Private equity investing in residential contractors has been a trend in the HVAC industry for more than a few years now. But what is private equity, what does this mean for HVAC contractors, and how much longer will this be a trend?

At the recent CEO Warrior event in Orlando, Ryan Sugrue, of Citizens Bank, and CEO Warrior CEO Scott Bohannon discussed everything related to this trend. From that discussion came the answers that a lot of HVAC contractors are looking for.

Question 1: What exactly is private equity?

Bohannon: Private equity is a group of investors who have raised private funds that are often in the millions and sometimes billions of dollars. Their sole mandate is to return two to three times the money people have invested in them. They do that by finding assets like HVAC companies to put that money into and then grow and ultimately sell them. Again, the goal is to provide the HVAC owner and investors three times their money.

Question 2: Why are they interested in HVAC?

Bohannon: The HVAC business is one that is essential. If an Orlando homeowner has an air conditioner go out in August or a Boston homeowner has a furnace break in January, they are going to get it taken care of quickly.

Private equity investors are trying to find stability in a business. They are looking for a demand that will stay steady, and they will try to accelerate it. HVAC is one such business.

The second reason is the fragmentation of the industry because private equity likes to consolidate. Unlike pest control, where a company like Orkin has a lion’s share of the business, there is not an HVAC company that has a similar market share. The thought process of private equity is to bundle contractors together, strip cost by combining resources, and improve capability, which leads to more value.

Question 3: What are investors looking for in an HVAC contractor?

Bohannon: The No. 1 item most are looking for is stability. How many years has an HVAC contractor been around and how stable have they been? They are, of course, looking for growth, but what they don’t want to see is a business that has major swings from year to year. They want a business that is well put together. And they certainly find size appealing. It is more valuable to have a $10 million business with a $2 million net than one with $5 million revenue and $1 million profit.

And they are looking for quality owners. Private equity does not want to come in and get a contractor out. They want to put money and resources behind the contractor so they can run the business better. That is why they want to buy 50-75% of the business, rather than 100%. They want the HVAC contractor to be motivated to grow their end of the business.

Question 4: How much can I expect from selling a portion of my business?

Bohannon: Less than you could have a couple of years ago, but not by much. The craziest time was in 2021, with insane money being thrown at contractors. The years 2022 and 2023 were tougher. If you have a $10 million business that nets $1-1.5 million, you are looking at six to eight times your net profit. The next major hurdle is the $25 million range with a similar profit percentage. For those businesses, you can expect about 10-12 times earnings. A business with a 50% gross margin will get premium values.

These evaluations should hold for a bit.

Question 5: What if I am just looking to sell my business and retire?

Bohannon: Ideally, you have built your company to a point where it can run without you. Do you have a quality No. 2 person that is running the day-to-day? Private equity will do their due diligence and that is what they are looking for in a business.

If you do not and are looking to retire, you should be looking for a big private equity platform that has already acquired a fair amount of HVAC businesses. You are looking for someone who is doing $250 million and can add your $10 million to tuck you into the company.

A new firm that is investing in HVAC for the first time is going to want to retain the owner/operator. So that is something to keep in mind when you are trying to find a match.

Question 6: Anything else private equity is looking for?

Bohannon: Private equity values maintenance-driven businesses in the HVAC space. You can grow very fast by blitzing marketing at 6-7% of revenue and selling big replacements. But that is going to have a slow season. In 2023, we saw businesses that do the best are those that have great customer service and have maintenance agreements. Right now, in this market, the sweet spot is 45% replacement/install and 55% maintenance agreements and repair.

Maintenance agreements lock in a customer and create a higher quality of future earnings. Private equity will be confident those dollars are going to come through the door during difficult times.

They will also look at what your technician base looks like. How you recruit, retain, and train your techs. It is important to have retention of the people that are talking to your customers.

Question 7: What changes can I expect when private equity comes into my business?

Bohannon: They undoubtedly like your brand, and they want to preserve it. Don’t be surprised if they want to add services like plumbing and electrical. They want to help you sell better so they will have a sales playbook they want you to deploy.

They will also be aggressive on spending. You might take an initial dip in profitability, but they think it is necessary for eventual big-time growth. They will want to put you on the same CRM or ERP system as their other companies. ServiceTitan tends to be the de facto platform. They do this because they want to measure you against their other companies, much like you like to measure your techs against each other. They will want to see how you stack up on items such as productivity, profit per call, and a host of other metrics.

Question 8: Any pitfalls I should look out for?

Bohannon: Check references of the private equity firms. Have them connect you with someone they have worked with to validate them as a partner because it is a partnership.

Find the right partner that will push you enough. Also, one that can free you up and accelerate your business. They are not buying you to stay flat. The one pitfall is when there is a mismatch between the investor and owner/operator regarding culture.

For more information on CEO Warrior, visit www.ceowarrior.com.