Many owners are taken back when they realize how much their HVAC business is worth. Some because they think it should be worth more and the rest because they didn’t know it was worth that much. The truth is that most of your personal net worth is likely directly contributed to your business. The sad reality is a large majority of owners will never actually realize or harvest that wealth. It just makes sense to pick a date or a personal liquid asset goal and then sell the business to retire or start a new venture. The worst thing you can do is run the business until you die and then let your family sell it in a hurry for a huge loss.
If your business is most of your personal net worth then you need to know exactly how much it is worth, or how much it would most likely sell for. There are a couple of different ways to value a business. The most common is the broker opinion of value. This is when an experienced broker looks at other business transactions across the US that involved your type of business and give an opinion of what a buyer would pay. Then there is a business valuation performed by a certified appraiser. The broker opinion is what the business would most likely sell for and the valuation by a certified appraiser is best for loan verification, partner disputes, tax issues or divorce settlements. There are no certified appraisals only certified appraisers. So, it’s best to use the right business valuation for the right valuation need.
There are many different factors that affect the value of the business. We will examine some of these in this chapter. This is not an exhaustive list. Thousands of factors play into the final value that is written on the closing contract. The key is navigating those factors and knowing how to negotiate through them in a manner that is most financially beneficial for you while simultaneously not killing the deal. This part of the process is more art than science. Let’s look at the short list of factors that have the most impact on value.
The true value of anything will always be what a buyer is willing to pay and what the seller is willing to accept. The seller always thinks the business is worth more and the buyer always thinks the business is worth less. The true value lies somewhere in the middle.
First let’s look at the business assets. There are two types of assets tangible assets or things you can touch and see and intangible assets such as operation processes, patents, and good will. Tangible assets can usually be given a value that is based on some data such as the value of a 2018 chevy service van with 135K miles. You can usually determine a close value for most tangible assets. Intangible assets are harder to value. For example, how valuable would a patent be for a PVC pipe bending machine that you invented. You probably think its super valuable. But the buyer might think you can get a pipe heater anywhere, it’s not of much value that yours heats the pipe 15 seconds faster. However, if you hold the patent for something that has a large demand and a proven sales history with straight up future sales projection, then that patent is most likely extremely valuable. The key is that your intangible assets do have a value. How much they are needed to successfully run the business adds value to the business.
Next, it’s important to understand good will. It is the most common tangible asset as it is the difference between the fair market value of the tangible assets and the actual price for the business. So, if your business owns $450K in tangible assets and you are selling it for $1M due to a valuation of 5x an EBITDA of $200K cash flow then you have $550K of good will. For this reason, almost every business transaction will have a significant amount of good will in the transaction. An example where this might not be true would be a large trucking company. There are times that the values of the assets are worth more than a given multiple of EBITDA. If you have $3.5M worth of tangible assets but he EBITDA multiple would place the value at $2.5M then it just makes sense to sell the business based on the value of the tangible assets.
When you place a value on a business there are several different ways to arrive at this value. The first is the income approach. This approach focuses on the income the business generates and the projected income that will be generated in the future. The next is the asset approach and it looks at the value of tangible assets and how much it would cost to replace them. The last is the market approach and it looks at how much would it cost to buy a similar business with similar assets and income. There are several other valuation methods but these three are the most used. Your broker will look at your financial data and determine the best way or combination of ways to value the business so that you realize the highest price at closing.
One of the first things your broker will do is to adjust the financial statements to produce an accurate value of the business. This is known as recasting the financials and it occurs in almost every business valuation. It’s important that you provide accurate data when your broker request it. The goal is to get the actual sellers’ discretionary earnings or cash flow. You want to know exactly how much money the business will generate for the new owner. This number will be multiplied by a number known as the multiplier.
The multiplier is a number that you multiply the sellers’ discretionary earnings by determine the value of the business. Identifying the accurate multiplier is the most difficult part of the process and this is where the “art” or experience of the broker becomes so valuable. Every business is different. They have different management teams, they are in different service territories, they have different customer bases, they are positioned different in the market, the list goes on and on. A low-priced company that primarily serves the property management or home warranty market is a much different company than one that is high value and holds a dominant market share of all the highest income neighborhoods in town. While both may be HVAC companies, and both generate $5M in sales the difference between the two can be night and day. The two biggest mistakes we see from companies that try to sell without using a broker is that they use the wrong multiple and either price the business to low (left significant money on the table) or priced the business too high (never goes to closing). A broker that has extensive experience in selling HVAC will produce the most accurate multiplier because they understand how your business is different compared to other businesses regarding the multiplier. Sometimes this difference adds value and sometimes it takes away value. But the most important benefit is an experienced broker knows what you need to fix to get a higher value.
Let’s look at some different HVAC business past selling metrics. These metrics should give you a basic idea of what your business is worth. Keep in mind a contracting company that is primarily managed by the owner and is owner dependent is worth less than one that has a management structure in place. A well branded company is worth more than a poorly branded one. A company with great marketing is worth more than one with no marketing etc. etc. So, these averages will not provide you an accurate value. These factors affect the multiple.
Value rules of thumb:
- 35%-50% annual sales plus inventory.
- 2-3.5 times Sellers Discretionary Income (SDI) plus inventory
- 2-4 times EBITDA
Residential service numbers are a primary indicator of business health as well as the number of service agreements. Residential replacement numbers and commercial replacement numbers are good. Large new construction numbers are bad.
Higher gross sales and higher net profit increase the multiple. When sellers’ discretionary income (SDI) rises above $800,000 a year, the multiple generally increases to 4x and rises slowly as SDI increases.
Higher multiples occur with limited owner involvement, higher number of service agreements and no new construction exposure. Age of fleet vehicles is a consideration. Age of employees is a consideration due to difficulty in acquiring new service technicians.
Most common valuation is 3-4 multiple of SDI.
Highest multiple companies exhibit:
- 25-30% profit margin
- Average income per employee $200K+ (average $175K-$250K)
- Average revenue per service truck $275K (average $225K-$300K)
Now many more variables come into play to determine the actual multiple. Also, each business is different. You then take that value and either place the business on the market to sell or begin making internal changes that will increase your multiplier.
To make that decision you must determine what is your magic number.