Subcontractors are becoming increasingly sophisticated in deploying their capital. As market conditions shift, so does their approach to managing risks – both at the project level, as well as in the administration of their business.
While the construction marketplace has always had its share of large, multi-region subcontractors that have been part of another holding company or corporation, it has been our observation that smaller, regional or local firms are now beginning to consider either a sale as part of succession plan (merger/acquisition), or a restructuring to insulate the parent from operational risk and/or tax liability.
It’s no surprise to the construction industry that there is an age problem. The construction workforce has been both aging and shrinking in scale, or not expanding rapidly enough to keep up with demand. While the actual workforce faces a retention problem (about one in five construction workers is 55 or older, with retirement of 20% of the workforce looming), approximately 60% of subcontractors’ businesses are estimated to be facing an ownership/succession transition in the next five years due to aging ownership.
The Importance of Understanding Your Subcontractor's Business Structure
Sale as Part of Succession
Generational transitions are not uncommon within the construction business, both at the general contractor and subcontractor levels. Many such businesses that have already experienced a transition from the first to second generation are now facing one from the second to third generation, or lack a generational successor or succession plan altogether.
These changes in ownership structure constitute a risk consideration necessary for the successful execution of your projects. There are losses within the Hudson SDI team's data resulting from a lack of failed succession planning of a subcontractor’s business, which is an area where little prequalification or due diligence is conducted. For this reason, it's suggested that information be collected about the years under the current structure, as well as gaining any insight into future succession plans and any financial implications.
©2024 Hudson Insurance Group. The information contained in this newsletter is for general information only and shall not modify the terms of any insurance policy.
SDI Newsletter | June 2024
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55+
55+
20%
60%
One-in-five construction workers are 55 or older
of current construction workers are eligible for retirement
When this happens, without a standing or subcontract-specific parent or cross-company guarantee (depending on structure, other subsidiary companies may hold real estate, intellectual properties, vehicles, equipment or anything else of value that is used by the operating companies that can be considered collateral), it insulates the holding company from legally having any financial or operational commitments that may have been made by the operating company. These operating companies are often limited liability companies (LLCs). While an LLC differs in some ways from a traditional corporate structure, it will typically protect its members from liability much the same.
We suggest if this type of organizational structure is present or planned that the holding company be the signatory subcontracting party, or that a legally binding guarantee be in place to back the commitments being made. This is important because the holding company almost always holds the keys to the cash register. Without their support, there is no ground to stand on in the event of performance failure.
(Re) Structure
Subcontractors are always looking for options to protect their business's current and future assets. One highly effective strategy has been to divide the business into multiple entities, all owned and controlled by a single holding company. Alternatively, subcontractors can sell their business to another holding company, thereby becoming its subsidiary.
Most often, the holding companies don’t sell any products or services, or conduct any other business operations. Their sole purpose is to hold the controlling stock or membership interests (including all or most financial health) in the other companies.
Electrical Company
Mechanical Company
Mechanical Parts Company
Motor Company
Electrical Systems
Company
XYZ Technoligies Inc.
XYZ Limited
XYZ Company Limited
Holding Company Structure
Organization Chart for Holding & Subsidiary Companies
of subcontractor's businesses facing ownership transition in next five years
In a typical holding company structure, the subsidiary companies manufacture, sell or otherwise conduct business: they are the ones executing the subcontract work! These are called operating companies. Subcontractors have become increasingly more adept in having these operating companies hold the subcontract risk (signatory to the subcontract), while using the financial health and position of the holding company to qualify and support the commitments being made.
Discuss impacts on balance sheet behavior. Consider collecting cross-company guarantees.
Subsidiary or affiliated company part of financials?
Are holding company financials being used? If yes, the parent company guarantee (PCG) should be collected. If a PCG cannot be collected, other controls will be required to monitor subcontractor financial health and payment behavior.
Parent company / holding company?
If yes, discuss / understand the plan and what impact it may have on project cost or resources.
Is the company looking to unionize?
If yes, discuss / collect succession plan
Is the company planning a change in ownership or succession in the next 12-18 months?
If less than 5 years = red flag If > 20 years, discuss / collect succession plan
Years under current management / ownership structure?
If less than 5 years = red flag If > 20 years, discuss / collect succession plan
Year formed / years in business:
Criteria / Prequal Info to Collect
Review Criteria to Consider / Adjust to Risk Appetite
Prequalification Considerations
One-in-five construction workers are 55 or older
Estimated that
Subcontractor's businesses are estimated to also be facing an Ownership/Succession transition in the next 5years due to an aging Ownership.
55+
Finished
projects
20%
Invested
millions
60%
OF