Acquisition is a tried and true approach to growing your service contracting business. Many successful service contractors have one or more acquisitions under their belts, and many have enjoyed growth and success because of an acquisition. With a business loan from Live Oak Bank, the nation’s leading SBA lender*, business owners can buy a business without tapping into their personal capital. Here are some tips when considering growth through acquisition.
Identify your goals
Business acquisitions come in all shapes and sizes, each with their own set of risks. Before entertaining a business purchase, first define what you are seeking to achieve. Some goals for acquisitions include:
- Quick additional growth to your existing business
- Tuck-in acquisition that goes beyond simply acquiring a customer list
- New business line: For instance, a HVAC business acquiring a plumbing operation
- New market: This could be a portion of your market not currently serviced or a different city completely
- Entering into the service contracting industry by purchasing a going concern
If a transaction does not make sense, or your existing business is not prepared to integrate a purchase, it’s perfectly fine to pass. When I am working with service contracting clients making their first acquisition, I always remind them that the best acquisition is the one they walk away from. One of the leading challenges buyers face is an unrealistic purchase price, which elevates the transaction’s risk.
Proceed with caution
Be cautious of overspending for a business that will all but be absorbed into your existing business. Chances are the target business is not a premier business and, therefore, doesn’t deserve a premier valuation. Business owners and brokers alike tend to overvalue small contracting businesses. A good tuck-in acquisition to an existing service contracting business should be relatively risk-free from the investment standpoint. Small businesses can be challenging to value, as their financial statements are not always accurate. Many times, the overhead structure of these businesses is not comparable to a larger contractor. These small businesses will often have higher net incomes, from a percentage of revenue standpoint, because they support less overhead or have an owner that performs multiple jobs. Without a full understanding of this challenge, a buyer could find him or herself overvaluing the target business. It is advisable for small business acquisitions to key in on the revenue of the target business and what that revenue will translate to your existing business based on your current business overhead structure. Take a hard look at your existing business first — are you operating a profitable business that can transition in the acquired revenue profitably? If not, it’s not the right time for you to purchase another company.
Things to consider
With an understanding of risks, consider these additional points when contemplating an acquisition.
- Understand the work mix. Many businesses have more than one focus, and I’ve found that at times, not even the business owner fully understands his work mix. Ask and verify. Post-closing is not the time to discover your newly purchased residential service contracting business reaps half of its revenue from new construction projects!
- Determine if the targeted customer base is relationship driven. This is especially crucial when considering the acquisition of a commercial business or businesses showing a skewed customer concentration.
- Determine the customer concentration. This is a real concern, especially for service contractors operating in the commercial and new construction fields. Understand the target’s top customers and how a change of control will affect the relationships.
- Plan for some customer fallout. This is not to say that you should plan to fail. Rather, it is suggested that you base your purchase decisions on attainable goals. Some attrition is only natural with the transition of ownership. Clear and honest communication from you and the original owner can help with attrition.
- Verify the number of active customers. Be skeptical of promises of customer lists that soar into the thousands. An acquisition candidate once boasted 30,000 customers. Upon further due diligence, it was discovered that this claim consisted of all customers from inception (25 years!). The target’s “current customer” list was actually around 3,000. Customers that have been serviced within the last two years were considered current.
- Focus on the number of calls and the revenue per call. You must have a solid understanding of your revenue per call. Is the acquisition candidate’s average call less than yours? If so, you may be able to get better pricing. If the average of your target is significantly less, spend more time understanding their service and customers. You may conclude that these customers are not the right fit for your business and would be better served by a competitor.
- Understand the businesses service agreements/contracts. These are the company’s real customers. Are there 100 or 1,000? Are these agreements properly managed and, therefore, easily transferrable to you? Speaking of transferring, these agreements are a liability purchased by you and you are expected to service these contracts. Of course, you will also reap the benefits of any up-selling efforts during these visits.
- What are the historical replacement revenues and margins? The best possible situation is that your candidate serviced and repaired equipment well beyond its useful life. If this is the case, you can benefit from selling replacement equipment to the acquired customers. If you find that the target sold a great deal of replacement equipment, but at a low margin, your newly acquired customer base may be of little value with exception to routine service calls. Do not overlook this point.
- Does the target business maintain any lines of work that you will discontinue or are outside your normal service offerings? An example here would be a residential HVAC contractor acquiring another HVAC contractor with a 65/35 residential/commercial mix. If you determine the commercial work is not going to be pursued after the transaction, be sure to factor this into how you calculate a purchase price. With the elimination of commercial work earnings, your purchase price may fall too short of completing the transaction. This is okay, as that will prevent you from overpaying for work you do not want or will not continue.
- Set proper expectations regarding employees that will make the transition into your existing business. Business culture can attract certain employees. When your culture clashes with the employees of the acquired business, the result will be attrition. Realistically, you should plan on losing employees from the acquired company. Historically, a change in control has served as a catalyst for employees who were already contemplating retirement, were considering a move, or were simply unhappy in their situation. The businesses sale will push these employees off the fence without giving you, the buyer, a chance. This is not always a bad thing.
- You do not have to put out all of your working capital to complete a transaction, nor do you have to rely upon the seller carrying a seller note. Live Oak Bank can provide capital for acquisition financing. Utilizing the SBA 7(a) lending program, the bank lends based upon the expected cash flows instead of assets. Existing service contractors acquiring tuck-in businesses may be able to secure a significant portion of the purchase price in a loan. This flexibility in working capital availability can be used in negotiations with the seller. Live Oak Bank has a dedicated team of service contracting lenders and they would be happy to discuss your acquisition plans.
To learn more about Live Oak Bank’s financing options for service contractors, visit liveoakbank.com/contractors.
*#1 SBA 7(A) Lender by dollar amount for FY 2019
Brandon Jacob is a consultant for Live Oak Bank’s service contracting lending team. Brandon Jacob’s career as a CPA for 30 years includes extensive experience in business valuations, exit strategies and business transactions. Specific to the contracting trades, Brandon has over 22 years of assisting in the valuation, sale and purchase of contracting businesses of all sizes. Brandon currently operates Contractors Financial Opportunity, LLC (www.Contractorscfo.com) a financial consulting firm specializing in businesses valuations, exit strategies and transactions for contracting businesses of all sizes. Brandon has had numerous industry speaking engagements and multiple articles published within his area of expertise and has published two contracting specific books: For What It’s Worth (www.Forwhatitsworthbook.com) which explains in detail how to value air conditioning and plumbing businesses and Operation Exit Strategy (www.Operationexitstrategy.com) which goes beyond valuations and explains what a business owner must in order to successfully sell a business. Brandon can be reached at 713-443-8311 or by email at email@example.com.