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Construction Sector Embracing ESOP For Sustainability

Construction Sector Embracing ESOP For Sustainability

After more than a decade of reluctance, the construction industry is starting to embrace the employee stock ownership plans (ESOPs) concept and finally accepting its benefits. Aside from providing a solution to management succession problem, ESOPs also provides tax advantages to both the seller and the company.

In an article published by trade publication Construction Business Owner, the ESOP Trust offers two key tax benefits. Selling the company through an ESOP provides tax benefits to the company owners who want to transition ownership to its employees. Under section 1042 of the Internal Revenue Code, a tax-paying C corporation which sells at least 30 percent of the block of stock through an ESOP, will allow the sellers to be entitled to defer payment of capital gains taxes on their sale proceeds.

The sponsoring company also stands to benefit from an ESOP because the law allows companies to take a loan to fund ESOPs and pay the loan with pretax dollars. These enables the whole transaction to be tax deductible.

Advantages of ESOPs

One of the latest construction firms to jump into the ESOPs bandwagon is Portland-based Wright-Ryan Construction. The company completed its transition to employee ownership in November by creating an ESOP.

John Ryan, co-founder and president of Wright-Ryan told the Portland Herald, "We saw this as an opportunity to think about more than just the sustainability and longevity of our company. It was a chance to look at the future of the industry in our region and ask ourselves what we could continue doing to make a career in construction an attractive, viable option."

Transitioning ownership through an employee stock ownership plans secures the company's future, instead of selling to a competitor that could imperil the firm's survival. ESOPs also eliminate the high-cost of selling to internal management.

Jeannine Pendergast, vice president and senior ESOP adviser at Spinnaker Trust in Portland, commented, "The only reason that I can see construction companies leaning toward ESOPs is that they typically have a hard time finding a third-party buyer. If they do, often they will not keep the company intact. They will take jobs out of the state, eliminate the name, etc. An ESOP is a way to keep the legacy and the culture of the company."

Construction Surety Bonds

One of the essential characters of the construction sector is its ability to secure security bonds, particularly in projects involving public works. A majority of public works projects require contractors to obtain bonds even before they could participate in the bidding process and might even require separate bonds before construction, as well as to protect the building owner.

In the conduct of its business, contractors must cultivate a healthy relationship with its surety for them to maximize the benefits of their bonds. With the current market, contractors now, more than ever, must realize the vital importance of bond in their operations. However, by carefully planning an ESOP, the trust is expected to deliver a positive impact on the business and further improve its surety program.

A construction surety bond is a three-party instrument involving, the Obligee, the Principal, and the Surety. The Obligee is usually a government agency or the party requiring the bond. It could also be the party who is the recipient of protection from the bond by transferring the risk to a Surety firm which provides a guarantee that the Principal is capable of fulfilling his or her contractual obligations.

Sureties assume some of the risks from contractors. They are expected to compensate the aggrieved party should the contractor fails to deliver the terms and conditions of the contracts and reneges on his or her contractual obligations. Because sureties assume some of the risks, underwriters are very careful when writing bonds. They must perform due diligence, conduct a thorough financial background check of the applicant and demand other pertinent information, including the credit score of the applicant. Surety firms are also expected to conduct a complete background investigation into the contractor's business history, organizational structure, and past performance to determine its capacity to fulfill the terms of the contract.

To allow sureties to provide guarantees, construction companies must also show financial strength and sometimes back their guarantees with their business assets.

Contractors Must Meet Surety Standards

Because a surety program is vital to a contractor's business, it should always commit to meet the standards set by these firms. Aside from what's stated above, contractors must satisfy sureties by providing them with clear proof that they are running a profitable company, well-managed organization, fair in dealings, and capable of performing all their obligations.

Contractors must also provide detailed information about their cash flow and capital showing its capacity to support the surety program, including the continuity of the management team and its principals. In most cases, underwriters require clients of the contractor to maintain a certain fund for working capital and net worth to justify their business plan and the surety program. Typically, sureties require a 5% working capital-to-backlog and a 10% net worth-to-backlog ratio. These means that a $1,000,000 surety program would need at least $50,000 in working capital and $100,000 tangible net worth. The general rule is, the higher your working capital and net worth, the bigger surety program will be given.

Surety Bond Requirements

Each underwriter has their distinct standards and requirements when issuing surety bonds. The rules will vary depending on your location, the type of industry, project, history, and if your company is a subcontractor or a prime contractor. Like any business, contractors must present their financial statements to sureties for better analysis of their viability when applying for a construction bond. It is always better to come prepared and present as many documents as you can and provide as many information to the underwriter for fast analysis of your standing. If possible, provide a financial statement that is prepared, reviewed and audited by a construction-oriented CPA. These type of CPAs can specify work in progress, their schedule and provide the status of a particular project.

During the enforcement of the surety program, underwriters should keep track of the projects to make sure that the contractual obligations are being met, particularly billing and profit issues. Surety firms must develop an accurate and complete recording of cost and accounting system when tracking the projects' progress. These systems are necessary to enable the contractor to identify problems immediately and allow them to make the necessary corrections before they become more serious.

As an extra guarantee to sureties, underwriters require contractors to execute an indemnity agreement. After all, sureties are providing guarantees that the contractor will fulfill all its obligations and is expected to compensate the aggrieved party should the latter fails to meet its duties as written in the contract. The indemnity agreement offers protection to sureties that they will be reimbursed for any loss or expenses they incurred as a result of the contractor's failure to deliver on its promise.