What Brings Together Buyers And Sellers?
Originally published: 12.01.11 by Ronald Seigneur
Part 3 of 3: Many motivations drive interest in acquiring HVACR businesses.
Editor’s Note: The first two articles in this series were written by Kevin R. Yeanoplos, appear in the September and November 2011 issues, and are available:
Why would someone want to buy an HVACR business? There are a number of reasons, including:
Acquiring market share: A motivated buyer might want to expand a geographic footprint into a new market by acquiring a suitable candidate versus opening a branch facility. The motivation also could e based on an ability to diversify into new product or service offerings that are complementary to what the buyer already offers.
Acquiring management and technical support: A buyer could have needs to expand or even replace key management and technical experience due to the loss of such resources for any number of reasons, including retirement, competitive losses, evolving technical needs, etc.
Buying a job: A buyer could simply be looking for an opportunity to be in business for themselves. It is not unusual for business brokers and other professionals to constantly look out for business opportunities in trades similar to HVACR for buyers who are seeking certain financial returns from an established operating entity.
These motivations also could be classified as falling within the following primary types of buyers:
Financial: Primarily focused on an acceptable economic return and an assessment of the business risks associate with those returns.
Strategic: Typically this is an astute buyer focused on economics, but in conjunction with the fulfillment of one or more strategic objectives, such as eliminating a competitor, buying up market share or expanding horizontally and/or vertically.
Entrepreneurial: Can be a financially motivated buyer but with a focus on entering into a market sector that is attractive to the individual often for unique reasons.
Regardless motivations, a well-informed buyer would be interested in certain aspects of an HVACR business as part of any due diligence process that would accompany the negotiations. The value drivers include:
Depth and breadth of customer base served. Having an emphasis on service versus sales can by huge in today’s tight economy where business from new commercial and residential development has come to a virtual standstill in many parts of the country.
Being overly dependent on one or more key customers can negatively impact the perception of enterprise value that is available to a bona fide purchaser.
Depth and breadth of suppliers and products/services offered. Likewise, being overly dependent on too few lines of products and the service opportunities the product lines provide can be negative. This is especially true in today’s marketplace, where competition is emerging from non-traditional sources.
Management and technical competence. The strength of qualified personnel cannot be over emphasized in the context of what brings value to a business in the eyes of potential buyers. The ability of a buyer — regardless of motivation — to acquire a turnkey operation with management and leadership in place that will enhance the retention of key customers and employees, is often the most important aspect of a transaction of a closely held business in this type of niche.
A strategic buyer, in some instances, is less motivated by this aspect when they have the ability to absorb the enterprise with adequate current management and leadership, sometimes to the point of not wanting to retain personnel. There is a ton of excess capacity in most sectors in today’s economy, and a strategic buyer may only be interested in buying top line revenues to shore up their own operating profile.
Equipment and fleet considerations. A buyer may have a keen interest in infrastructure aspects of a business, especially when the fixed asset base is significant, which can be the case with an HVACR-related enterprise. An aging fleet may be a sign of other deferred maintenance concerns.
Intangibles. An established HVACR business may have significant value within a number of intangible assets, including a trained workforce, a recognized and respected name (inclusive of trade names, trade dress, etc.), customer lists, proprietary technology, and more.
Stepping back from the target business itself and evaluating other externally driven factors that affect value also is important. While The Great Recession officially ended in June 2009, many owners and operators of a closely held businesses continue to see and feel the impact of our soft economy, especially in trades associated with the real estate industry, which many think has several more years of modest or flat growth.
Strange things are happening wherein the relevant economic landscape can be like a roller coaster, with solid competitors leaving and entering markets in a fashion that can have a significant impact on how a business will perform into the future.
Historical patterns of operating performance are more difficult than ever to rely on with respect to measuring the value of an HVACR enterprise. More emphasis is being given to projecting what the future will look like and traditional valuation models and methods that have relied on three-to-five years of historical performance are giving way to what is referred to as a discounted future benefits model, where future cash flows are discounted back to today’s value at an appropriate risk-adjusted rate.
It is extremely important to focus on opportunities for upgrading existing equipment to be more energy efficient. Upgrades and enhancements will be competing for dollars until many customers are more fiscally sound and willing to invest in new equipment. From a buyer’s perspective, this all adds up to a need to be thorough and detailed when analyzing an opportunity to acquire a business in the HVACR sector.
A buyer of a closely held business typically also will be focused on how an acquisition will be structured and financed. The actual “price” that is paid for the assumed value can be greatly influenced by a number of factors, including:
Owner carry-backs and earn outs: It is not unusual for a buyer of a closely held business to negotiate some level of financing from the seller of the business. The seller can simply carry back a portion of the purchase price as a note receivable, especially in situations where the buyer does not have the wherewithal to finance the entire purchase price. The price itself can be greatly influenced by an earn-out arrangement, where the purchase price is partly contingent on future performance, customer retention, or other measurable benchmarks. This consideration will be much more important to the entrepreneurial buyer and some financial buyers, versus the typical strategic acquirer.
Covenants not to compete. The price paid for a business can be highly contingent on the ability to restrict the current owner from competing with the buyer once the business sale is transacted. Often a portion of the purchase price is essentially carved out into a covenant, which in most jurisdictions must conform to local rules and precedent in terms of the geographic and time limits that can be placed on the seller. The need for a covenant is often balanced against an employment contract when it is logical to have a seller who desires to do so, to continue working in the business in some capacity.
Tax attributes. A buyer will have an orientation toward tax liabilities that is dependent on their specific circumstances. Someone who has accumulated net operating losses, for example, might be willing to pay more than another buyer, due their ability to shelter some amount of profits from the business that is acquired.
Related-party issues: A seller may have other business interests that are implicated to the potential sale of their business. It is not unusual for the seller to own the real estate that the business operates out of, and a sale of the business may also be contingent on keeping it in the same location or otherwise allowing the seller an exit strategy for their other ancillary holdings.
Seller’s non-economic motivations: Often an entrepreneurial owner-employee will have certain non-economic motivations that can greatly impact the price of a business. A seller who is financially secure may put much more emphasis on the ability to pass along an enterprise that retains other key employees, retains the name of the business, or the like, as opposed to getting the optimum price based on appraised indications of value. A seller can also be motivated to find someone that will treat customers with the same amount of attention and respect that the seller has been accustomed to providing.
This third installment of our three-part series should provide a motivated buyer of a HVACR business with a number of key concepts and considerations when assessing an opportunity. The attributes outlined in parts one and two are also quite relevant when compiling a list of where attention should be given during the due diligence process and in conjunction with the overall evaluation of an opportunity.
Ronald Seigneur is the Managing Partner of Seigneur Gustafson LLP in Lakewood, CO, and has over 30 years of experience working with closely held businesses in appraisal and exit planning related engagements.