Are You Looking to Buy?
A close-up look at the acquisition process
Buying another company may sound like the fastest way for an HVAC contractor to grow his or her business, but according to industry leaders with experience in acquisitions, it’s not a quick process.
In fact, the No. 1 trait needed to complete the purchase of another business might just be patience. Here is an inside look at how HVAC owners have successfully approached the acquisition process — from the initial conversation to after the sale finally closes.
PATIENCE AND RELATIONSHIPS
Matt Bergstrom is president of Thornton & Grooms in Farmington Hills, Michigan, which just completed the acquisition of another local contractor, Mechanical Energy Systems of Canton, Michigan, in April 2016. According to Bergstrom, the overall process took about five years.
“You have to be patient through the process but be active at the same time, which is a fine balance,” he said.
All the acquisitions Bergstrom has been involved with have resulted from relationships he has formed with other contractors.
“It’s not a quick thing,” he said. “It all starts with an exploratory conversation.”
Bergstrom began talking with Mechanical Energy Systems’ owners, Joe and Donna Napolitano, around five years ago. The Napolitanos were exploring retirement options, and Bergstrom was interested in their air conditioning business, as well as their share of the solar market. Emotions can run high during this conversation and the eventual acquisition process, Bergstrom said. “It’s hard when you have a relationship with the owners. You respect them and want them to do well, and, at the same time, they’re trying to give you their baby,” he said. “They poured their blood, sweat, and tears into their companies for their entire lives.”
To make the process less emotional for all involved, Bergstrom recommends bringing in third-party advisors.
“Push to let the personal details be handled by a lawyer, accountant, or financial advisor,” he urged, noting this is especially beneficial for the seller. “It takes some of the emotion out of it, and the third-party person is able to help [the seller] understand that this is — or isn’t — a good deal.”
According to Ben Stark, networking is everything when it comes to acquisitions. Over the course of his career, Stark has started and sold two contracting companies and been involved in at least 12 acquisitions along the way. He currently serves as an HVAC industry consultant through his firm, Outlook Texas LLC, in Colleyville, Texas, and he reiterated that good relationships and patience are essential for buyers.
Reminiscing about when he first went into business for himself, Stark said he started small, which meant he needed help from other local contractors when he got busy.
“I was a pretty small contractor from 1986 to 1990, and when you’re small, you’ve got to kind of buddy up with other people so you can help each other out when you get excessive business,” Stark said. From this networking, he learned one of his buddies was tired of running his own business. So, in 1990, Stark said they worked out a deal where the other owner came to work for him.
“After that, I started looking for opportunities [to acquire more businesses],” Stark said. He eventually sold his first company during the 1990s consolidation trend and founded a second contracting company in 2000.
“When I started my second company, people knew me from acquiring and selling companies so then, all of a sudden, when guys were looking to retire, they’d come knocking on my door,” Stark said. Many of his acquisitions continued to be sparked through local relationships and his participation in an ACCA regional chapter. Yet, he noted, the overall acquisition process still required time and patience.
“Seldom does anything work right away,” he said. “It may be six months or a year before you end up actually working on the acquisition of a smaller company.”
One of the good things about the length of the process is that it provides a buyer with a lot of time to investigate the potential acquisition.
Ken Haines, CEO of the Wrench Group in Marietta, Georgia, discussed the importance of understanding the financial records of any company being considered for acquisition. Haines has extensive experience in mergers and acquisitions (M&A) and said the Wrench Group hopes to acquire two to three top-tier contracting companies per year. (See the sidebar to the right for more information on the Wrench Group.)
Initially, he said, as a buyer, he wants to gain an understanding of how profitable the business is.
“We’re obviously looking at sales growth,” he said. “Typically, we’ll go back 12 months but, in most cases, we dig deeper over a three- to five-year period and look at what the sales trends have been.”
Additionally, Haines said he wants to understand how contractors manage their operating expenses and how, or if, they’ve been reinvesting capital into the business.
“We look all the way through post-margin trends and operating expenditure trends,” he said. “Therefore, we look at what the bottom line is.”
Haines continued, “Once you get through that process, and you have the economics agreed upon, there’s a purchase agreement you can move forward with. Then, the due diligence starts.”
But, he noted, “As you start digging in, depending on what’s found, you sometimes end up in a situation that offsets the purchase price offer. That’s why accurate financials are crucial for owners looking to exit.”
While noting that most contracting companies in the HVAC industry are not audited annually, Haines said he looks mainly for accuracy in accounting as well as adherence to generally accepted accounting principles (GAAP). Sometimes, he said, a contractor’s accounting department may be understaffed or lack knowledge about GAAP and accrual-based accounting methods.
“Owners may be more focused on accounting for saving taxes, which doesn’t necessarily align with GAAP,” Haines said, noting that these cases are different from situations where owners try to hide things in the books. Still, he said, there’s always the chance a deal can go south if the buyer doesn’t have confidence in the seller’s recordkeeping.
Stark agreed, saying people not knowing their numbers was what typically scared him away from potential acquisitions or led him to offer less.
He cautioned, “When people play with numbers and buy boats and big, expensive houses and run them through the company, those are big red flags.”
Yet, if the buyer cannot trust the seller’s financials, it’s still possible to do an earn-out on acquisition, he said. In an earn-out, he explained, the buyer tells the seller: “The only way I can purchase this is if I give you a down payment for these assets, but the rest of the money is going to be paid as 10 percent on your customer base.”
Stark said this allows buyers to protect themselves, adding, “That way nobody gets hurt.”
Another area to watch closely is warranties, he said.
“If [the seller] had gone out and told their customers they had 10-year warranties, you’ve got to make sure those promises are not going to decrease profitability. It’s a huge exposure to your company,” Stark said.
Bergstrom also mentioned additional areas where buyers must take care to protect themselves. He noted that taxes can be tricky to walk through.
“Don’t just take someone’s word that they’re all caught up, because those are things that don’t die with the purchase,” he said.
And, on the commercial side, he added, noncompete agreements are vital.
“In a residential world, noncompetes are super nice to have, but they’re definitely not as important as when you’re in the commercial world, and you’ve got a relationship with just a few people,” Bergstrom said. “Somebody can walk away and take that relationship with them pretty quickly.”
He noted that these can be sticky subjects to discuss when the buyer and seller already have a relationship, but pointed out this is where third-party advisors can help set up clauses to protect the buyer.
AFTER THE SALE
When an acquisition finally closes, a buyer should immediately focus on integrating the new employees and customers.
“The two most valuable pieces of that purchase are the customers and employees,” Bergstrom said.
Based on his experience, Bergstrom recommended that owners be very active and very empathetic both with the customers as well as the employees who are making that transition. He admitted that it can be difficult for a busy owner to remember to communicate with new team members after a sale. But, he noted with sympathy, “The employees didn’t ask for this, so make them feel welcome and help them transition well during the change.”
Stark also said it’s important to integrate new employees into the existing culture.
“Any company that is growing and has a good foundation has a culture built into its company,” Stark explained. “You want to make sure after that acquisition that the culture still exists. You’ve got to completely onboard the new company and new employees. You’re trying to sell them on a new concept and a new way of doing business.”
But, he warned, not everyone may be a good fit.
“If they don’t buy in, you’ve got to exit them quickly,” Stark said. “You don’t want to bring bad habits into your company.”
In addition to integrating employees, Stark noted it’s also important to integrate customers. In the first year after an acquisition, he always sent specialized marketing pieces to the acquired customer base.
“We’d send four to six letters in that first year reminding them we’re here to help them,” Stark said.
He continued, “Another big lesson is that you have to re-educate customers on realistic pricing. So, many times, contractors don’t realize how to price for the overhead it takes for a successful company to operate.”
However, Stark said, when it comes to raising prices for newly acquired customers, a gradual approach is best.
“Make adjustments to your pricing in the beginning so you retain more of those customers,” he recommended. “Get them used to your services and get them willing to pay more for better services.”
5 QUESTIONS FOR OWNERS
According to Rich Biava, vice president and co-owner of GAC Services in Gaithersburg, Maryland, company owners need to ask themselves hard questions before buying another business, such as:
1. Does the business easily fit into your organization?
2. Can you improve the business efficiencies?
3. Will this acquisition give you a competitive advantage?
4. What additional investments will be required to make this acquisition work?
5. The people of any organization are true assets. Are those employed in this company worth investing in?
A NEW APPROACH TO M&A
The Wrench Group is a home-services company that was created earlier this year and owns four regional brands across the country. The company is looking to acquire more HVAC, plumbing, and electrical contracting companies; however, CEO Ken Haines is quick to point out that the Wrench Group is not a consolidator.
“We’re very different from a consolidator in that we’ll buy your business and put you on some type of earn-out,” he said. “With us, you remain an owner. We want great operators who want to stay and remain on board, help grow the business, and keep an equity stake.”
The Wrench Group is only interested in acquiring top-tier home service companies, according to Haines.
“We want market leaders who have great branding, reputations, and cultures. We want those who treat their team members well and take care of their customers,” he said.
While the company is headquartered in Marietta, Georgia, its business model is best described as decentralized. None of the local brands are being renamed to create a national brand. Instead, the Wrench Group wants to support, collaborate, and add value to each of its regional brands in its efforts to grow and improve market positions.
“For us, it’s about keeping the local presence, keeping the local brand intact, and letting our leaders continue to run their businesses with our support and help in areas that make sense,” Haines said, noting the Wrench Group can help contractors with best practices, business insurance, health care, benefits, enterprise software, and purchasing.
“We allow the owners, at that stage of their lives if they’re ready, to take some chips off the table, put some money in the bank, secure their futures, roll equity, and remain and have ownership in the bigger enterprise,” Haines said. “And, then, when the second bite of the apple comes five or seven years down the road, there’s another trigger and additional financial reward.”
Publication date: 2/13/2017