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    HVAC PRIVATE EQUITY: Sell Now, or Wait?

    Oct. 31, 2023
    The PE furor has cooled down some. There are still opportunities, but they could improve in a year or two.

    Private equity, while still active, might be slowing down. Contractors are questioning whether it is already too late to take advantage of the land rush and cash out. In short, it is not, though the market for contractors will likely improve in a year or two.

    Why HVAC is Attractive 

    Private equity has an enormous amount of money to invest, but where? The service trades came to the attention of private equity during the Covid lockdowns. When most of the country was locked down and struggling, residential service contractors were experiencing a record year. Private equity funds looked at HVAC and saw a fragmented market with consolidation opportunities and products that people cannot live without. The money poured in. 

    What Changed

    The opportunity for solid contracting businesses to sell to private equity remains. However, the rise in interest rates should put downward price pressure on all but the most stellar enterprises. Most private equity funds utilize some leverage and debt has become more expensive. With debt more expensive and risk-free returns trending north, investment hurdle rates are bound to rise. This means scratches and dents that would previously be ignored in a contracting business are likely to result in buyers discounting the valuation. 

    The rise in interest rates should put downward price pressure on all but the most stellar enterprises.

    Private equity is also learning more about the industry. The shipment cliff is a 40% contraction in shipments 15 years ago that is being echoed in the replacement market. Initially, it was hidden by price increases, but is becoming apparent. The market decline caught private equity by surprise and the built-in assumption of perpetually increasing revenue is now shaken. The result is increased scrutiny of acquisition candidates.

    Pressure On Performance

    The financial pressure not only affects acquisitions, but also operations. Contractors who sold their companies to private equity and stayed on in a management role are under increasing pressure to deliver stellar growth in revenue and EBITDA. At a time of structural market contraction for change outs and general consumer financial stress, many contractors are shifting to service and system enhancements/add-ons. Contractors working for private equity continue to be pressed to generate more replacements. 

    Private equity funds are generally run by people with financial backgrounds. When the market is tight, their gut reaction is to cut costs. There is only so much that can be cut in an HVAC business if the operation is to continue growing. If the private equity executives feel they can get by with a lower cost general manager, contractors who stayed on may find themselves pushed out.

    Creative Destruction

    Some debt laden private equity funds will likely look for an exit and sell to better financed private equity. In some cases, the funds will exit because they are struggling with their debt burdens. Others will be looking at looming expiration dates for low interest debt that must be replaced by equity or higher interest. 

    A significant percentage of former owners with expired non-competes or who have relocated to different markets can be expected to start new contracting businesses. In this go round, they will be well financed and experienced in growing a contracting business. Moreover, if the new company is in the same market, the best technicians are likely to migrate to their old boss.

    A significant percentage of former owners with expired non-competes or who have relocated to different markets can be expected to start new contracting businesses. 

    Private equity is in HVAC to stay. While is has not happened yet, a shake-out and reduction in the number of players is inevitable. Overall, whether they are private equity owned or independent contractors who sold and are starting new businesses, the professionalism in the industry is bound to improve.  

    Sell Now or Wait?

    Contractors pondering the sale of their businesses should consider several factors. Is the business buttoned up today? Is there a track record of recent growth? If the answer to both questions is yes, this remains an excellent time to take chips off the table. If the answer is no, contractors should spend the next couple of years working on their businesses. 

    The impact of the shipment cliff will expire in the next year or so and replacements will start a decade long run of increasing numbers year over year. When the economy improves and interest rates hopefully decline, private equity will still be buying. Waiting for a better market and working on improving the attractiveness of the business might be the best investment a contractor can make.

    Contractors electing to wait and work on their businesses should considered the Service Nation Alliance. Learn more at ServiceNation.com.

    Matt Michel is a member of the Contracting Business HVAC Hall of Fame. You can reach him at [email protected] or 214-995-8889.