In the October issue, we announce the winners of this year’s National Housing Quality Awards: gold award recipients DSLD Homes and EYA, and silver award winner French Brothers.
For many builders, finding a tolerable path into retirement is the toughest management challenge of all. Here's how to get started.
Most American home building companies are personal businesses. The owner's name is on the sign out front - often first name as well as last. And inside you usually find a middle-age, workaholic male chewing a pencil over a land purchase or an uptick in warranty costs, but he's not thinking about when he'll retire - or even how to make that possible. Most builders have no exit strategy. Their lives and their companies could be so much better if they planned their way out of active management. If you see yourself in this picture, read on. End games abound. You can find the one that's right for you. But first you have to address a series of challenges that complicate choosing the right course of action.
The personal and private stuff nobody wants to talk about
When we looked to interview builders who have wrestled with personal and family issues, we got a lot of polite "no thank you" and a few terse "no comment" responses. Who can blame them? It hurts when offspring fight inside the company or Dad's dictatorial control drives Junior into another state.
Because relinquishing control is hard, many builders wait too long to deal with estate planning and the transition of company ownership within large families that might be complicated by divorces and second marriages among the offspring. Often, builders are so hamstrung by the potential for family conflicts that they just stay put as Lion King. But until ownership strategies are in place, management transition can't begin.
Start With a Family Council
Family business consultant Leslie Dashew, president of Human Side of Enterprise in Scottsdale, Ariz., specializes in working through the problems inside families that often complicate succession planning. She advocates forming a family council to provide a forum for family members to discuss their concerns about the future ownership of the business.
"If the family wants to retain ownership after the leader's retirement or death, it's important that it speaks with a single voice to managers and employees," Dashew says. "Don't put them in a position where they are forced to take sides in disputes inside the family, especially if the plan is to turn over leadership to a successor from the outside."
Family council meetings should be held regularly, Dashew says, and moderated by a professional facilitator, not by the strong-willed entrepreneur trying to relinquish control of the business. "A person used to telling others what to do is not the best one to get all the thoughts that may affect the future of a family business out in the open."
Independent Directors Help
Almost as critical to Dashew's approach for preventing family conflicts from adversely affecting management transition is an independent board of directors, with members from outside the company and the family.
"Most of the builders I've helped to develop an independent board say it's really valuable to the business as well as the family," Dashew says. "They say building an effective board is an exciting new challenge. Many try to get builders from different parts of the country, people they respect - and don't compete with - as board members. It doesn't hurt that those board members often face the same transition challenges inside their own families and companies."
An independent board can provide objectivity in assessing candidates to succeed the current leader as CEO.
Early Decision on Successor
Perhaps the most important decision that must be made is whether a family member will be that successor. Builders who plan to turn a personal company into an ongoing family business, or continue a family business into another generation by turning over management to an heir, need to start working toward that goal 10, maybe even 20 years before the target transition date.
"It takes a long time to get a son or daughter ready to take over, especially in a production building company," says Mark Schickner, an Atlanta-based management consultant. He cautions that offspring need time to decide if running a building company is something they want to do. And the builder (and perhaps board) needs time to assess if the candidate, no matter the relationship, is capable of filling such a demanding position. Even if an heir has the drive and talent to succeed, experience can't be overlooked. Sending an offspring to work for another builder in a different part of the country has helped some. That's often followed by years of moving up through the ranks in the parent's firm.
A Vote Against Offspring
Still, there are strong arguments against finding a successor within the family. "The track record of kids taking over established home building companies is not stellar," Schickner says. "The failure rate is high, and the number of kids who exceed the parent's performance is minuscule. Most builders would be better served to keep their kids out of their companies. They need a passion for this business that most of them don't have."
Get an Estate Plan in Place
Estate planning is another critical family issue that affects transition into retirement and requires significant lead time. No business owner wants to see heirs or the family business burdened with a heavy load of estate taxes. So owners use trusts to transfer company ownership to heirs gradually as they approach retirement age.
Atlanta attorney Bill Merritt specializes in corporate organization and estate planning for builders. He favors limited partnerships over limited liability corporations and Subchapter S corporations, and generation-skipping trusts (GSTs) over grantor retained annuity trusts (GRATs) to keep estate tax liability away from the family for generations.
"Builders can create new entities with the stroke of a pen when they move from one project to the next," Merritt says. "All the value can be created inside a GST and be out of reach for estate tax purposes for generations. The only trouble with GSTs is that there's more accounting complexity. You have to keep books for each entity you set up. But at the end of 10 years, using GSTs, all the wealth you've accumulated is outside your estate.
"In a GRAT, you're transferring equity into the trust for a specified period, during which the trust pays an annuity back to the grantor [builder]. If you outlive the trust period, the stock in the trust is out of Uncle Sam's reach."
Kentucky-based builder Ralph Drees used to own 85% of the stock in his company. But in the mid-1990s, he began using GRATs to transfer ownership out of his estate. "I'm now down to 29%," he says.
Atlanta builder Tom Bradbury, who recently sold Colony Homes to public GIANT KB Home, calls estate taxes a penalty for dumbness. "Estate planning is something you have to do over 20 years," he says. "I'm now to the point where I'm starting to keep some things in my estate just because I'd like to have a little left!"
What happens to the business after the owner leaves?
For most builders, their business is their baby, almost a second family. While their real families will see more of them in retirement, builders know they will miss the company and worry about what will happen to it. Estate planning, even writing a will, is a snap compared with planning what will happen to a business. Often, builders worry about it enough to talk themselves out of leaving. They decide to retain ownership, even in the face of compelling reasons to sell, because they can't stand not being the boss, no matter how much money they have in the bank.
Home building is one of the last refuges of unbridled entrepreneurs, and big egos drive success. When it's time to transition leadership, many builders find it's almost impossible to let go.
Schickner, a former senior executive with firms such as Toll Brothers and John Wieland Homes, says the personality traits that lead builders to success also make even the thought of retirement painful. "They are high-risk, high-reward, entrepreneurial deal-makers," he says. "But that type person also has a very hard time letting go of control. They are detail-oriented micro-managers, perfectionists who believe they can catch a mistake no one else even sees. And often they do."
Plan Time to Detox
"To be successful, builders develop a keen sense of the risk associated with land and product design," Schickner says. "To let go of those critical decisions and retire, a builder must be confident that his successor's decision-making aligns with his own. It takes a well-planned, systematic, three- to five-year process of gradual separation. It's almost like weaning. And it has to include a long time training the successor."
Obviously, choosing a successor is the most critical decision of all, unless the end game is to sell the company or liquidate it. Even if that's the choice, builders often are too compulsive to accept retirement as most people define it. Many of the retired builders we interviewed for this report are engaged in second careers. As former Wayne Homes CEO Dave Showers puts it, "No builder is going to sit around and watch soap operas."
See a Beginning, Not an End
Bruce Wright, an exit strategist and consultant in Simi Valley, Calif., says the concept of retirement needs redefinition. "I hate the word," he says. "The trouble is, too many entrepreneurs are sitting down with accountants, lawyers and estate planners to develop exit strategies, and those professionals ask the wrong questions. They deal with strategies, tactics and financial tools without ever asking about vision, commitment and goals.
"The right question is: 'If you had all the money you'll ever need, what is your vision of an ideal life and a perfect calendar?' Another would be: 'What is the highest and best use of your time, talents and resources?'"
Wright tells of a California builder who defined his occupation as "developing land to create houses for people." When asked if anyone else could do that work, the builder replied, "Yes, but no one does it quite like me."
"He was delusional," Wright says. "When I finally talked him through his highest and best use and perfect calendar, he suddenly became passionate about mentoring young people from impoverished backgrounds toward careers as entrepreneurs. Finally, he became more and more frustrated with how his job and his company were holding him hostage in 14-hour days - keeping him from his second career."
Sell if You Can (Come Back if You Must)
Large local production builders with significant land holdings - owned or optioned - have the best opportunity to sell to a GIANT. That's the option grabbing headlines now. In the consolidation frenzy, a few publicly held GIANT have grown to massive proportions while accommodating many local builders' desire to catch the peak of their firm's value on the strength of housing's 11-year run of strong sales.
Old-time housing guru Lee Evans used to say, "If you stay in this business long enough, you'll go broke!" He advocated cashing out every five years. It's still good advice, for no other reason than the problems builders have getting cash out of their capital-intensive companies.
Michael Kahn, an attorney in Jacksonville, Fla., is the most active middleman brokering sales of building companies. He says you need 250 sales a year and at least $50 million in revenue to get an offer from a national builder. If you have the numbers, go for it. Nothing is permanent. If you can't get housing out of your system, develop land for a couple of years and then make a comeback when your no-compete clause expires or your buyer goes broke (both have happened ad infinitum).
Seek a Successor Carefully
If you're not big enough to sell to a GIANT, your staff isn't strong enough to carry an employee stock ownership plan (ESOP) and you don't have an heir apparent in the company, five years from a targeted retirement date is probably a good time to start looking outside for a successor as CEO. Many builders who have gone this route started with a judicious selection process to find the right headhunter to conduct the executive search. It's a good move because if you get the right person, it might put enough of a charge into your company to get a good sale offer.
Bob Piper, president and senior partner of The Talon Group in Addison, Texas, says even builders who are large enough to attract public GIANTS will get a better offer with a young stud running the company rather than a rich, old man. "They don't want to see an autocratic owner hanging around, micro-managing everybody," Piper says. "What they want to see is an aggressive, professional CEO with a strong management team. That's why you now see so many owners recruiting CEOs from outside the organization."
"I interviewed three search firms before selecting one," says Bill Paulsen, former CEO of Summit Properties, a Charlotte, N.C.-based apartment builder. "They brought me 20 candidates. I interviewed 10, then narrowed it to three for in-depth interviews. I hired Steve LeBlanc as COO, worked with him for a year, then flipped him the keys on my way out the door on July 1, 2001."
Bakersfield, Calif., builder Kyle Carter, 46, recently sold Kyle Carter Homes to The Corky McMillin Cos., a private builder based in National City, Calif. His explanation for selling: "I'd already made all the money I need to live really well. Do I need to risk money I've already made to make more money that I don't need?"
He says he sold to McMillin because Kahn told him the Bakersfield market (3,000 houses a year) wasn't big enough to attract public builders. "Shortly after we started talking to McMillin, a broker called me to say D.R. Horton and M.D.C. were interested. Then our biggest competitor, Coleman Homes, sold to Lennar. A little later I got a call from K. Hovnanian. Looks like Bakersfield is big enough now."
Pick an end game fast: Getting started pays off immediately.
Whether your end game is to sell your firm or to continue it in some form after retirement, it's best to make the decision now because it might take five to 10 years or more to put all the pieces in place to ensure success. Moreover, there are benefits in the here and now for having the process in place.
Solutions: Package for Sale to Improve Results
Almost any course you decide to follow toward the end game of your choice likely will improve the performance of your company almost immediately. For instance, if you decide to try to sell the company, the right course is to begin to package it for easy assimilation into the purchasing company. Just think about the ways that can improve performance.
"I tell builders if they want to sell their company to a public company, they need to make it look like a public company," Schickner says. "That means cleaning up the balance sheet - no more personal cars or boats on the company rolls. But more important, it means standardizing processes and tightening operations. Fully integrated management information systems with purchase order capability will enhance the sale price.
"Public companies like to see as many lots controlled through options as possible, rather than direct ownership. And the great thing is, if you take all these steps, the profitability of the company is almost bound to improve, and that sure doesn't hurt the prospects for making a sale."
Kahn says big public builders always look for builders with an organization chart that shows a capacity to grow to the next level of production. "They don't want to see an owner micro-managing and supervising everything himself," he says. "They want a management team in place to grow the operation. Anything they want to buy, they plan to grow.
"They like to see lots optioned because return on assets is now Wall Street's favorite measure, even more important than units, revenues and profitability."
Even 30% ESOP Might Be Win-Win
If you decide to sell your company to employees through an ESOP, test the waters with an offering of 30% of the stock, the minimum allowed. Even at that limited level, you can reinvest the gross proceeds of the stock sale any way you wish with no capital gains tax liability.
And giving employees a stake in the company likely will boost morale and productivity. According to a study published recently by the National Center for Employee Ownership, ESOPs tend to boost growth by 8% to 11% per year. At the 30% level, a builder can take some cash out of the firm tax-free and indulge any inclination to remain in control.
However, Martin Staubus, director of consulting at the Beyster Institute, a California nonprofit organization that provides information on employee ownership strategies to entrepreneurs, cautions that the most important asset a company needs to launch a successful ESOP is a successor CEO in place and ready to go.
Former Colony Homes CEO Tom Bradbury says he didn't have to package the Woodstock, Ga.-based firm to provide the management information systems needed to appeal to a public home builder. "To my knowledge, we were the only home builder operating with all management information coming from a single database, in real time," he says. "Everybody, from customers to trades to the mortgage company, could access the information they needed directly without communicating with anyone over the Web. All they needed was an e-mail address."
Bradbury says he tried for a long time to retain ownership of Colony, which ranks No. 70 on PB's GIANTS list this year on 1,872 closings for $244 million. "I never hid anything from the team, and I finally concluded I was holding them back. I would not sign any loans personally. If I'd been willing to do that, we could have taken Colony into PB's top 10 within three years. When you get close to 60 and you've got all your eggs in one basket, I don't think that would be prudent."
Bill Kennedy, 61, chairman of Kennedy Homes in Barrington, Ill., put a unique exit strategy in place in the mid-1990s. He split his production building company into four equal parts and put one member of his management team into each as a minority partner. Each new mini-company was set up to do about 100 homes a year. Corporate was cut to the bone and organized to provide accounting and other services.
"My goal was to gradually increase the equity of each partner until mine finally just disappeared," Kennedy says. It didn't work. Four years ago, he reassembled the big company, this time to work on implementing the Rayco model and focus on regularized production. However, the four managers are still minority partners with Kennedy.
"It was the best thing I ever did, and so was bringing them back together," he says. "Each was struggling with a different issue, but the cross-training they got during the five years they operated on their own is invaluable to us now. They all understand the big picture."
But what about Kennedy's end game? "I have a new plan," he says, "but it's not ready for public unveiling yet."