The construction industry was busy last year — not only with the business of building, but also with mergers and acquisitions (M&A). A record 534 M&A transactions were announced in 2018, according to 2019 M&A Trends for Engineering and Construction, a report issued by industry consultants FMI. That’s a 26.5% increase over the 2017 results and the highest level FMI has ever recorded.
Although activity is expected to cool off somewhat by year end, there are still plenty of deals under consideration and in the works. So, it’s a good idea to stay up to speed on some fundamental M&A concepts.
Time it right
Perhaps the first thing to cross any construction business owner’s mind when the prospect of an M&A deal comes up is: Should I do this now? Whether you’re a seller or a buyer, timing is everything.
As a seller, your retirement is obviously an ideal time for an M&A transaction. If you plan to, at least in part, live off the proceeds of the sale of your business after you retire, you’ll need to start hunting for the right deal well in advance of your bon voyage party.
But that’s a best-case scenario. An acute need to sell can arise at any time. Shifting market conditions, disruptive competitors or just one too many unprofitable projects may drive you to consider a merger or sale.
For buyers, timing is somewhat simpler. It’s generally a matter of opportunity plus capital. But an M&A target must fit in with your strategic goals. You’ve got to ensure that the construction business you’re buying will make you more competitive and profitable — not just briefly put your name in the news.
Due diligence is of paramount importance. That means not only fully grasping the target’s finances and any legal issues involved, but also looking closely at the target’s operations and culture.
Prepare for taxes
As you might expect, Uncle Sam will want a piece of any M&A transaction. But not every business sale need be immediately taxable. Some arrangements may qualify for tax-deferred treatment. Examples include transactions in which the seller receives buyer stock or certain qualifying property in exchange for their stock or assets. Corporate or partnership / limited liability company (LLC) mergers may be eligible for tax deferrals as well.
Understandably enough, many parties to M&A deals favor the idea of a tax-deferred sale. But there are situations in which paying taxes upfront is the better way to go. For example, despite immediate taxability, cash-only sales are simpler and typically quicker to execute. Buyers typically favor a taxable sale to get a stepped-up basis in the assets, which can reduce future taxes.
If your construction company — or one you’re thinking about buying — is structured as a corporation, you’ll have to choose between a stock sale and an asset sale. Parties to an M&A deal often end up at odds. Sellers look to stock sales to get favorable capital gains treatment. Meanwhile, many buyers prefer asset sales to maximize future depreciation write-offs and to limit legal liability. (The buyer assumes the known and unknown liabilities in a typical stock deal.)
Many buyers also tend to frown on stock sales because they’ll have to deal with the carryover basis in the assets, which may raise their future tax liability. Conversely, stock sales of C corporations appeal greatly to sellers because the departing owner(s) may avoid double taxation when they sell the assets and then distribute cash to shareholders.
Keep it in mind
Depending on the size, market and specialty of your construction business, an M&A opportunity may never come up. Then again, the chance to buy out a competitor could materialize tomorrow, or you could get a call with a buyout offer you can’t refuse. Keep the possibility in mind and turn to your CPA and other professional advisors should the situation arise.
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