LBM dealers have a variety of options as they look toward transitioning their business. As we talk to business owners about succession planning, we help to identify the best option(s) by considering the business owners’ goals, the number of employees, the ownership structure, and the profitability of their business. Because we believe it is important for every dealer to know all their choices, here’s an overview of the five most common transition options.
1. INTERNAL TRANSFER
The first place owners should look for a successor is within their family or current management of their business. A child working in the business, or a key employee, can make a great successor because they are familiar with the organization’s operations. In our experience, it is typically not the financial structure of the deal that causes a succession plan to fail. Rather, the lack of a plan to transition roles, responsibilities, and relationships can create turmoil during the transition. By setting up a multi-year process for transitioning management to a current key company member, an owner can mitigate this risk of failure.
2. EXTERNAL TRANSFER (COMPETITOR)
Another option is a sale to a strategic competitor, typically one that does business in your region or is looking to expand into it. Sales to a third party tend to be asset sales, which means that the sale is likely to be taxed at a mixture of ordinary income and capital gains rates. Further, it is important to complete thorough due diligence on your potential acquirer to make sure they are a good cultural fit. Discordant corporate cultures can cause key employees to leave post-transition, which can jeopardize business sustainability and the payout to the departing owner that is tied to future performance.
3. EXTERNAL TRANSFER (FINANCIAL BUYER)
The sale of your business to a Private Equity (PE) roll-up or PE-backed acquirer typically occurs during periods of strong performance for the LBM industry (e.g., 2020-2022). While these buyers may be able to pay higher prices, they are primarily focused on short-term company performance because they have their own three-to five-year exit strategy. Selling to a financial buyer requires you to correctly time the economic upcycle and requires the use of a good investment banker who knows the LBM industry.
4. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
ESOPs allow the owner to sell all or a portion of the business to their employees. Shares of an ESOP are held in a retirement plan that is overseen by a trustee. There is the opportunity for the seller to defer capital gains taxes if the company is (or can convert to) a C Corporation prior to the sale. Further, if the company is an S Corporation upon the sale (or converts to an S Corporation after the sale), the portion of the business that is owned by the ESOP does not pay federal taxes. ESOPs, however, are expensive to implement and maintain, with implementation costing well over $100,000 and ongoing maintenance typically between $20,000 and $50,000 per year.
5. WORKER-OWNED COOPERATIVE (CO-OP)
An alternative to an ESOP that is cheaper to implement but still provides the seller with the opportunity to defer capital gains taxes is a Co-op. Owners who sell to a Co-op receive fair market value for their shares, can sell to the Co-op over time, and can provide their employees with an opportunity to share in the business’ profits. Co-ops also allow the business to set parameters an employee must meet to be considered for ownership and are still run by a management team whose focus is growing revenue and profits.
Click here to download more details about the requirements and impacts of each of these options, and to learn more about various ownership transitions for LBM dealers. We believe it is critical for owners to understand the pros and cons of each transition option so they can create a succession plan that works for all stakeholders.
Stratus Wealth Advisors owner and founder Sam Brownell helps independent dealers by quarterbacking a comprehensive succession planning process to provide clients with essential data and advice to make the best decisions for their company and their family. Reach Sam at firstname.lastname@example.org.