FROM THE HORSE’S MOUTH: A Buyer’s Perspective

Want to know what buyers are looking for in the HVAC sector? Read our Q&A with Michael Arrieta, Founder & CEO of Garden City, an Atlanta-based, permanent equity holding company.

Garden City buys, grows and permanently holds service companies. The team partners with founder-led, family-owned businesses and provides long-term capital, with the goal of supporting growth and delivering value in any way possible. Garden City focuses on service businesses with $2M to $5M in EBITDA that are based in the Southeast.

As a buyer, how would you describe the health of the HVAC sector?

Generally speaking, buyers are finding the non-cyclical nature of this business appealing right now. Professional investors are realizing that many of these companies are very sustainable in the long term. Stable, strong demand in recessionary markets is very attractive for a buyer looking to deploy capital — especially for buyers like Garden City, as we buy with no intention of ever selling.

How has the pandemic affected HVAC companies?

When it comes to the impacts of Covid-19, it depends whether you’re looking at the commercial or residential side of things. Historically, companies that were heavily focused on new installation from commercial customers tended to be the safer bet for investors.

Those companies generate about 80% of their revenue from installation, and most of that comes from new construction (versus replacements). Only about 20% of revenue comes from maintenance and service calls for commercial-focused service companies.

Not surprisingly, the pandemic has slowed down new commercial construction, and with many offices shut down, the demand for service and maintenance has decreased. Plus, businesses are rethinking their footprints — they’re wondering if they really need all of that office or retail space. So for commercial-focused service companies, there’s just more uncertainty than ever before.

On the other hand: residential-focused companies are doing quite well, especially the ones that generate most of their revenue from replacements and repair/maintenance versus new installation. People are spending more time at home, so customer demand and usage has skyrocketed.

What are the key factors that increase the value of HVAC companies?

There are a few characteristics that can drive value and ultimately lead to higher multiples. These include:

• Recurring annual contracts with customers
• High “attach rate” (i.e. conversion rate from new construction installation to service contract; 30% would be impressive)
• Technology enablement
• The ability to upsell other complementary services — like those related to energy conservation and usage — where there’s a holistic, end-to-end approach to customer relationships
• Strong labor retention and employee satisfaction

What does Garden City look for in a business?

In addition to the items we just discussed, we’re typically looking for companies where at least 30-50% of revenue comes from replacement and/or maintenance/repair. This makes them more stable and predictable.

Given how fragmented the industry is, we’re also attracted to companies that have expanded to other regional markets to grow their footprint and customer base.

We’re not as attracted to businesses with 1099 contractors; we’re geared more toward W2s. That’s because the biggest constraint in the HVAC space is labor. If you can use that as a competitive advantage, it’s like a secret weapon, and the way you do that is by building a strong team and culture.

Culture is everything in this trade. If you create an environment where people love working, where they have leadership opportunities and ongoing development, and where it’s clear you care about your team — then you’re going to attract great employees. This then generates great, loyal, and repeat customers. For us, those kinds of businesses tend to be the mission-aligned partners we strive to partner with for decades to come.

From your perspective, is now a good time to sell?

Over the past 3 to 4 years, we’ve seen a lot of activity in the space — probably somewhere between 300-400 deals.

Right now, if an owner wants to sell a company that fits our criteria, then we want to buy. However, it’s worth noting that we’re going to buy on the most recent financial history. As I mentioned earlier, while some companies are benefiting from the current state of affairs, other companies have seen a bit of a slowdown. So that means the earnings we’d be willing to pay a multiple on may have been suppressed, recognizing that other acquirers may be willing to normalize 2020 and look past the last six months.

Right now, if an owner wants to sell a company that fits our criteria, then we want to buy.

Some of those owners may not want to sell in a “hiccup” year like 2020, and they’ll decide to wait it out. But it’s also an election year, and depending on what happens in November, capital gains rates could significantly increase. Many business owners who are thinking about selling in the near-term don’t want to play with that. They would rather sell now and not have to deal with the headaches.

There are also owners who are ready to retire, and Covid-19 has thrown them into a frenzy. They don’t want to wait five more years and experience another possible downturn or recession. The emotional stress and financial headache may not be worth it to them, and in that case, it’s probably worth moving forward sooner rather than later.

What would you tell a business owner who is thinking about selling their HVAC business in the next 12 months?

Start preparing the business to be sold. That includes things like cleaning up your financials, but it’s also important to think big picture. What’s the ideal scenario for you? Do you want to sell a majority or minority stake? Are you okay if the buyer puts debt on the business? Do you want a buyer who’s going to buy the company and flip it in a few years? Would you rather have a partner that puts no debt and holds forever? Is it important for you that your management team stays on board?

Figure out what your ideal buyer looks like and what your objectives are. Ideally, you should work with an advisor who can help you map that out on the front-end and also help you structure a transaction on the right terms.

Beyond that, focus on enabling the business for further growth. Pay attention to those value-drivers we discussed. Invest in technology and culture where you can. You’ll also want to demonstrate that if you’re removed from the business, it can still thrive — so if you don’t have a solid management team on board, start building that out and setting them up for success right away.

Post-transaction, what would you tell a management team to expect?

It depends on your buyer and the deal you’ve structured. For Garden City, we’re here to serve management in whatever way they see fit. Usually, we seek to partner with the management team across three buckets: culture, tech enablement, and sales/marketing.

We’re not going to insert a new team, or step in and assume we know how to run this business better than you do. We come alongside management and say, let us know where we can add value.