What do home service giants like Goettl Air Conditioning & Plumbing, Best Home Services, and Any Hour Electric, Plumbing, Heating & Air all have in common? They leveraged private equity (PE) partnerships to achieve extraordinary business growth and unlock uncommon wealth.
These companies—along with hundreds of other HVAC, plumbing, and mechanical contractors—did it with financial advice and investment help from SF&P Advisors, a 21-year-old success-strategy firm with over 50 years of combined experience in the financial and capital markets.
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Whether you dream to one day sell your service business for a profit, plan to partner with PE firms to expand, or better understand the current mergers & acquisitions landscape in the trades, SF&P Advisors help contractors in the trades do it all.
Managed by CPA Fred Silberstein, SF&P helped contractors complete 315 transactions representing a combined $1.65 billion in total transaction revenue over the past two decades. In 2021 alone, the company closed 34 transactions representing $587 million in revenue.
"Starting in 2015 with the Wrench Group by Alpine Investors, private equity has been aggressively investing in the trades, with particular focus on HVAC, plumbing, and electrical contractors,” Silberstein says. “We think there are 57 private equity-backed strategics at this point. There is certainly a lot of interest.”
SF&P Business Strategist Brian Cohen says the number of buyers interested in making transactions involving the trades has grown exponentially, just in the past few years.
“When we took a transaction to market, there were literally 15 buyers we knew that we could potentially do a transaction with. Now, when we take a residential HVAC plumbing company to market, we may get 70, 80, or 90 buyers that are signing non-disclosure agreements to take a look at that potential transaction,” Cohen says.
But what’s driving private equity’s interest in the trades? Silberstein says it boils down to the following three reasons:
Highly fragmented market (no one has a majority of market share)
Essential services (the trades have always been recession-resistant, and in 2020 they proved to be pandemic-resistant)
Recurring revenues (no customer concentration exposure with single-family home residential customers)
In a recent webinar, titled “The State of Private Equity in the Trades,” the two SF&P professional brokers break down the most important things for contractors to know before partnering with a private equity firm, such as:
A general understanding of private equity as an investment vehicle
Learning more about private equity’s interest in the trades
Industry outlook predictions based on the current heavy investment activity
What is Private Equity?
Private equity refers to an investment made into companies that are not publicly traded, SF&P President Silberstein says. Typically, PE investments are made into mature businesses in traditional industries in exchange for equity, or ownership stake.
PE firms invest in businesses with a goal of increasing their value over time before eventually selling the company at a profit. Like venture capital firms, PE firms use capital raised from limited partners (LPs) to invest in promising private companies.
Two things make up the purchase price for a service business: EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) times a multiple.
The valuation a buyer pays is a multiple of your EBITDA, based on historical growth and expected future growth. EBITDA measures cash flow, and shows the true results of the business, Silberstein says, and that’s what all buyers want to bid on.
“Private equity firms seek large transactions where they can deploy a lot of capital,” he explains. “We're seeing some of the starting points start as little as two, three, maybe even four million dollars. There's certainly other ones that have started, 10, 12, 13, 14 and even higher EBITDA, and they continue to grow.”
Recent headlines in the news show the high level of interest by PE firms in the trades, such as:
“OMERS Private Equity Further Expands US Portfolio Through Acquisition of TurnPoint Services”
“Knox Lane Announces Investment in Any Hour Services”
“Odyssey Investment Partners Acquires Service Champions”
“The Jordan Company, L.P. Closes Acquisition of Heartland Home Services”
“Morgan Stanley Capital Partners Completes Investment in Sila Heating & Air Conditioning”
“What’s really important when you see all of these different press releases, is the multiples these guys are getting,” Silberstein says. “There's a big multiple arbitrage play here, and that's one of the reasons why private equity likes the industry so much. The multiples do seem to be going up and not down.”
From a valuation standpoint, companies with a longer history tend to be valued higher, he says.
“If you've been around a long time, there's a lot of brand awareness,” Silberstein says. “One of the biggest mistakes we made in what's called that first gold rush in the late 1990s was not recognizing the brand equity. I think this time around with private equity, they've gotten a lot smarter.”
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Understanding Private Equity’s Interest in the Trades
The idea behind private equity investment in the trades, Silberstein says, is for home services companies to take on an investing partner to supercharge their company’s growth. PE firms provide working capital to help you run and grow your business, but they typically don’t get involved in the actual operations of your business.
“PE firms want to be inquisitive, they want to help you grow your business, but they're not trying to operate it,” Silberstein says. “We deal with sellers all the time, and they're concerned about how things are going to change on the other side of the transaction. For the most part, PEs do become somewhat of your own peer group. You get to work with other like-minded contractors, you get to share best practices.”
How Private Equity Wins:
Management and Performance Fees
Fees incurred by a company from its private equity sponsor. These are not how PE wins, rather how the firm covers overhead costs.
Investment Exit
PE deploys capital into its investments to grow the asset and add value. The actual ROI on the limited partners’ investments is not fully realized until the firm exits/sells the asset to another party.
This can be accomplished by three main ways:
Sale to another financial sponsor (PE)
Sale to a strategic (company with existing assets in the space)
Going public via an IPO or special purpose acquisition company (SPAC)
Private equity really makes its return based on the exit, or on improving your company’s performance and then selling it to somebody else.
“They grow it, and then they typically sell it to a different PE firm, maybe through an auction process. At the core, these are really good cash-flowing businesses with really good characteristics and PE wants to keep investing,” Silberstein says.
For PE firms, investing in a home services company to help it grow can lead to rollover, or what Silberstein describes as “the second bite.”
“The second bite is when the initial PE firm exit should be worth more than your first bite,” he explains. “The idea here is if you take a $10 million EBITDA business and you take that up and to the right [grow cash flow] through some organic growth and creative acquisitions. If you get that up to $40 million or $50 million, and you trade at a higher multiple and you still own a percentage of that, you own a percentage of something bigger, but a smaller percentage. Guess what? It's going to be a great windfall.
“We've seen our clients who are now on their second bite, and we're sometimes amazed at how much that second bite can be worth,” Silberstein adds.
Another defining characteristic of private equity is its leveraged buy-out (LBO) strategy, where investors bring debt onto a business to accelerate growth/cap out potential losses.
“Basic Finance 101, debt is always cheaper than equity, so if you can bring in money and you can bring in debt, no matter what the terms are, it's always going to be cheaper than equity,” Silberstein says.
“One of the reasons why this works so well is because we are in a low-interest-rate environment,” he adds. “If interest rates rise, if we go into an inflationary period and interest rates really rise, that will have an adverse effect. If the cost of capital becomes more expensive, that's not great for our business, and it's not great for private equity.”
For example, a company with $10 million EBITDA x 10 multiple = $100 million in enterprise value. The PE would then bring in some debt and equity as part of the capital structure, such as $40 million worth of debt and $60 million worth of equity to reach a total value of $100 million. That means the PE investment netted $80 million, rolled $20 million, and PE still owns one-third or 33% of that equity investment.
“You're still a shareholder, and this is where that second bite is really important,” Silberstein says.
Essentially, contractors who partner with PEs may own a smaller piece of a bigger company, but they stand to make more money — as much as 2.5 to 3 times the original invested capital — each time PE takes a bite.
“That's the game and that's how you play,” Silberstein says. “If private equity loses, guess what? They lose their investment. If private equity wins, it's a multiple of their invested capital.”
Again, private equity likes to play in the mature phase of a company’s business life cycle. If you’re in the startup phase and need some seed funding, look into venture capital investors. For companies in the development phase, check into leveraged buyouts.
“By doing a PE partnership, by bringing in that partner to help supercharge that growth, you're personally diversifying,” Silberstein says. “You should never have all of your eggs in one basket. The PE partnerships really allow you to diversify.”
However, today’s PE transactions also involve less-mature companies, with owners less than 40 years old, Cohen adds.
“You have younger guys now that understand the time value of money, really understand the detail of how these financial transactions work with private equity,” Cohen says. “They want to get paid today, they want to get their equity rolled. They've got the energy and enthusiasm to keep pushing, because they're playing for that second or possibly even third or fourth bite of the apple.
“You don't always have to be a mature company,” he adds. “Their play is, the market is moving up and to the right. They want to take advantage of it now. They're smart enough to recognize we haven't seen this in 20-plus years, and we don't know when we're going to see it again.”
Industry Outlook Predictions for Private Equity in the Trades
Silberstein breaks down the growth for private equity in the trades over the past 10 years into the following four categories:
Investments: 3.5 x the number of global buyout deal value
Dry powder: 2.5 x the number of global private capital
Exits: 3.5 x the number of global buyout-backed exit value
Fund raising: 3.2 x the number of global private capital raised
“Dry powder means the amount they're sitting on to invest,” Silberstein says. “Globally it's $3.3 trillion. It used to be $1.2 trillion. In the United States alone, it's about $1.6 trillion of dry powder. Those are U.S.-based private equity firms looking to deploy capital into these types of assets.
“The exits have grown as well,” he adds. “It was $283 billion in 2011, and today it's $976 billion.”
So, why so much private equity interest in the trades? Silberstein, again, points to 1) a highly fragmented market; 2) essential services; and 3) recurring revenues. Simply put, all signs point toward growth.
What Private Equity Looks for in a Home Services Company:
Size (revenue/EBITDA)
Historical performance
Management team
Industry
Geography
Growth
What Home Services Companies Should Look for in a Private Equity Partner:
Control vs. Non-control investing
Operationally focused vs. passive/silent capital
Average investment hold period
Prior industry experience
Common vs. Preferred Securities
Amount of Uninvested Capital Left in Fund
“They do look at the management team, they do look at the geography,” Silberstein says. “When we go into management meetings and there's a single owner there, those meetings tend to be a little bit more flat and you don't get as much. When an owner includes his key people in it and the buyers are able to see how much the management team has dialed in, those situations definitely go better.”
Top Mistakes Companies Make When Partnering with PE:
Trying to negotiate a deal on your own. PE firms are professional deal makers who do this for a living.
Not understanding working capital, particularly what accounts are defined in the definition.
Not understanding that institutional capital comes with certain implications. Some PE-sponsored companies are adopting more stringent and formally written COVID policies, for instance.
Not understanding how the business plan moves forward after partnering.
Not understanding the structure of your deal and the funds flow (i.e., earnout, holdbacks/escrow, fees, rollover equity).
Not setting achievable goals when partnering, especially regarding organic growth targets. Don’t promise 20% year-over-year growth consistently. “The trick isn’t to hit only home runs,” Silberstein says. “Singles, and doubles, with a great batting average does the trick.”
The bottom line when considering private equity in the trades? Use a professional, like SF&P Advisors, to seal the deal.
“Each transaction has its own nuances and its own characteristics...we have to navigate through those stressful minefields,” Silberstein says. “We've had clients tell us that it's like selling their firstborn and it's very emotional for them.
“We try to guide them through as calmly and clearly as we can so they can see the big picture,” he adds. “But when you're going through due diligence, which is not an easy part of the transaction, it can be very frustrating and you may just want to throw up your hands and say, ‘Forget it, I don't need this, I don't want the money.’ Cooler heads usually prevail and we're able to find some middle ground.”
Some General Mistakes Sellers Make Once They're in a Process:
Taking your eye off the business and producing bad results in the diligence period (when everything is magnified).
Not operating in the ordinary course — i.e., giving raises that are above historical levels (taking care of employees on your way out), increasing rent on owned properties, etc.
Not understanding both levers of the deal (EBITDA x Multiple).
Not understanding legality of entity (S vs. C).
Lack of Key Performance Indicators.
Not having an adequate team or bench beyond the person selling the business.
Financial literacy.
Overall business mix.
Service contracts (“fence around the customer”).
Running a process alone.
Cohen says many home services businesses may only do one PE transaction, but it’s usually one of the biggest transactions they ever do. It’s important to work with a company like SF&P that speaks the same language as PE firms, and can provide the right support and expertise.
“To not have the support of an expert who knows what they're doing in this arena, you can get smoked in this situation,” Cohen says. “We field calls, probably a handful of times a year, about deals that went really bad.
“The owner, post-transaction, is really pissed,” he adds. “They weren't represented properly, or thought they could handle it on their own, and realized how much money they left on the table. You get to do this one time, make sure you do it right.”
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