Uncovering the Hidden Dollars

January 22, 2007
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Do business owners actually plan their exit strategy even before starting a new business or buying an existing business? It may not be as unusual as one might think. After all, planning for life after owning a business can be just as important as building the business in the first place.

So why do so many HVAC business owners place more importance on one and not the other? How does an HVAC contractor build value in his or her business and know when the best time is to sell (or buy) a business? The NEWS asked some members of the leading HVAC contractor groups to give their opinions on the topic.

“Many people in our industry start or buy their businesses to control their own destiny or to build something for their children. But until they see it as more than a job, and see it from a prospective buyer’s eyes, many don’t realize that all they have to sell is themselves,” said Doyle James, president of Aire Serv Heating & Air Conditioning Inc.

Smart business owners, those looking to make a healthy profit on the sale of their business, understand that building value in a business can be just as important as making a reasonable profit each year and staying solvent.

Richard Parker, president of Diomo Corp. and author of How To Buy A Good Business At A Great Price, said, “Accurately valuing a small business is often the most challenging part of the process for prospective business buyers. However, it doesn’t have to be an overwhelming or difficult undertaking. Above all, you should realize that valuation is an art, not a science. As a buyer, always keep in mind that the asking price is not the purchase price. Quite often it does not even remotely represent what the business is truly worth.

“Naturally, a buyer’s valuation is usually quite different from what the seller believes the business is worth. Sellers are emotionally attached to their businesses. They usually factor their years of hard work into their calculation. Unfortunately, this has no relevance whatsoever in the equation.”

WHAT ARE BUYERS LOOKING FOR?

In order to understand how to build value, it is reasonable to assume that prospective buyers define value in a number of different ways. The old cliché that “beauty is in the eye of the beholder” can be translated into “value is in the eye of the buyer.”

James noted that there are two types of buyers that are typically in the market to purchase an HVAC business. One may want to go into business either initially or in another market for expansion. The other is expanding the base of business in the market they currently serve. The needs of both can be different.

“The key feature for an entrepreneurial start-up buyer is to purchase a business where the owner is not in the business,” he said. “In other words, they want a business that continues to operate successfully even after the previous owner is gone. Typically a company like this has documented systems and procedures, and everyone on the team understands their responsibilities and the goals of the company.

“In an expansion acquisition the buyer is often looking for acquiring the business’ phone number(s) and is interested in the future business that company would expect. The older a company is, the more likely it will have a strong customer following. Customers tend to hang onto old Yellow Page books and invoices, or call from stickers having the previous company’s phone number. A company that is strong in service would be the most attractive for repeat business.”

Acquiring a strong customer base can be the most important reason for buying an existing business. But how does a business owner keep a strong customer base in order to ensure repeat business? Lon Cassel, vice president of business development for Clockwork Home Services Inc., said it is all about service agreements.

“The most attractive feature to buyers is the number of active residential service agreements,” he said. “The value of a service agreement is huge today with the big box retailer competition. You don’t have a customer unless there is a service agreement attached.”

Jack Tester, business coach for Nexstar Inc., added that having a loyal customer base is very important, as long as the customers are loyal to the business and not necessarily to the business owners. “Buyers should look for attributes that will make for an easy transition to new ownership,” he said. “For example, customers who are loyal to the company, rather than to the owner or any one key employee.”

“Buyers want to be sure that the existing employees are well-trained and follow systematic processes,” said Scott Giacobbe, president and CEO of Linc Network LLC. “If an organization relies too heavily on one or two key individuals, then the business may be viewed by the purchaser as having higher risk. Conversely, some buyers may not be as concerned about the current state of the business and are buying location and a foundation that they’re willing to rebuild.”

WHAT ARE WAYS TO ADD VALUE?

Even if an owner does not understand or focus on what buyers are looking for, there are ways to add value simply for the purpose of making a business run more efficiently and profitably. Those two factors alone are important to any buyer.

Lawrence Snow, business coach for the Quality Service Contractors (QSC), said there are a number of ways that HVAC contractors specifically can add value to their businesses. “Have the sales system running like clockwork,” he said. “Make sure all leads are tracked to completion. Spiff techs for qualified sales leads. Join a proactive association and rub shoulders with others in your trade going through the same issues you are going through.”

Giacobbe said it is all about effectively and efficiently managing an organization. “Through the process of due diligence, all aspects of a company’s operations are reviewed to determine its health,” he said. “In a way, the process is analogous to purchasing a used car. For instance, if an owner/seller uses paint and wax to touch up the car’s exterior, when you pop open the hood and examine the engine, you’ll see if the car has been properly maintained. That inspection is known as due diligence in the acquisition process, and it will tell you whether or not you want to buy the car. It’s a similar process with evaluating a company.

“If the seller has managed the organization throughout its growth and development, then he will put his business in the best possible position to get the maximum return on the investment.”

Tester listed four key things to consider to help add value to a business. These include:

1. Develop a deep customer base that is not dependent on the owner or one or two key employees. You want customers loyal to the company, not you. A vibrant service agreement program is a good place to start.

2. Develop great people with emphasis on your management team. Instill loyalty and top pay/benefits so that the only way a competitor can get to them is by buying your company.

3. Proactively develop an exit plan so you have options if you want to sell. These could be an employee purchase plan or having enough money saved for retirement that you don’t need to sell the business to have a rich, full retirement. Nothing drives up a price like competition (or the buyer knowing you don’t have to sell). If a potential buyer is the only bidder (or knows you are in a position of weakness) you will never get the best price and terms.

4. Develop a highly profitable business and share the wealth with your employees. The bottom line is the bottom line. If your business is profitable, it not only makes your company more valuable, it gives you and your employees more options.

He added, “There are tens of thousands of HVAC companies. Unfortunately, most of them are marginally profitable. If you can develop a profitable company with the infrastructure where you can acquire a competitor’s customer base and turn unprofitable work into profitable work, you have a built-in growth strategy for the foreseeable future.”

James reiterated the need for keeping the focus off of one person or persons. “Cross-train and build in redundancy,” he said. “If the new owner is afraid that the company revolves around one salesperson or manager, what happens if they leave? HVAC business owners should cross-train personnel on systems to minimize being held hostage by one person.”

He noted several other ways to add value, including a clean customer database. “Keeping the company computer database clean and addresses up to date (through a list cleaning service) makes it easy for a new owner to proactively market new products and services,” he said. “Extended warranties and prepaid service contracts are also a big deal. When a business is up for sale, any prepaid item can be considered a liability. Making sure service agreement funds are escrowed and third-party extended warranties are purchased will help to reduce that liability.”

Cassel also repeated the importance of building a strong customer base through service agreements. “Have one thousand residential service agreement customers for every year in business, producing double-digit profits,” he said. “It’s obvious, the more customers under agreement, the more defense you have against the stiff competition coming in the future. And it’s coming!”

SO, WHEN IS THE BEST TIME TO SELL?

It would be easy to say that the best time to sell is the time when the owner wants to retire and believes the business is in the most saleable position. But in reality, there may be a number of other key factors that determine when the time is right to sell. Snow said the choices are pretty obvious.

“The best time to sell a business is when you are doing well,” he said. “The worst time is when you are out of control financially or operationally.”

Tester had a more fundamental answer than that. “This sounds simplistic,” he said, “but the best time to sell the business is when you have absolutely no need to sell. When you enjoy what you do, your company is growing and profitable and on a nice trajectory. When you and your business are in this position, you can demand the best offer and terms rather than having to accept whatever the market will bear when you have to sell.”

Giacobbe said that the best time to sell may be at a time when an owner least expects to, but is forced to from a buyer who won’t take no for an answer.

“Either something drives someone to sell, or a buyer approaches a seller because they want their business for strategic reasons,” he said. “When the latter occurs, the seller is now faced with a very important, emotional, life decision. Sellers that are approached to sell then have to work through the personal life decisions as they question if selling is the right thing to do.

“The right time to sell a business is in the eye of the seller. There are always personal and economic factors at play, such as interest rates, market interest, available equity partners, number of interested sellers, etc.”

Casell said the best time to sell is when an owner has management in place to run the company without the owner, and has consistent double-digit profits over a three-year period. That can be achieved by showing a percentage of residential service to total revenue of at least 25 percent. “The more service to revenue, the more opportunity to grow the business,” he said. “Consistent gross margins and net profits over the past three years are keys, as well as an operating system in place that does not require the owner to be on site every day.”

Tester summed up what every HVAC contractor should do, regardless of whether preparing to sell the business or to just add value.

“I believe a great business can sell anytime the owner wants,” he said. “Great companies spend more time developing a vibrant, sustainable business that will survive for decades than trying to guess when the next buying cycle will be at the peak.

“Great companies don’t dress the business up for a sale. They constantly work on providing great service, instilling employee loyalty and giving out top pay and benefits, gaining new customers and growing the bottom line. Great companies make decisions with the next five years in mind not the next five months.”

If you are planning to sell your business or would like more information on adding value to a business, visit the Websites of the sources quoted in this article: www.aireserv.com, www.clockworkhomeservices.com, www.nexstarnetwork.com, www.qsc-phcc.org, or www.thelincgroup.com.

Publication date: 01/22/2007

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