewing net benefits are critical for retention. Non-qualified retirement plans help you accomplish this with minimal reporting and regulation, while using permanent life insurance as the funding vehicle allows you to maintain both flexibility and tax-efficiency without offering any equity.