Ep11 - Interview with Bonding Agent with ESOP experience - Margie Morris from Guignard Company

Welcome back. Thanks for tuning in. I'm the ESOP guy and let's continue on this journey to an ESOP. This podcast is for those that are thinking they might want to consider an ESOP company becoming an ESOP company, whether that is through a growth strategy, a succession strategy, or maybe even an exit plan for their business. Today, I'm excited to have the privilege of interviewing Margie Morris with the Ginnyard Company from Central Florida. They literally have clients all over the United States. Uh, Margie has 33 years of experience. She started working in bonding um with the Traveler's Company and is now a partner with the Gard Company, and she's been there for 18 years. She is a prominent bonding agent in the Florida marketplace and has a wide breadth of experience in working with all types of bonding programs. Margie has experience in working through the entire ESOP process from beginning to end. Uh, today we are going to discuss the impact of a construction company going through the process of becoming an ESOP. We'll discuss the issues related to a company's balance sheet and income statement and really other factors that affect their future bonding capacity. So if you like what you hear, please subscribe to the ESOP podcast and share it with a friend. So today, thank you, Margie, for joining us. Thank you, Phil. It's my pleasure to join you today. Great. So, Margie, I wanted to start with just my own, my own experience in working with construction companies um over the last 20 years has, I've seen this over and over is that the companies that they are owned by um either one owner or multiple owners um usually have um a limited amount of options when it comes to selling their business. Um, how often are you guys running into succession and exit planning when you're talking to your, to your clients? Great question. We had this conversation with our clients on a regular basis. We know it's a sensitive subject to a sole owner of a construction company, and so we have to have a lot of discussions over a couple of years, mulling over the options before we can truly put something in place, you know, when you consider the life of. Tractor the constant is that individual owner. The employees come and go, so when you have a sole owner with no succession planning, then eventually they become a higher risk to creditors depending on the project size, length of project duration. So we definitely encourage our clients to evaluate this early and evaluate it at least annually. Yeah, that's, and that's one of our experiences. And 11 of the things that has been um really interesting and, and great for me too is, is, is working in tandem in terms of our practice and also in tandem with the bonding agent, which Margie is really good at, um, working with her clients. So when working as a team together, we really do help represent a client much better in the process and coordinating all these efforts. Uh, Margie, given the COVID crisis right now that that we're we're, that we're under, um, and the amount of uncertainty that is in the marketplace, what I, what I'm experiencing with a lot of the planning is, is it's very, people are looking at this as, let me, let me hold off on doing a lot of planning right now because I've got to deal with the, the COVID crisis, which I absolutely agree with because we know that, you know, we have to take care of things. But there are elements within the um the planning process that I think are really incredibly important. Um, such as, um, updating the company's forecast, which is something that we use early on in the process of going, of taking a company through, um, to an ESOP, um, given the discounted evaluation approach. So in your opinion, Margie, with all this is happening, um, what should, what should companies be focusing on right now, um, in, in how do we kind of balance out that idea that they, they still need to be planning for the future? Given what's going on with the COVID-19, we are seeing various things going on with projects either getting canceled or suspended, and that in itself creates, you know, from an unknown period of time, you know, how to collect receivables, you know, managing cash flow, and really evaluating, you know, all the things that go into, you know. Pulling on and off a project, so cash flow forecasts becomes critical, I think, in this situation and in any situation, and it's a big piece of the equation. You know, in addition to the forecasting of cash flow, you need to be forecasting in general, you know, because everybody's looking at, you know, what are the what are the owners doing with the contracts, and so we definitely are encouraging the owners to be doing these forecasts to keep things current. Excellent. Yeah, and I, and I, and I totally agree with that. And I think sometimes we, we get so it's so involved in the managing a crisis that we, we, we don't necessarily always keep going on the other, on the other elements of what you're supposed to be planning, which are the forecasts. Um, one of the things I see are common when we do have these kind of crisis is, is what do I do with my business? And I have, um, you know, the, the idea behind an ESOP is that you, it is an internal sale at the end of the day. Um, there are, there are certainly things you have to take care of on the outside, um, with your trustee, but there is definitely more of a, of an opportunity to manage through a difficult economy when you have done an internal sale. So for the companies that have already done an ESOP. Um, they're managing that just like anybody else would, but it's not like they, they've lost control of, of that from an internal standpoint. Um, but keeping the ones that are going towards that process, I think, is, is really the suggestion is, is continue to build your forecasts and, and update those um as you go. Margie, in your experience in the marketplace, what are the issues related to construction companies evaluating, you know, just in general, whether an ESOP, an employee stock ownership plan will work for their plans towards succession um in relationship to the continuation of their bonding program, um, and really kind of what makes this, what makes a successful ESOP company. Well, I think the issue I see in succession planning is where the owner doesn't do anything, and I think, you know, in ESOP, it can be a little foreign and it takes time for to go through that process, you know, to really take the time and understand it, you know, from start to finish, it could be anywhere from 4 to 6 months. So I think it's, you know, very difficult when the owner is trying to decide, you know, giving up ownership or having to disclose financial information, so it's a, it's a process that you need, you want to start and really understand because the benefits are, are huge uh once you go through it. So it does work, that works well when you have an owner who has a team of employees. Uh, wants the legacy to carry on, you know, and to have that part of it and then understanding the tax implications, so there is quite a bit for the owner, um, having to be comfortable with, uh, understanding, so. You know what I think works really well and what I've seen that works really well is when you have a business, we call it the three pillars that helps with that process on the backside of it is you need to, the owner needs to make sure that they have a team of people that someone is, uh, that can lead the company uh alongside them or even when they're gone. So you want to make sure the leadership team that there's someone that can actually Take that lead and carry the vision on with the company. You also want to have a strong CFO who understands the deeper level of accounting because there is a deep dive in information that the CFO needs to provide both internally and externally in order to keep the ESOP, you know, valid and then an operations person, so when you have all those. Three key components and you've had them there for a period of time, it gives lends comfort not only to the seller, but it also lends comfort to the any external creditors that are lending credit from the bonding standpoint, you know, and lastly I would say is also identifying beyond the next level of rising leaders beyond the new. Not from the owner but from the leadership team that's in place because you're constantly wanting to keep the trick that going. So you're always wanting to identify who the next generation is beyond your generation. Yeah, and, and so what I like about this, this conversation is that these are things that whether you go towards an ESOP company or not, are all elements of just good business. And, and what we're, what Margie and I were getting at too is this idea that your ESOP is if a company is going to go towards an ESOP as a construction company. One of the aspects of that is we really need to get the the surety company comfortable with this environment. And what she's really saying is, is that the leadership of that company is really critical in demonstrating to the surety company that they're able to manage this transition. And, and that kind of applies towards any, any aspect of a transition, whether it be towards an ESP or anything else. And, and the experience I have is, it's really never too early to start this process to work towards that. And I've got one I've been working on for really 3 years because there's been a lot of starts and stops and the starts and stops have been to identify ways we can really make this a little bit of a better situation and, and a lot of what the work we've done with this one client has been to try to increase and um improve this, this leadership group that they have at the top end. And so those have actually led to more success for the actual business, even though we haven't yet pulled the trigger on the ESOP. And so I think the, the general idea here is that even going towards this process, any kind of succession process is going to be valuable, um, if you have the right team, um, advisors around you to help you through this, through that very like those important steps. Margie, that, that kind of sets us up to discuss from a, and this is from a construction company standpoint, credit risk, um. In that, that the longer they take to put a plan together, you know, and that means, you know, your construction company that's waiting and waiting, um, there's inherently more risk due to the age of the owners and other aspects that they've been, they've been delaying really kind of building this, this leadership team. What are some aspects of credit risk that you find related to, um, you know, directly related to succession planning or the lack of succession planning? Well, the biggest credit risk is how far a surety will extend surety credit to a contractor. So, you know, again, surety is extremely relationship driven, so you really want to know, you know, the health of the owner, the age of the owner. Around that owner relative to again the the management team, you know, we always say, you know, if it's a sole owner, for example, a 70. Single owner taking on say a $50 million project that spans over two years with no succession planning in place is considered a higher risk to the surety, you know, ultimately the surety will want to know who can finish that job in the event that something does happen. And so we really encourage, you know, that being the biggest risk is, you know, how far will the surety go. Exactly. Now I know that um when you have that risk happening, it's more difficult as a bonding agent to get them, you know, bigger and bigger programs if they're trying to really grow their business and um I think that's important that we all kind of look at that and say, when, when should a 70 year old have a plan? And obviously, it sounds kind of obvious, but it's very difficult, I think sometimes because delays happen and, and you get to a point where um they're just um They just delayed so much and procrastinated that it becomes more difficult as as time goes on. Um. Yeah, because it's hard for them to, you know, look around at that point in time and say, who are they gonna, who, who's going to take over the company now. And really with any strategy when it comes to selling your business, if it's an ESOP or even a management buyout, you're still gonna have to get people to operate your business for you. So you can't start soon enough to transition those roles within the company, which was one of the reasons I did one of my podcasts on the management transition planning, um, and really spent 22, actually 2 podcast episodes on just that issue. Um, so how, how does the surety company look at, um, when you look at the creditworthiness of a, of a construction company, when you're comparing the, um, so when I look at an ESOP, the tax advantages of an ESOP compared to a management buyout, really do, like, for me, they, when I put that into a model, I'm getting a lot more cash flow coming out of an ESOP, because I have, I'm paying as an S corp, I'm paying really no taxes. Comparatively, if I look at that with uh with a management buyout, they're paying all those debt payments after tax. And so there's, there's in some cases very significantly different, differences in that cash flow. If I have a company that has more cash flow in general, they're gonna be able to build their balance sheets stronger, um. And they're going to kind of get out of debt quicker than they would. And so when I look at the comparative between an ESOP and a management buyout, I'm looking at it from the standpoint that the ESOP actually feels like it has less, less risk, less credit risk. Um, how does the surety company look at that issue? Well, the surety company, when they look at it, they look at, um, can the con the ability of the contractor to make money and debt service. So the surety is truly gonna focus on the company needing the forecasts, their management ability to continue. the curing work and completing the work profitably and you know, at the levels that that will help manage the debt service. So that's going to be the key for the. Yeah. And so in keeping with that, one of the things that I think is important is, is to, and this comes back to the forecasting thing. is to have a very strong um forecast when we do an ESOP, what we do is we, we, we work them through a five-year forecast and then we're using that in the um in the effort to determine your cash flow break even points. And in order to make sure we are able to communicate that directly back to the, to the uh surety and say this, this would be a good ESOP because they can meet these cash flow payments. Um, so I know that that's a big part of it. And so how do you, so you guys, when you look at that issue, um, I know a lot of your clients are doing, you know, those kind of forecasts. Um, so you guys, when you support that, how does that work for you? But the company, the surety will look at, you know, once the ESO is complete, then they're going to look at the the the post transaction of the balance sheet and how that, what that reveals. And so that becomes what they focus on is, you know, over. Next 2 years because typically construction projects go anywhere from 1 to 2 years, they want to know that there's the revenue and backlog to support any of the debt service pertaining to the ESOP or anything else that's sitting on the balance sheet. So they really are going to take a hard look at the working capital, you know, what additional resources are available if needed to help continue the bonding program that the contractor is accustomed to having, and that can triggers potentially. Capital retention agreements or personal indemnity or subordination of the loan, so it could be a multiple of things. It really just depends on the level of the surety and support that's being required and how the relationship is with the contractor and the surety. Right. So, so one thing that was a question that I had was, I know with personal indemnity being an issue, and the owner is trying to sell their portion of what they own the company, how, how does that work when the surety that is saying, hey, no, we need this personal indemnity to continue your bond program. So the indemnity is it depends on the indemnity package that was put in place. Before the ESOP transaction, so for example, if you have a contractor who had no personal indemnity before they went into the ESOP. The personal indemnity may be required to a level or it may not, depending on how the balance sheet appears. So you know they always sure he always wants to know that the person, the company who found it, the owner who founded the company is still engaged because obviously they want the company to. and so they want to make sure that the owner is available to some level or if the management team is willing to step up, you know, at some point, but it really is a question and a conversation that has to take place early on because you know the indemnity. That was on the table prior or not on the table, it all is going to depend on how the conversation flows and the level of surety support that's being required throughout the process. So unfortunately it's not black and white, but it's a conversation that needs to be right and that's that's really what we what we try to support in this. I go through the due diligence or go through the uh the valuation and the feasibility stage. And then the next step is to meet with your bonding agent and really discuss this um as a possibility and get their influence at the very front end of the potential ESOP transaction before you, you get too far in the process and spend a lot of money. Um, you want to nail down the personal indemnity and other factors. Um, that brings us to this other question of how, you know, working capital is a very big part of our modeling. How does the surety company look at working capital, um, and in terms of, of what you need to make sure that that company is sustainable. So working capital is key to the surety company to continue lending surety support for a contractor. So the quality of the working capital, I always say there's good working capital and bad working capital. For example, if you have a company that has a million dollars in working capital. How is that working capital made up? Is it made up of receivables and underbillings, or is it made up of a good balance of cash receivable and underbillings? So the surety is going to weigh in heavily on what makes up that $1 million working capital. So if the working capital, for example, is majority cash, collectible receivables, and minimal underbillings, then that's that good working capital, and then they're going to determine the bonding program based off of that. They're going to look at the working capital of the backlog, so. We always say for a general contractor, the surety will go to what's called a 5% case. What that means is that they have a million dollars of working capital, that a 5% case would give them a $20 million program or sometimes if it's a subcontractor, they may want to see a 10% working capital case, which means that they had a million dollars in working capital that would give them a $10 million program. So the working capital becomes, you know, very important, and that's how the surety would calculate it is they would look at what makes what makes up the working capital and then the bonding company that Understand the whole ASP will understand that the equity side of it will be flipped upside down, but they're going to look at the total debt and working capital is what gets you out of problems, you know, not necessarily the equity. And I think that that last point is very important to like, not all bonding companies in your experience are that are as familiar with or maybe even comfortable with ESOPs. So I think 11 aspect of that is you really do need to make sure that you've aligned yourself in your um in your approach to going towards an ESOP with the professionals that can really help you and support you that understand that that process and I know. Um, with Margie's experience, she's had other clients that were with bonding companies that weren't necessarily understanding ESOPs and we, and she had to do some work. Um, to move those, those companies into different programs. Is that, do you have anything else to, to add to that on, on your experience with um bonding companies? Yeah, I would, I would say upfront, you know, your, your external partners become extremely critical and, and going through the ESOP, you, you wanna make sure you have the right uh. CPA, you want to make sure you have your bonding agent who is communicating way up front to the surety and to evaluate if that surety really is knowledgeable with these thoughts and what the obstacles will be and so it's really more about the communicating and who your external team is and I always say, you know, just always, you know, we always ask, you know, what's, what's the experience? How, how much experience do you have uh with ESOP? And because they're all different and, you know, every, everybody's gonna look at it differently. So, you know, just having the right uh team externally is gonna be the key to maneuvering through the process. Thank you so much. And Margie, I, I know we're out of time now, but I just wanted to say thank you so much for your time today. Um, having information from a bonding perspective is so important and so valuable. Uh, your experience is just, you know, been really important and critical in this whole process of looking at, at, at companies that want to go through the ESOP process. Um, as I, as we close out, I just want to remind you, if you like what you hear, please subscribe to the podcast and share it with a friend. Um, have a great day and we will look forward to next.