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. The multiple which many HVAC business owners target is 5x.
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 two key points…
- Among HVAC listings, more than 50 percent of the listings never sell.
- 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 $1 million+ in revenue to a marketable multiple close to 4x.
What Does it Take to Achieve a 5x Multiple?
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 support a 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.
At least 10 percent net income margin
Healthy margins are indicative of a business that will stand the test of time. A 10-15 percent margin, after fair owner/president salary, is reflective of a scalable HVAC business. Beyond 15 percent is not bad, but may throw a discerning view as it typically tends to indicate a high owner involvement, underpaid staff/management, or a market advantage that is not sustainable.
If paying a 5x multiple, a buyer is looking to fill the role of CEO, not an operator or hands-on man. To operate as a CEO, a management team with tenure needs to be in place. At the bare minimum, there should be three managers, a general manager, an operations manager, and a sales/office manager. Each of them should have at least two years in their current role and be compensated at market rates.
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 than 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.
Documented Systems & Procedures
Scalable and highly valued HVAC businesses require 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 fully 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 two minutes. If that cannot happen, the documentation and training needs improvement. This is one of the key things we work on in our exit method.
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 tenureship.
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 percent of revenue.
Stable Revenue / Profit
Oftentimes, HVAC owners will come to us in a time of hyper-growth, looking for a high multiple. Unfortunately, hyper-growth is not rewarded. In the HVAC industry (and other contracting industries), businesses are valued on their cash flow 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.
In business at least seven 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 the brand name is generally viewed as a red flag to potential buyers.