This Way Out

Bob Mckelvey, a third-generation home builder, had been running the company his grandfather founded in 1898 for nearly 40 years when he decided it was time for a change. But his children weren't involved in the business, and the prospect of selling out to a large, national home builder didn't sit right with him. Suddenly, after more than a century serving St. Louis–area home buyers, Chesterfield, Mo.–based McKelvey Homes was facing an unclear future.

“I talked to some bigger companies. They were interested, but it was obvious [my company] wouldn't remain the same,” McKelvey says. “The biggest concern I had was that whoever got it wouldn't run it right. I was afraid of getting a phone call from someone saying, ‘Look, I know you don't own the company anymore, but I've got to tell you what this guy is doing to the business.'”

As he was driving back from a meeting one day in 2002, unsure about what to do, his cell phone rang. McKelvey had been letting friends in his builders association know he wanted out, and for the second time in as many days, someone suggested contacting Jim Brennan, an executive at another builder in town looking to go out on his own. “That's when I knew I should make the call,” McKelvey says.

Now, after having struck a deal with Brennan and having spent three years as a paid consultant to transition the business, McKelvey, 76, spends the falls and winters in the milder climes of Florida. He comes back to his native St. Louis for spring and summer, knowing that his family namesake is intact with Brennan at the helm.

“He's doing better now than I did,” McKelvey says. “He kept the name, he kept all the people, he even stayed in the same offices. It was just a good arrangement for everyone involved.”

Bob McKelvey (left), former owner and Jim Brennan, president, McKelvey Homes

“The American dream is to own a home,” says Brennan, now owner and president of McKelvey Homes, which has expanded to building in eight locations from three. “But I think after that, the next one on the list is owning your own business. It's been so rewarding. Bob convinced me to buy it, and I'm so pleased that he did.”

In an industry where inventory is generally viewed as a liability and a business' brand is closely connected with the owner's name, exiting one's home building business can be one of the biggest challenges of one's career. And while selling to a larger, national company may be an option, just as often in this housing slowdown, it's not.

For many, selling out to the big boys just feels wrong, something akin to throwing your life's work—and the loyal employees who've helped make it successful—to the home building wolves. But the story of McKelvey Homes, and others, proves there are options for builders in their silver years to exit the business while ensuring that the firm they've established keeps chugging along.

In fact, right now, options other than selling to a national firm might be the only alternatives. Observers say that in the current market environment, major home builders are likely to stay away from the deal-making table for several years. “There's very little appetite from the publics for doing acquisitions right now, because their stocks have been knocked down 50 percent and more,” says Martin Freeland, president of Organizational Development Associates, an Atlanta-based consulting firm.

Given that situation, observers say there are three main routes for exiting your company now, while giving the business a chance to survive after you're gone: You can sell to a third party in your own market, sell to an individual or group within your own company, or set up an employee stock option plan, where all of your workers eventually end up owning a piece of the company (see “ESOPs: A Little Bit for Everyone,” page 244).

Of course, there's a fourth option, too: winding your land and inventory down until there's nothing left. “But that's the most painful way to do it,” says John Westrum, CEO of Fort Washington, Pa.–based Westrum Development Co., who sold his own home building business to Pulte Homes in 1999. “In that case, you're saying to your employees, ‘OK, stick with me for this amount of time,' and promising them a severance package for staying to the end.”

For builders who want to move on but leave their business running, here's a look at how others have done it.

As McKelvey did with Brennan, one of the first places to turn when looking for a way out is your peers. While the pair had met before, Brennan and McKelvey didn't know each other well. But when two associates recommended Brennan to McKelvey, it got his attention. “I was just telling a lot of people what I was looking for and what I was doing,” McKelvey says. “For me, networking was just the best way to do it.”

In other words, don't keep your plans a secret. Attend your HBA functions, press the flesh, and keep an ear to the ground. Then, when a name appears, make sure the fit is right for both parties involved. For McKelvey, for instance, it was important to find someone with the education, experience, and enough accrued capital to secure financing. Brennan, an accountant by training who had established himself in the home building business already, had been squirreling away his money for just such an opportunity. He fit the bill to a “T.”

“Bob was pretty selective about who he was talking to,” Brennan says. “But it was also a two-way street. We both did our due diligence on each other.”

For Carl Riden, who founded what is now Harcrest Homes in Buford, Ga., in 1977, getting out of the business in 2004 meant looking within. With a collection of loyal employees at his company, making sure the business continued in good hands was crucial. “For me, the company was like a family, and it was critical for me that it stay that way after I left,” Riden says. “I wanted to make sure the great employees we had could maintain the status quo.”

As it turned out, finding the right individual to make that happen involved a little bit of luck. Michael A. Smith was just a few years out of college, with some home building experience, when he answered a newspaper ad to work as an assistant superintendent at the company. Little did Riden know when he hired Smith then, in the early 1990s, that he was looking at the future president of Harcrest Homes, and the man who would eventually buy him out.

“After we worked together awhile, I noticed he was pretty ambitious and very systems oriented,” Riden says. “I figured if I didn't do something for Mike, he'd probably go out on his own.”

So in 1998, more than 20 years after starting the company, Riden asked Smith to come in as a partner and made him president of the company. Because the original name of the firm was Carl Riden Homes, the pair also elected to change the name to Harcrest Homes—a composite taken from the initials of Smith's three kids, Hayden, Andrew, and Reece—to give Smith a chance to establish his own name as the leader of the firm. “That was six years before I left,” Riden says. “It wasn't just a wild hair we came up with.”

Exit experts say that's exactly the kind of thought-out plan builders need when they want to move on. Particularly important, especially when grooming an employee from within, is making sure the person has enough time to be recognized as the next leader of your company, both internally and externally.

“You've got to give yourself enough time to let that person become the new face of the company,” says Tom Stephani, a former builder who's exited from two companies and is now president of Custom Construction Concepts, a home building consulting firm in Crystal Lake, Ill. “It's important not only for the rest of the employees at the company you leave behind, but for the outside world, as well.”

Name changes, or composite names, can help with shifting identities. For instance, one of the companies Stephani founded was called William Thomas Homes. “But William Thomas is not a real person; it's just an amalgamation of names,” Stephani says. “You need to depersonalize the business as much as you can.”

Of course, for many builders, finding just the right person to replace them isn't easy. In Riden's case, Smith, whose father had been in the trades, took to the business with natural ease. Other candidates might not be so obvious. When looking for people from within, remember: You want a leader, not just a great employee. Often, the two are not one and the same.

Mike A. Smith (left), president and Carl Riden, former owner, Harcrest Homes stan kaady

“You want somebody who's a little bit of a rebel, maybe somebody who was on the verge of being fired but who was too good to let go,” Stephani says. “Those are the ones who are willing to take risks, and that's what building is all about. You've got to find the person who's willing to jump out of the airplane and make his parachute on the way down.”

Once you've identified that person, it's key to put them into a position in the company where they'll be able to build up the capital they'll need to buy you out down the road. Riden and Smith, for instance, set up an intermediate company in which Smith collected profits out of every third home the firm built. That enabled him to invest capital into the main company when it was time to phase Riden out.

Just make sure you're ready to go when the time is right for you to move on, something that can be hard for workaholics who are about to give up their baby. Experts say that when it's time, a clean break is best. “I thought about maintaining partial ownership, but I knew I would stick my nose back in if I did. I just had to go,” Riden says.

Of course, there's no reason you have to limit yourself to just one person to take over the business. Many successful exits have come on the heels of an owner building a management team that slowly buys the owner out over time. That group approach is beneficial both for the ability of the team to raise more capital and in ensuring the continuity of the company after you're gone.

“In an operation that's sold out to a management group, you institutionalize the business,” says Rick Thompson, a partner at Aurora, Ill.–based accounting firm Sikich, which has helped several construction firms transition to different ownership structures. “If anyone steps in front of a truck, the company can carry on.”

There are other benefits to the group approach, too. For instance, at one large, family-owned subcontractor in Chicago, the patriarch of the business started building a management team 10 years before exiting the company. “By the time the management team finally bought out the original shareholder, the customer no longer identified the company with that original owner,” Thompson says. “Instead, they identified with the company's name, value, and services.”

By planning ahead and thinking about your exit strategy now, it's possible to get out of the business and still have your business carry on. Just consider Harcrest Homes, which recorded its highest number of closings and largest revenue last year, two years after Riden's retirement. While Riden still offers advice to Smith when he's asked, he says he doesn't accept money for the consultation.

“If I accepted money, I'd have to do work,” Riden says. “That's not why I retired. Now, my business card says, ‘Available for opinions, lunch, golf, and happy hour.' For the first time in a long time, I don't really have any responsibilities, and that makes it kind of nice.”

Now that's a clean getaway.

Once considered exotic, employee stock ownership plans, or ESOPs, are wildly popular today. They're especially useful for small companies, because they allow an owner to sell his shares to his employees while exiting the business gracefully. That was the case for Larry Sietsma, founder of Melbourne, Fla.–based Holiday Builders. “I only saw three options: Go public, sell out to a national company, or do an ESOP,” says Sietsma, who retired from the company in 1999. “I thought the first two options would create too much pressure on the staff.”

Now, Holiday is a 100 percent employee-owned company, and since Sietsma's departure, it has leapfrogged from being a regional player in Florida to holding a solid spot (No. 25) on the BUILDER 100, selling 3,819 homes with revenue of $695 million in 2005.

While navigating an ESOP can be complex, the basic structure is simple. Think of it as an escrow account between you and your employees. When you exit your business, you “sell” your shares to the ESOP itself. The ESOP then redistributes your shares to the employees over time, based on their tenure and a predetermined vesting schedule. The money that funds the original transaction may be borrowed from a bank, but in many cases the owner underwrites the note himself.

Sietsma, for instance, carried 100 percent of the note for Holiday's ESOP but says he's been fully repaid by the company now, more than 10 years ahead of schedule. “The booming market helped, I think,” Sietsma says. “But I also think, once they were all owners, everyone seemed to work a bit harder and have a better feel for the bottom line.”

ESOPs have other benefits, as well, including a 100 percent tax break if set up correctly. But they can be expensive to administer, and valuing the company is often a sticking point. Also, because the owner frequently acts as both the seller and the financier of the transaction, some financial experts steer clear of ESOPs altogether.

“We're not big fans of ESOPs,” says Kevin Short, managing partner at exit strategist Clayton Capital Partners in St. Louis. “Quite often, the seller ends up taking on too much risk. We try to recommend developing a group of key employees to buy the company instead.”

Still, for all their wrinkles, there are plenty of ESOP success stories. For Sietsma, it was the perfect way to go. “I came out OK as the seller, and it kept the staff intact,” he says. “For us, I thought it was the perfect win-win situation.”