The problem was, there was really no ideal exit strategy available. According to surveys by both SMACNA and ACCA, at that time the average HVAC contractor achieved between 3% and 5% net profit. That is a small profit percentage to make the business very interesting to an investor. The other alternative was to sell the business to a current employee. However, this would usually require owning a loan that would need to be paid from future profits, meaning the contractor could not really separate himself from worrying about the company’s success.

In the 1990s, five separate consolidating companies came forward with an idea to provide what they felt was a desirable exit strategy for hardworking contractors — people who had worked their entire lives building a business to hopefully provide security for them going forward. The consolidators did a tremendous amount of marketing to show those waiting contractors how this was finally the opportunity for which they had been searching: an opportunity to leave the business and reap the financial rewards of all of their years of efforts.

The consolidators’ offers were this: they would negotiate a sales price for which they would purchase the company. Often these prices were at relatively high capitalization values. When the closing occurred, the seller would receive 50% of the agreed upon sales price in cash and the other 50% in stock in the consolidated company. In essence, the seller was counting on the success of the consolidated company in order for him to continue to receive payouts and eventually not only his remaining 50% but, per the consolidators’ marketing materials, many times more in additional profits. On paper and in theory, this sounds like it might be a good proposition. But let’s take a look at some of the hidden problems.

The success of the consolidator was dependent on the fact that the new consolidated company would continue and be more profitable than the original individual companies. Remember, the average contractor was netting 3-5% net profit. There were obviously going to be some costs for the consolidation efforts. They were sending salespeople around the country to trade shows and seminars extolling the benefits of the consolidation effort. That cost money and had to come from that 3-5%. Then take this into consideration: All of those consolidated contractors had just sold 50% of their businesses. Previously, working at their utmost capacity, they were averaging 3-5%. Do we really think that, having sold 50% of their company and knowing they would only be receiving a portion of the rewards for their hard work in the future, they would continue to be producing at 110%?

I didn’t think so. The consolidators had professed, and I suppose hoped, that having the additional buying power of multiple contractors would increase those 3-5% profit margins. What they found is that the margins up and down the HVAC industry supply chain are so small that there is not “fluff” which can be obtained by adding a few contractors.

As these numbers began to play out, there was another side effect of the consolidation efforts that the selling contractors had not considered. They assumed that all of those hardworking employees who helped them achieve their success would be permanent fixtures with the new company. Of course, they had no input on those employment decisions. As a result, many longtime, loyal employees — those who had been with the company for years and achieved a high salary — were let go and replaced with a lower-salaried person in an attempt to regain some of the profits that were not materializing. This was a situation selling contractors had not considered.

The end result was that eventually the consolidators failed, and many contractors lost untold dollars. In essence, they had given up their business for just 50% value. And in the end, that 50% cash was all that they received. More devastating to many of those contractors was the fact that the business they had worked so hard to develop was no longer part of the industry in the manner they had pictured it would be.

There were some winners in this process. The contractors who were the originators of the consolidation process — and were the ones taking possession of companies for only 50% of their real value — were able to cash out before the consolidated company expired and had taken home some nice cash returns in the meantime.

My reason for going through this history lesson is merely to give contractors some food for thought if they are considering being part of a consolidated company. To summarize, if you are considering be part of a consolidated company:

1. The cash you receive at the time of sale is the only real cash you can be sure of. Make sure that you are comfortable with that amount if no other cash is forthcoming.
2. Remember the potential effects on the look of your business as well the effects on the longtime employees who have helped you achieve your position. These may or may not have any meaning to you, but you need to at least consider them.
3. Make sure that the situation into which you are being led will not require more effort for you, both physical and financial, especially if part of your reason for considering being consolidated is to use it as an exit strategy.