Following up on our first blog post about employee stock ownership plans (ESOPs) for construction companies, this post addresses surety bond requirements as well as the way in which ESOPs can incentivize employees and increase cash flow.
Satisfying Surety Bond Requirements
Construction companies are typically required to obtain surety bonds to guarantee a project owner that the contractor will comply with the terms and conditions of the contract. Surety companies will ordinarily conduct an extensive underwriting review of the contractor and continue to do so periodically while the bond is in place. The underwriting review will consider the contractor’s financial condition, structure, experience, and capacity to meet the requirements of the contract. The surety company will typically focus on the maintenance of a certain amount of working capital and sufficient net worth to support the construction company’s business. Sureties may require financial statements from a construction-oriented CPA firm on a reviewed or audited basis. They will be interested in work in progress and the status on projects. A construction company will usually be required to execute an indemnity agreement, which may include a personal indemnity/guaranty by one or more of the company’s owners that obligates the indemnitors to protect the surety from losses. Existing surety bonds likely limit the ability of the company to incur debt and therefore almost definitely will require the consent of the surety for a leveraged ESOP transaction.
Construction companies considering an ESOP should begin discussions with their surety in the early stages of the transaction. Depending on the surety’s familiarity with ESOPs, this education process can take time and is best done with the help of professionals who specialize in ESOPs and can adequately communicate the ESOP deal structure and the benefits of ESOPs.
Many construction companies are closely held companies that do not have a business continuity plan. They may be owned by the founder or a small number of shareholders who are not working for the company. An ESOP can provide continuity by establishing a market for the purchase of shares from the controlling shareholders.
An ESOP is designed to provide employees with “skin in the game,” thereby hopefully incentivizing them to increase the value of the company stock and their beneficial ownership. Given labor shortages in the construction industry, an ESOP can provide an important retention tool and incentive for employees to remain employed with the company and pursue long-term growth. An ESOP may also reduce employee interest in unionization.
Increasing Cash Flow
In certain settings, an ESOP can be an effective tool for increasing a company’s cash flow. A contractor can reduce its corporate income taxes and increase its cash flow and thereby its net worth through an ESOP structure. If the contribution to the ESOP is made in lieu of contributions to a 401(k) plan, the cash flow savings are even greater. The additional cash can be used to finance projects and the growth of the business.
All of these issues should be evaluated in deciding whether an ESOP is the right solution for your company. If you have any questions about ESOPs, contact David Joffe or Emily Horn.