Selling to Your Employees: How ESOPs Work for Construction Company Succession | Ep. 394

You’re 58. You built a real company. No kid taking it over. No partner who can write the check. Most of your competitors won’t pay what it’s worth, and private equity isn’t calling. So what now? Kelly Finnell has spent 45 years answering that question for owners exactly like you. In this episode of Construction Genius, Kelly walks through ESOPs as a succession path that’s now growing faster in construction than anywhere else.

What you’ll learn:

• Why construction is the fastest-growing industry for ESOPs in the country
• The three sources of capital that fund an ESOP: bank loan, seller note, excess cash
• How two contractors with $3M EBITDA sold for $25M to an ESOP after $12M offers from a strategic buyer
• Why an owner is not personally on the hook for the ESOP bank loan
• How to manage the repurchase obligation so it doesn’t crush you in a down year
• The first two moves to make if you’re 58 and seriously considering this path

Listen or Watch the Episode

Why ESOPs Are the Fastest-Growing Succession Trend in Construction

Most construction owners think they have four exit options. Pass it to a kid. Sell to an employee. Sell to a competitor. Sell to private equity. For a lot of contractors, two of those four aren’t real. Private equity skips most contractors. Strategic buyers often aren’t buying.

Kelly has done 22 ESOPs for general and specialty contractors in just the last few years. And it’s not a quirk of his practice.

“Construction industry ESOPs are the fastest growing trend that we see in our world.”

That’s because an ESOP creates a buyer where the market doesn’t have one.

How an ESOP Actually Pays the Owner

People hear ESOP and assume they’re getting a check on day one. That’s not how it works. There are three sources of capital in the deal. A bank loan. A seller note from the company to the owner. And often, excess cash sitting on the balance sheet.

The bank piece is typically a five-year loan. Kelly’s firm sees most of them paid off in three to four years. Then the company often goes back for a second tranche to wipe out 80 to 100 percent of the seller note. That gets the owner fully paid in four to six years in many transactions.

“ESOPs work well for business owners that want a glide path to an exit. But if a business owner has to have the money to run, then an ESOP is probably not the appropriate strategy.”

If you need a lump sum to walk away clean, this isn’t for you. If you want a runway to develop your successor team while you get cashed out over time, this is the structure that gives you that.

The Common Misconception That’s Costing Owners Real Money

A lot of owners assume an ESOP means leaving money on the table. They’ve heard you sell for less than you would in a competitive market sale. Kelly was direct on this. Two examples from the last 12 months.

A general contractor in Nashville. About $3 million of adjusted EBITDA. An investment banker took the company to market. Best offer came in at a 4x multiple. Twelve million dollars. The owner turned it down. Sold to an ESOP for approximately $25 million.

Same year. Electrical contractor in Dallas. Same EBITDA. Same story. Twelve million in the market. Twenty-five million through the ESOP.

That’s $13 million the market wouldn’t pay. The ESOP did.

Where ESOPs Work Best in Construction

Kelly’s sweet spot is the middle market. Companies with $2 million to $10 million of adjusted EBITDA. The average ESOP transaction sits around $4 million of EBITDA and 95 employees. There are billion-dollar ESOPs every year too, but the heart of the market is the size most listening to this episode are running.

Why that size? Culture. Owners of those companies built something they’re not willing to hand to a strategic buyer who will gut it. They’re also motivated by tax savings, and ESOPs deliver real ones.

Surety, Bank Debt, and the Personal Guarantee Question

Two big questions every contractor asks. What happens to my bonding line? What happens to my bank?

On surety, some companies stick with their incumbent and get the surety up to speed. Others move to a surety that already understands ESOP balance sheets. Kelly has done 22 transactions and not one has been blocked by bonding. Four or five had to change sureties.

On the bank loan, here’s the part that surprises owners. No personal guarantee from the seller. The bank gets its skin in the game through the structure itself. The seller note is deeply subordinated to the bank debt. So if a bank loans 35 percent of the value and the seller is owed 65 percent, the seller has every reason to make sure the bank gets paid first. That’s how the bank thinks about it.

“No owner is gonna sell to an ESOP and take on bank debt if on top of all of that they have to be the guarantor on the surety.”

Either the company is already big enough to be off the personal guarantee on the bond line, or the ESOP transaction is the moment that ends.

The Repurchase Obligation Most Owners Worry About

When an ESOP employee retires, dies, becomes disabled, or leaves, the company has to convert their stock to cash. That’s called the repurchase obligation, and it gets named the biggest long-term risk in an ESOP.

The law gives you a long runway. For death, disability, and retirement, the company doesn’t owe anything for one year, then pays out 20 percent a year over five years. For termination or quitting, the company owes nothing for five years, then pays out 20 percent a year over five years.

After the ESOP debt is paid off, the cash that used to service that debt now funds a sinking fund for repurchase. Kelly calls it a first-world problem. The system funds itself if you design it right.

The First Move If You’re 58 and Thinking About This

Kelly’s answer was clear. Educate yourself first. The ESOP is the least-known succession strategy, and most of the books are written for lawyers and CPAs, not owners. Kelly wrote The ESOP Coach specifically in business owner language, with six or seven case studies.

After that, go to nceo.org for the best library of ESOP educational material. Then get a feasibility study from somebody who has done this work in construction specifically.

That’s the path. Education. Then feasibility. Then a real decision.

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If this episode hit home, share it with someone on your team who needs to hear it. Subscribe to Construction Genius wherever you get your podcasts. Leave a rating and a review. Visit constructiongenius.com for coaching, courses, and the book.

Connect with Kelly Finnell on LinkedIn: https://www.linkedin.com/in/esopcoach/

EFS ESOP Consultants Website: www.execfin.com

The ESOP Coach (Kelly’s book): https://www.amazon.com/ESOP-Coach-Ownership-Succession-Paperback/dp/B010CKUN9U