Growth through acquisition is a tried and true approach to growing your service contracting business or getting a jump start into business ownership. Many successful businesses within the service contracting industry have one or more acquisitions under their belts, and point to these purchases with catapulting their growth. Better yet, with available capital from Live Oak Bank, the nation’s leading SBA lender, an acquisition can be made without tapping into valuable working capital. There are right ways to go about acquiring service contacting businesses and many wrong ways, so here is some initial guidance for those contemplating growth through acquisition.
Identify your goals
Business acquisitions come in all shapes and sizes–each with their own set of risks. A business acquisition can be as simple as obtaining a telephone number from a defunct competitor (typically minor risk with a limited upside) or as involved as purchasing a profitable going concern enterprise (greater upside with potentially more risk). Before entertaining a business purchase, first define what it is 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
With exception to the quick additional growth choice, where you may have been offered an opportunity at a no-risk price, each one of the above reasons should be seriously analyzed prior to making a move. No one is bound by making a business purchase. If any transaction does not make sense or if your existing business is not prepared to integrate a purchase, it’s perfectly fine to pass. When I am working with service contracting clients who are making their first acquisition, I always remind them that the best acquisition is the one they walk away from. Often, the reason for a transaction not making sense is an unrealistic expected purchase price. Such a purchase price elevates the risk of the transaction over and above what should be considered.
Proceed with caution
Be cautious of over spending 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 does not deserve a premier valuation. Business owners and brokers alike tend to over value small contracting businesses. Shame on you if you make the mistake of paying for them. A good tuck-in acquisition to an existing service contracting business should be relatively risk-free from the standpoint of the investment. Small businesses can be difficult to value, as their financial statements are not always accurate and many times the overhead structure of these businesses is not comparable to a larger contractor. Often these small businesses will have higher net incomes, from a percentage of revenue standpoint, because they support less overhead. Without a full understanding of this conundrum, a buyer could find him or herself overvaluing the target business. On small business acquisitions, it is advisable to key in on the revenue of the target business and what that revenue will translate to within your existing business based upon your existing businesses overhead structure.
Things to consider
With an understanding of risks and the risks associated with overvaluing acquisitions, the following are some additional points that should be considered when contemplating an acquisition.
- Understand the work mix: Gain a 100 percent understanding of the target’s work mix. Many businesses have more than one focus, and I’ve found that at times, not even the business owner fully understands his own work mix. Ask and verify. After the transaction closes is no time to discover your newly-purchased residential service contracting business earns half of its revenue from new construction when all along you were expecting a much higher percentage from residential service and replacement.
- Determine if the targeted customer base is relationship-driven: Be careful in conducting this research. This is especially crucial in the consideration of the acquisition of a commercial business.
- 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 relationship.
- 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.
- 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. The target’s “current customer” list was actually around 6,000. Customers that have been serviced within the last four years were considered current. If you have not serviced a homeowner in four years, can you really consider them a customer?
- 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 capitalize on 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 of your targeted acquisition are best served by your competitor.
- Obtain an understanding of the acquisition target’s service agreements/contacts: 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 the earnings from the commercial work, your purchase price may fall too short of completing the transaction. This is okay, as that will prevent you from over paying for work you do not want or will not continue.
- Set proper expectations regarding employees that will make the transition into your existing business or under your leadership: Business cultures attract certain employees and when your culture clashes with the employees of the acquired business, the result will be attrition. Plan to lose employees from the acquired business. 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 sale of the business 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, under the SBA 7(a) lending program, is ready to lend purchasers of service contracting businesses capital to complete transactions. Under the SBA 7(a) program, the bank lends based upon the expected cashflows as opposed to 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.
If you are considering purchasing a service contracting business to grow your existing business or to launch ownership of a business, the above points will help you acquire the right business for the right purchase price.
In closing, I encourage purchasers to have patience when contemplating an acquisition. It is not uncommon for some smaller transactions to take an extended period due to the lack of preparedness by the seller. In addition, as previously mentioned, negotiations often start on the high end attributed to the seller receiving insufficient information or basing expectations on emotions. Proceed with patience. You are exploring the purchase of someone’s business and pride of ownership is a real factor in these types of transactions.
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 20 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 Brandon@contractorscfo.com.