Why I Love Private Equity, and You Should Too

Private equity has rushed into the service trades, acquired a number of legendary contracting businesses, and caused no shortage of consternation on industry message boards and forums. Frankly, the private equity land rush is the best thing to happen to the HVAC industry since the 1990s consolidation.

Let me start with a mea culpa. I sold my company to private equity way back in 2017. I’ve experienced the wire transfer and life as an employee in the company I used to own. I know the pros and cons personally. The pros clearly outweigh the cons.

Private equity is making a lot of multi-millionaires in the service trades. This is an awesome outcome. Your buddy, your peer, who’s built a pretty good company is able to take a lucrative exit. Moreover, it’s incredibly positive to see outside money pouring into the trades. It’s about time.

Look, you work a lifetime building a business. You’ve worked hard. You’ve put up with all of the nonsense that comes with a contracting business. You’ve had employees cut your heart out for a buck an hour more from a competitor. You’ve had to fret over cash flow during seasonally mild weather. You’ve dealt with a government that overregulates with regularity. If you manage to muddle through all of that and build a profitable business, you deserve a profitable exit. Before private equity, you didn’t have much of one.

Profitable contracting businesses typically sold for four times EBITDA (earnings before interest, taxes, depreciation, and amortization). A company with $8 million in revenue and a 15% net would sell for $4.8 million at a 4X EBITDA multiple. That seems great until you consider 20% capital gains and the 3.8% net investment income tax (i.e., Obamacare). That reduces your take-home to $3.7 million, depending on your state. State capital gains range from 0% to 13.3%. If the latter, your net is $3 million.

While $3 to $3.7 million still sounds like a lot of money, consider living on the proceeds of the money when invested. Financial advisors typically recommend reinvesting 2.5% to keep up with inflation and taking 4.5%. This gives you $136,000 to $166,000 for living expenses. Gulp! Anyone running an $8 million business is probably paying himself a lot more than that.

All that’s changed with private equity. It’s not unusual for that same company to sell for a 8X to 10X multiple. If we split the difference and use 9X, the net to the contractor from the sale of his business ranges from $6.8 to $8.2 million. That’s a world of difference. Your living expenses range from $306,000 to $370,000. Plus, returns can be even higher after earn-outs and equity rolls are factored in.

Private equity has made contracting businesses more valuable. It has given contractors the ability to exit their businesses before they otherwise could and live comfortably on the proceeds of the sale.

What about the independent contractors who don’t want to sell? Private equity is helping those businesses, too, simply by the prices they charge. The most common problem in the industry is poor pricing. As a rule, the contractors purchased by private equity tend to price near the top of the market, but many private equity groups push the top higher.

The pricing levels of some of these companies may seem absurd to the average independent contractor. They are not absurd; they are what is apparently possible, especially with attractive financing programs.

Private equity pricing gives other independent contractors the ability to raise their prices while remaining under the top of the market. Independents may not buy as well as private equity groups, but neither do they have to carry the same levels of overhead. Thus, independents can price to deliver better profit margins than they ever dreamed possible. The entire industry can be more prosperous.

Private equity has also changed the perception of HVAC. For example, a Wall Street Journal article declared HVAC contractors were the new millionaire class due to private equity. The message is that HVAC is a great career choice and more high school graduates are getting the message.

Private equity has brought investment to the industry in other ways. Seeking efficiencies, private equity groups are driving AI development in the industry and causing other entrepreneurs to develop innovative products and services for HVAC.

Even if you never plan on selling, you should love how private equity is making the HVAC industry better and more lucrative for contractors.