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Achieving A 5x Valuation Multiple In An HVAC Business

At a simple level, HVAC businesses sell for a multiple of owner benefit (the cash that flows through to the owner), plus a valuation of assets that the business has (real estate or vehicles).

Maximizing the valuation multiple is key to getting the highest exit price.

If you’re reading this article, you’re probably already familiar with the concept of valuation multiples and are looking to get the maximum multiple. The multiple which many HVAC business owner target is 5x.

Achieving a 5x valuation requires building a scalable business and is ‘beyond average’, when considering the comparables.

When it comes to analyzing valuation data of HVAC businesses, we look to Florida. Florida is one of only a couple states that has a business MLS system which aggregates the information, and Florida has a relatively active category of HVAC businesses.

The data reveals 2 key points…

#1) Among HVAC listings, more than 50% of the listings NEVER sell.

#2) Among the listings that do sell, the average multiple is 2.3.

While the average among all listings is quite low, we do find that with a little refinement following our Exit Method Framework and consulting services we can drive most HVAC businesses doing $1mm in revenue + to a marketable multiple close to 4x.

With that in mind, let’s take a look at what it takes to achieve a 5x multiple.

1) At least $5,000,000 in annual revenue. At a 5x multiple, the buyer pool is going to be savvy investors looking for a very ‘established’ operation with revenues to a support management team, adequately compensated staff, and at least 20 employees. This typically starts to come together around the $5,000,000/ yr in annual revenue mark.

2) At least 10% net income margin. Healthy margins are indicative of a business that will stand the test of time. A 10 – 15% margin, after fair owner/president salary, is reflective of a scalable HVAC business. Beyond 15% is not bad, but may throw a discerning view as it typical tends to indicate, a high owner involvement, under paid staff/management, or a market advantage that is not sustainable.

3) Management Team. If paying a 5x multiple a buyer is looking to fill the role of CEO; not operator or hands-on man. To operate as a CEO a management team with tenurship, needs to be in place. At the BARE MINIMUM, there should be 3 managers; a general manager, an operations manager, and a sales/office manager. Each of them should have at least 2 years in their currently role, and be compensated at market rates.

Side note: often we see ‘managers’ in place that were promoted from within and are under compensated. For valuation purposes, to reflect market rates, each of those roles would be expected to receive at least $80,000 in compensation. Managers with less compensation then that will not be viewed as sustainable in the long run as if they leave it is likely a replacement at those rates will not exist.

4) Documented Systems & Procedures. Scalable and highly valued HVAC businesses required documented systems and procedures. To achieve a 5x multiple EVERY operational activity needs to be on paper and all of the staff need to be full trained on the activities as it relates to their role. As a rule, when asked “how do you do that?”, everyone on staff should be able to point to the exact procedural document within 2 minutes.

If that cannot happen, the documentation and training needs improvement. This is one of the key things we work on in The Exit Method.

5) Internal Employee Promotion Plan. Finding, recruiting, and training employees is perhaps the biggest challenge facing HVAC business owners. In our experience as home service business owners, and agreed upon by most seasoned owners, the best method to fill the org chart is to promote from within. Having a documented internal employee promotion plan, gives buyers the assurance that there is a talent pool that will continue to fill the ranks and it also shows employees that there is a growth path and contributes to their increased tenurship.

6) Diversified Customer Base. Relying on a single customer for a large portion of revenue is risky business.

Potential buyers will wonder, “will this customer stick around if the current owner leaves?”

We recommend that no single customer account for more than 10% of revenue.

7) Stable Revenue / Profit. Often times HVAC owners will come to us in a time of ‘hyper-growth’, looking for a high multiple, as they are growing “faster than anyone”. Unfortunately, hyper growth is not rewarded. In the HVAC industry (and other contracting industries), businesses are valued on their cashflow and stability. There have been countless examples of high growth businesses that eventually go ‘bust’. Savvy buyers are aware of this and will not pay a premium.

Growth is good and ideal, but as a rule of thumb, should be capped at 15% year over year for the purpose of maximizing valuation.

8) In business at least 7 years (with the same brand name).

Length in business is highly valued. A brand name that has been around for decades has brand recognition that cannot be duplicated other than being active in the local market through time.

Following that, the brand name should exist consecutively. While rebranding could be good for business, a recent change in brand name is generally viewed as red flag to potential buyers.

‘High Performance’ vs ‘Average Numbers’ in HVAC Businesses & Valuations

Occasionally we run across owners of HVAC businesses considering an exit, with ‘high performance’ numbers. Typically that is reflected in either rapid growth in revenue, or a high net income margin (net income / total revenue). We would consider a 20% margin high.

With numbers that are outperforming industry standards, owners are looking for an exit price that is subsequently higher then average.

But that isn’t always realistic.

High performance HVAC businesses can actually dissuade buyers, and when the demand decreases, so does its selling price.

Here’s why… buyers value stability and likelihood that the business will continue to produce the same numbers after acquisition. Let’s look into this further.

In the scenario of a business that is rapidly increasing in revenue, a buyer will think this rapid growth is unlikely to continue, and the local market may crash. Even with a marketing plan in place a buyer may feel the business that the plan is the brain-child of the current owner and they are unlikely to continue it.

Best solution: Anticipate a valuation at a slightly lower multiple, or ride out the growth path until you reach current operational capacity and then sell.

In the scenario of business that generates a high margin, buyers will see the high margin as unsustainable because…

A) Market competition is likely to increase (squeezing down margins).

B) Staff are underpaid.

C) The owner/spouse is handling multiple roles.

In most businesses we see with high margins, the margins are typically NOT the result of a competitive advantage, and should not be valued at a premium.

Best solution: Make sure all staff roles are properly documented and compensated sufficiently. Then document any competitive advantage that maintains that margin.

9 Things Buyers Need To Look For In HVAC Businesses For Sale

This piece is a work in progress.

The first 5 have to do with Operational Infrastructure. As a buyer the primary concern should be that you understand how things get done and what you will need to do.

What Does The Owner Do?

Is the owner responsible for getting the crews out the door in the morning or do they spend most of their time tucked away in the back office? … or not even in the asset at all?

Figuring out what the owner does and how in-grained in operations they are will determine whether you are buying an asset, or a job.

HVAC businesses for sale that have a heavily in-grained owner are not necessarily a bad thing; actually sometimes the opposite. Consider a business where the owner is a control freak and simply does not know how to properly manage. In those businesses there are often many capable employees that with proper guidance could fill higher level roles. In these cases, the businesses sell for lower multiples and with just a little refinement can be transformed into an asset that has a higher multiple valuation.

Is There A license Holder?

Generally no matter where you are are looking to buy an HVAC business, licensing will be required. It is common place for a prior owner to hold the license for a period of time after the acquisition and that has satisfied the SBA lender in the past.

However, since 2019 the SBA has tightened their lending requirements around licensing. They are no longer happy lending to a business with a prior owner holding the license and look to see the new owner having a license already or a non-equity employee holding the license.

Aside from lending it is good practice to have another license holder on staff if you wish to build a true asset.

Who is responsible For Getting Staff Out The Door In The Morning?

The first hours of the day, between when operations staff arrive at the shop, and when they depart for their first job site is crucial in any HVAC business.

Operations staff tend to ‘drag their feet’ in leaving the facility. They might forget the right materials. They might not be clear on what and where they need to go for the day.

Whom ever holds this roll, which can be highly stressful, and ‘game winning/losing’ for the business holds a key roll.

Is it the current owner? Do they have a non-compete? Are they someone you could work with?

Nothing reveals more about the true operational structure and active role of the owner of an HVAC business than the question “who is responsible getting staff out the door in the morning?”

Field Service Management Software

Field service management software is the cloud based back bone of a modern HVAC business. It provides centralized app for scheduling, job management, estimate recording, employee time logging, and in some cases a lot more.

Not all HVAC businesses use a proper software. Some still operate with carbon paper while others hack their way around using a mix-mash of apps and calendars.

Understanding what system the business currently uses is an insight into how accurate quoted data really is, and how much work you might need to do as a new owner to implement proper software.

Documented Systems & Procedures

It is uncommon to find small HVAC businesses (typically for sale at an asking price below $3,000,000 to have documented systems and procedures but a business that does have everyting mapped out on paper would be worth more to a new buyer than one that does not.

Pricing Structure

HVAC businesses of all size should have a documented pricing structure. This ensures that suitable quotes have been giving out and that technicians and sales people are held to a standard when quoting.

As a potential buyer this also gives you the ability to review the structure. Is pricing above or below the local market?

Financial Performance

HVAC businesses are valued primarily on the value of their cashflow and likelihood that it will continue; therefore financial performance is crucial.

For maximum valuation, HVAC businesses should have a healthy margin, and consistent numbers over the past 3 years.

Growth is good, but rapid growth can be a bit of a crux. Businesses experiencing rapid growth shouldn’t expect compensation for the growth, as buyers are skeptical that same growth rate will continute.

Similar principle applies to net income margin. We occasionally see sellers with businesses generating a 20% or high net income margin, expecting to be valued at a premium for this. Unfortunately, that is generally not the case as buyers view that margin as unsustainable in the long run because…

A) Market competition is likely to increase.

B) Staff are underpaid.

C) The owner/spouse is handling multiple roles.

Condition of Assets

Will assets need to be replaced or upgraded quickly. This is something that needs to be budgeted for prior to making an acquisition.

Diversification of Customer Base

This doesn’t come up often in the residential sector, but often HVAC businesses with in the commercial sector rely heavily on a single client. This is a negative position for nearly any buyer. If that one customer is lost as result of the intangible relationship when the current owner exits, revenue and profit take a hit.

We recommend that no single customer accounts for more than 10% of revenue.

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