The Market is Red Hot
Some Quick Points Regarding Today’s M&A Frenzy
To say that the first quarter of 2021 M&A activity within the residential service contracting trades is hot is an understatement. In fact, there has never been as much buying and selling going on within our industry! Not even the Consolidation Period of the late 1990’s compares to what is occurring today. HVAC and plumbing service contracting businesses are the thing with private equity investors and have been for a while now. As this trend continues, more and more investors are finding their way into our world.
What has changed in 2021 are the number of buyers jumping in on the action has as well as the flexibility of both the size of the businesses acquired and expansion into secondary markets. Whereas your business better produced $1M in EBITDA to attract a buyer in the past, I am seeing buyers consider businesses that produce less than $1M in EBITDA today. In the past, the less than $1M EBITDA was a no man’s land for finding qualified buyers, not so much today.
No one can predict when the heated interest in our industry will slack up; all we know is that at some point, the activity will morph back into a less frenzied pace. If you are a service contractor and you want to sell your business, now is the right time. Although there has never been a better time to negotiate with a buyer, a business owner should keep the following points in mind:
Although buyers are stretching for premium businesses, the highest offers are going to businesses with consistent double-digit earnings within markets that can facilitate growth. One exception might be smaller acquisition targets in markets that the buyer has already made a commitment (add-ons or tuck-ins).
Buyers may want you to roll a part of the proceeds back in the transaction which would make you a minority owner going forward. Retaining a minority ownership and continuing to grow your business under the support of private equity partners or new owner can be an excellent opportunity for you to enjoy what is referred to as the “second bite of the apple”. The second bite comes when the private equity partners grow and then sell their collection of businesses at a higher multiple than what you would be able to achieve for business alone. In many cases, retaining a minority interest of say 20% can result in a payday equal to or higher than when you sold the original 80%.
Understand the meaning of the word arbitrage. If a buyer has already put together a significant operating group, it is likely that they are able to sell that group for a multiple much higher than what your business, as it stands alone, can demand. What this means is that a buyer can stretch significantly as long as the arbitrage makes sense. The best way to explain this is by example. Assume a buyer pays you 8x for your business, and that buyer is able to then add your business into their group. Now assume their group collectively demands a 15x multiple – the arbitrage here is 7x earnings. The day the buyer purchases your business at 8x, they automatically can sell it for 15x. The magic of arbitrage is what is driving the impressive earnings multiples today.
Despite recent off-the-chart sales prices and other tales of great deals, a business owner must still understand the basic concepts of valuation, what builds value, and how earnings ultimately drive values and purchase prices. Make note there is a big difference between valuation and price, especially today. Understand valuation, but think price when it comes to selling. Consider a formal valuation, but be sure that the professional completing your valuation understands what is occurring in our industry at the moment.
Don’t be fooled into thinking everyone who contacts you via letter or telephone is a buyer or actually represents a buyer. With the interest in our industry, you are being bombarded by every investment banker and business broker who has ever turned down a thermostat. Many clients report they are contacted weekly by buyers, when in fact, the contacts are mostly from people looking to list and sell their business. This does not mean real buyers are not directly contacting business owners because they certainly are.
Don’t waste time on buyers who are not serious or incapable of completing a transaction. There are a lot of qualified buyers out there today. Potential buyers include private equity, strategic buyers, and individuals (to name a few). There are also a lot of time wasters. The quickest verification is to ascertain the capital a would-be buyer has to actually complete a transaction. Does a potential buyer have the capital, and if not, are they working with a lender such as Live Oak Bank (who specializes in lending within the service contracting industry)? Without the capital or without a plan to secure capital, whether conventional or SBA, the would-be buyer is just wasting your time. Another quick verification is whether or not the would-be buyer has a history of completing transactions.
Although you may have been contacted by a buyer and have received an offer, have you negotiated the best offer (counteroffer)? Are you prepared to navigate through due diligence, and have you fully negotiated the entire transaction? Although you may not require a business broker to find a buyer, you will still need a team to ensure that the transaction closes and closes for more money than the original offer. Consider a consultant who understands the M&A process, a good M&A attorney, and of course, your tax CPA. On the surface, nabbing a multi-million-dollar offer may seem simple, but in all actuality, the work has just begun. A good M&A consultant will have gone through the procedure many times before, understands both value and purchase price, and is able to guide you throughout the entire project. Many projects that I have taken part in over the last 24 months begin after the seller has been contacted by a buyer.
Do not discount the chances to sell your business just because it is relatively small or services a smaller market. I have assisted clients in transactions of all sizes over the last year, and I am finding more and more buyers for businesses with less than $4M in revenue. This is especially the case in hot markets where strategic buyers are frantically looking to “add-on” to already purchased businesses. I have even assisted a small HVAC contractor in a rural market recently that, up until now, I would have falsely concluded there was little chance of the business trading at what the buyer proposed. Again, we are in uncharted waters and the nets buyers are casting get wider and wider by the day.
In summary, the service contracting trades are hot today. The trend ends are unclear, but we can be certain that over time the frenzy will lighten up. However, prior to that, the opportunity to sell your business exists today regardless of size and to an extent, your geographic market. If you have been approached by a buyer or if you are considering taking advantage of the market, feel free to reach out to me and I will be able to provide further insight.
Brandon Jacobs is a CPA and operates Contractors Financial Opportunity, LLC. For more information, contact Brandon at Brandon@contractorscfo.com.
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