Every company is a team effort, but construction businesses really depend on teamwork. Everyone must come together to win profitable jobs, complete them to the highest quality and quickly move on to the next project.

Construction company owners may electrify engagement and enhance their succession plans by implementing an employee stock ownership plan (ESOP). However, there are also potential risks to consider.

What’s the big idea?

ESOPs are a type of qualified retirement plan, somewhat similar to a 401(k). But instead of investing mostly in mutual funds, an ESOP primarily invests in the employer-sponsor’s stock. Because of this, only businesses structured as C or S corporations can offer ESOPs.

To establish one, your construction company first sets up a trust. It then contributes ownership shares to the trust or uses cash to buy and contribute shares. Over time, the plan allocates shares to eligible participants, typically based on compensation level and years of service.

Why should we consider it?

Under the right circumstances, ESOPs offer several potential advantages. First, as noncontrolling owners of the business, participants tend to be much more motivated. After all, they literally have a stake in the company’s long-term success. Engagement and productivity often improve as a result.

There are also tax advantages. Your construction business’s contributions to the plan are generally tax deductible. Meanwhile, participants face no immediate tax on stock allocations and favorable tax treatment on distributions. Other tax benefits may be available depending on whether your company is structured as a C or S corporation.

An ESOP can help construction business owners with succession planning, too. It creates a built-in market for company shares, which can be highly beneficial in an industry where finding an outside buyer or passing ownership to a family member isn’t always feasible. Plus, you and any other owners can gradually exit the business in a tax-advantaged manner while leaving the company in the hands of plan participants committed to its success.

And the risks?

ESOPs present certain risks — and these can be especially acute for construction businesses. First, the plan requires the employer-sponsor to buy back shares from departing employees under a process called a “repurchase obligation.” Thus, strong cash flow is critical. Unfortunately, construction companies tend to struggle in this department because of seasonality, slow-paying owners and project delays.

You’ll also need to deal with business valuations. ESOPs generally require an annual independent valuation of the employer-sponsor’s stock. Because construction companies often report uneven revenue and face customer concentration risks, valuations can produce unpredictable results. Moreover, you’ll have to commit time and resources to getting them performed.

Finally, ESOPs come with a notable amount of administrative and regulatory complexity and costs. As mentioned, they’re qualified plans, which means they’re subject to the Employee Retirement Income Security Act. The IRS and U.S. Department of Labor will be watching closely.

Who can help?

An ESOP can be a powerful motivational and succession planning tool for a construction business in a suitable financial position with leadership committed to the concept. However, these plans are anything but “do-it-yourself.” If interested, contact your CPA for help deciding whether an ESOP is right for your company.

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