On a day when consolidation’s greatest success story is being auctioned off for roughly 2% of the company’s purchase price a little more than a decade ago, it might seem silly to ponder whether consolidation can come back. Yet, the fundamental drivers supporting consolidation remain. That means someone will try again.
Consolidation will return because contractors need buyers for their companies. They need an exit strategy. A larger, more substantive company is not only worth disproportionately more than a mom-and-pop firm, it’s far more saleable. The necessity of an exit strategy was the mother of consolidation once and will likely give birth to it again.
It shouldn’t surprise you that early consolidation efforts failed. Pioneering efforts often stumble, providing valuable lessons for followers. Consider the HVAC industry’s experience with franchises.
Twenty years ago conventional wisdom stated that franchising wouldn’t work in the residential HVAC industry. After all, every residential HVAC franchise organization launched to that date had failed.
Nevertheless, the fundamental need that led some contractors to invest in franchises before remained in place for many others. Today, the industry supports two stable conversion franchises and a variety of add-on franchises are in early stages of formation.
What changed? It wasn’t the market. It was the business model. People looked at what worked, what didn’t, and made adjustments.
The next wave of consolidation will also involve adjustments based on the mistakes of the earlier efforts. Indeed, small regional consolidation efforts are already quietly growing. The wave is underway. It’s just not a tidal wave.
Future consolidators are likely to follow one of two paths:
Acquisiton of strong companies. Some will seek substantial companies with strong bases of service agreement customers, solid middle managers, and defined processes. These are companies that can operate without the owner. They command a premium because they are sustainable operations. They lack a risk discount.
Acquisition of weak companies. The other consolidation path is to purchase distressed companies with large customer bases. In essence, it’s a play to buy customers, and maybe, a brand. The consolidator then imposes its managers and processes upon the acquisitions. These companies sell for pennies on the dollar because they are unsustainable without their owners. They carry a substantial risk discount.
Consolidators will also differ. We are unlikely to see the Wall Street-driven companies that characterized the first wave of consolidation. Draconian government regulations have made IPOs much less attractive, especially for companies under $50 million.
Instead, consolidation will be driven by private equity attracted to the fundamentals of a low-tech, high-need service business. Other consolidation efforts will be utility or warranty company-driven. In fact, utility companies are already buying contractors.
Finally, contractors will lead their own consolidation efforts. This round of consolidation is far quieter. It is far slower as acquisitions are based on fundamentals and fit more than a headlong rush to report growth in the top and bottom lines. These efforts don’t command trade publication headlines, nor are they the subject of trade association meetings. This consolidation movement just quietly happens.
It’s in your best interest
As the owner of a mechanical systems business, you should welcome this wave of consolidation. Unless your kids have the contracting gene, consolidation may be your most attractive exit strategy. However, you need to get your company in shape now so that you’ll be ready when opportunity comes knocking. You don’t want to own a job when it’s time to retire. You want to own an attractive, saleable business that can command a premium without a risk discount. Right now, most contractors do not.
Preparing for a profitable exit is neither simple nor easy. It takes years of effort, which pays off with greater rewards along the journey as well as the payoff at journey’s end. Of course, you might discover that the journey is so much fun you want to become one of the consolidators.
Matt Michel is CEO of the Service Roundtable (www.serviceroundtable.com). The Service Roundtable is an organization founded to help contractors improve their sales, marketing, operations, and profitability. If you’re interested in how you might get your company ready to sell or how to start your own regional consolidation effort, contact Chris or Charlotte about the Service Nation Alliance. Call toll free: 877/262-3341. The Service Nation Alliance is a coalition of select contractors dedicated to best practices, continuous improvement, and the creation of a marketplace for buying and selling HVAC companies.