Orren Pickell has been through a cycle or two. He started his Chicagoland-based eponymous building company in 1975. Within just a few years of finishing his first house, he found himself in the midst of the early-1980s recession, the worst economy the U.S. had faced—up to that point—since the Great Depression.
“That was tough,” says Pickell, now 62. “I was just starting out and I was paying 23% interest. But until this last one, that was the only down cycle that ever really bothered me.”
By “this last one,” Pickell is referring of course to the Great Recession, the economic unraveling that decimated the U.S. housing industry. During that time, Orren Pickell Building Group went from 150 employees generating $60 million in annual revenue to just 22 workers, eking out what they could to stay in the black. Now back up to 35 employees with sales approaching $25 million, he’s optimistic about the outlook for builders over the next few years.
Which is why he says now is the perfect time to get out. “I have no intention of selling, but obviously, you always want to sell when business is good,” says Pickell, who plans to turn his company over to his COO and daughter, Lisa, when he retires in the next five years. “If you wait until the down cycle, it’s already too late.”
With housing starts getting traction after several years of malaise, pent-up demand emerging from the shadows, and lenders coming back to the table with attainable mortgage options, observers say conditions are right for builders looking to exit their careers—whether through a sale, handing over the reins to a family member, or working out a deal with current employees.
“If you’re thinking about [exiting] your home building business, now’s a good time,” says Donald J. Kaiser, a CPA and principal at Beachwood, N.J.-based Mazur, Krieghbaum & Higgins, CPAs, which specializes in advising home building and construction clients. “The economic outlook for home building is good, housing starts are on the rise, home values are increasing, and interest rates are low. If you made it through the Great Recession and are making money, it might be the perfect time to get out.”
Indeed, the NAHB projects single-family starts to grow another 18% in 2016 to 840,000, following 2015’s 10.4% increase to 715,000. Given the dark days of 2009 to 2011, when the industry produced fewer than 500,000 single-family starts for three consecutive years, those numbers and projections point to supply finally meeting the marketplace’s pent-up demand.
But given single-family’s lingering labor crunch, making up that backlog won’t be a cakewalk. That’s why builder-owners nearing retirement age may have their best chance to exit gracefully through the window of opportunity opening in 2016, even though the industry won’t hit a million single-family starts for at least another year or two.
Full Sales Ahead
“You don’t have to sell when it’s hot, you just have to sell when your numbers are up,” says Pickell. “It’s very difficult to sell a building business. It’s really an asset sale—if you own land, and you have contracts, and maybe some goodwill, you can sell those assets. But right now, with the population growth and lack of new supply over the last eight years, we should be well poised for a good run of building houses. It might not be a bad idea to try to woo whichever large public builders like to work in your area, or even builders who might not be there now but want to be.”
If you can find that buyer, your company is likely to be worth more now than down the line, especially if land appreciation values take a breather after the run up in recent years. “Earnings are up,” says J. Benjamin English, partner at Richmond, Va.-based law firm Hirschler Fleischer. “That’s good, because most businesses are priced on a multiple of earnings, and the current robust market cycle has increased valuations. All those factors become less favorable as the cycle matures.”
It’s also worth keeping in mind that while most private companies are valued on a single-digit multiple of earnings, that changes for public companies. For example, the average among the public homebuilders is currently around 15. That means if a public comes in and pays the right price, it can double that value on its own books down the road.
“Realistically, the publics are going to pay a five multiple, because the market has gotten a bit more competitive,” says Stephen East, an analyst at investment banking advisory firm Evercore ISI. “Within 18 months or two years, they can put a 10 or 11 multiple on it.”
Some already have. While general expectations for acquisitions among home builders are more modest for 2016, one need look no further than the Taylor Morrison-Acadia and Sumitomo-Dan Ryan deals, both announced in the first week of the year, to see evidence of bigger builders investing in smaller outfits. Those two deals followed Pulte Homes snapping up John Weiland Homes in December for a price in the $430–$450 million range. Pulte received a full 7,400 controlled lots and 280 homes in backlog.
Then there’s the example of M/I Homes scooping up privately held, Twin Cities-based Hans Hagen Homes for an undisclosed sum in a deal that closed Dec. 1. Marking company founder Hans Hagen’s retirement, the deal illustrates nicely the one area in 2016 where more transactions are expected: retiring builders looking to cash in.
“I’d say most of the public builders are actively listening and evaluating,” East says. “They recognize you’ve got a baby boom generation that doesn’t want to go through another downturn, and that the businesses are healthy enough now that owners think they can sell.”
Sniffing out a buyer
As with any business decision, one of the best places to start is the numbers. “You need to ensure that your house is in order, financial statements are strong, and debt is as low as possible,” advises CPA Kaiser.
One way to do that is with an internal audit. Not only will that help you get a realistic idea of your company’s value—“It’s never worth as much as you think it is,” quips Pickell—it will lessen the potential for a black eye should a suitor come calling.
“Have an auditor look under the hood so there are no surprises,” says Bob Gellman, managing director at the San Diego office of accountancy CBIZ MHM. “You want to have specific controls in place. For instance, is there a procedure for what you do with any cash you take in? You want to define that kind of thing first.”
East says it’s still the bottom line that matters. “The publics will generally tell you it’s a land purchase, but I think the reality is they’re treating it more than that. It allows them to get into markets immediately, without big start-up costs, where they can hit the ground running and really turn some volume,” he says. “In the past, when they’ve primarily done it for the lots, they’ve had to go back and do a lot more with the operations, which has cost them time and energy. So if you’ve got modest profitability now, you’ve got to turn that into much higher profitability.”
It’s also important to consider who will guide the company after a transaction happens, and if the buyer will want you to stick around for a little while until they’re up and running.
“A lot of lucrative sales depend on the owner staying on board for a period of time to help with the transition,” says Linda D. Henman, Ph.D., president of Chesterfield, Mo.-based business advisory Henman Performance Group. “If you wait until you’re ready to retire—or an emergency forces you to—you lose a huge advantage.”
All in the Family
If, like Pickell, you want to leave the company to the kids, there’s a lot to sort out as well. Business advisers stress the importance of distinguishing between the continued management of your company and its actual ownership after you leave. In fact, as an owner you can retire while retaining ownership—perhaps taking a payout over time in the form of dividends from ongoing profits—as long as operations remain solid.
“The ownership of your company does not necessarily have to be tied to its management,” Henman says. “In that case, you want to start talking about setting up boards of directors or advisory boards that will influence the business going forward.”
That’s the kind of structure Pickell already has in place. While he plans to hand down ownership to his three children, he put an executive management group of four trusted employees in place more than 10 years ago to make sure decisions get made no matter who sits in the owner’s chair. For him, that setup was especially important to lessen the potential for business disputes within the family down the road.
“Making family business decisions so that you don’t ruin the family is tricky,” Pickell says. “I’ve got three children, and if they all have a one-third ownership, that could quickly end up with two of them being pitted against the other one. So you have to have a tiebreaker in terms of how you run the business versus who owns it, and that’s what our executive management group does.”
In other instances, the succession structure families set up can have a big impact on limiting tax liability. “If there are family members in a position to lead the business, you can set it up through a series of gifts or sales of interests to the next generation,” says Beth Shapiro Kaufman, member at Washington, D.C.-based law firm Caplin & Drysdale, which specializes in succession planning within the real estate sector.
At Portland, Maine.-based M.R. Brewer, a design/build shop co-founded in 1987 by owner Rusty Brewer, when it came time to start handing the controls over to sons Matt and Jeff, it meant a restructuring of the company. Originally set up as an S Corp., Matt and Jeff didn’t have the cash to buy Rusty’s shares outright, which also would have had tax implications. So, with an attorney to walk them through the process, the trio set up M.R. Brewer Inc. as a holding company for two new entities: M.R. Brewer Construction LLC and M.R. Brewer Millworks LLC. After a holding period, Matt and Jeff will start acquiring shares of the LLCs, while Rusty will be paid dividends from the ongoing operations of M.R. Brewer Inc., which he’ll still own with his wife.
“Trying to get out of a business that you started is tougher than you might think,” says Rusty. “It’s not like you work 20 years in the railroad, get your gold watch, and say goodbye. It’s your baby. You started it; it’s your name on it. You want it to continue on.”
Most importantly, the planning they’ve done will allow Rusty, now 64, to step away from the business when he knows his sons have the wind at their backs. “Now is a good time,” Rusty says. “Last year was our best year ever in this business. We have plenty of work, and the future looks good. It’s time for the next generation to get their face out there.”
Selling to a partner or employees
If you plan to make a deal with a partner or employee to take over the business, ensuring a smooth transition beforehand is key to leaving your company in good shape—for you and the people who will continue to work there.
“A sale to a partner can be negotiated on terms satisfactory to both sides, if you set it up right,” says Kaufman. That can include a buy-sell agreement that establishes the price at which one partner buys out the other, if the remaining partner has the cash.
But in most cases, selling to a partner or employee will take some kind of financing from you to pull off, where the remaining person pays you over time with part of the ongoing profits of the company. While that can provide you with built-in retirement income, it also keeps you connected to the ongoing risk of the company, and you may find yourself back at work if things head south.
The good news is, external financing so you can make a cleaner exit is available in today’s rosier business clime. “The current financing environment is favorable,” says attorney English. “We are seeing leveraged recapitalizations used to generate liquidity for the selling partner.”
All in for an ESOP
Another vehicle that’s widely used when an owner retires is an Employee Stock Ownership Plan, or ESOP. Companies usually set up ESOPs for the sole purpose of buying out the owner’s shares, funded by tax-deductible contributions from the company. When your day to exit comes, the ESOP buys your shares either for cash, a note that’s paid back to you over time, or a combination of the two.
The advantage is that if you set it up right, you don’t need external financing to pull off the deal. If you then roll the proceeds of the transaction into qualified properties, you can avoid a tax hit. As a bonus, if the firm becomes 100% employee-owned, it becomes a tax-free entity.
There are annual administrative costs to putting an ESOP in place—a trustee to run it and an annual company valuation are required—and most firms will take an initial hit to profits to set one up. Even with those detractors, they’re often a favorite among business succession planners.
“The sales transaction with an ESOP is often much faster and less complicated than a sale to a third party,” says Jeannine Pendergast, senior ESOP client advisor at Portland, Maine-based Spinnaker Trust. “There’s usually little disruption to the business during the ownership transition. For builders with a large number of employees and the leadership to take the business forward, an ESOP is worth looking at.”
You’re still the boss
Whatever path you choose, the first thing to figure out is what’s right for you, and when. For instance, regardless of the business cycle, how much is it worth to be able to spend time doing things other than work? “I had a client that I’d been discussing options with call me on a Sunday from their campsite in Utah,” says Gellman. “He told me he wanted to spend more time with his grandkids, and he was ready to move forward.”
From that perspective, know what your options are and what each one will mean. “The family business owner focused on the next generation will not get as much cash out of the deal,” English says. “On the other hand, selling to a partner or employee will probably mean some cash at closing and some seller financing, so you’ll still be involved until you’re paid off. Selling to a bigger company will yield the most liquidity, but it also means you’ve got little or no influence over how the new owners treat employees or the business itself.”
You’ve been building your business for a long time, and not just to make money. Whatever you choose, make sure your legacy can weather the ups and downs of construction, no matter what the cycle brings.
