My post last week that asked whether you would pay $6.2 million for a specific heating, ventilation and air-conditioning business brought a lot of great comments with lots of smart analysis. Some readers ? including Fred T and vulcanalex ? say that the profits this business claims to be generating sound too good to be true.
I see it differently. It?s my belief that this business is not too good to be true. In fact, I think it?s a rare opportunity for a buyer to purchase a business at a reasonable price and learn from people who know what they are doing. Obviously, it is always important to do due diligence, and the seller of this company will have to answer some questions ? including some of those suggested by Warren Miller (like why revenue declined in 2011).
But I think the buyer of this company has the opportunity to take a system that is working and clone it in contiguous areas. There is every reason to believe that, as long as the buyer continues using the methods and strategies of the current owner, the success will continue.
This company appears to have achieved an outstanding level of profitability in three ways:
One, it has developed a strong niche business. It knows who its best customers are, and it doesn?t wander outside that niche. Businesses are always more profitable when they stay within their niches instead of taking business wherever they can get it. In this case, the owner has learned how to generate profits by specializing in serving homeowners who are buying replacement units.
Two, it has taken waste out of the process. It?s rare that you see a construction company use state-of-the-art ?lean? techniques. The whole point of lean is to remove waste, and this company appears to have done a great job of it ? for example, by declining business outside a driving radius of 20 minutes from the office. You mostly see lean in automotive and aircraft manufacturing industries. Companies that adopt lessons from the automotive industry often get huge returns.
Three, training is often a real problem in industries that train on the job. I have no doubt that because this company trains in its offices ? before its techs hit the field ? it will have a better-trained work force. I know that in my vending business days, we managed to decrease our training time and increase our efficiencies? dramatically by moving our training in-house. I can tell from the financial performance of this company that the same is true here.
There are companies in every industry that are outliers, and I believe this is one of them. If I were a buyer, I would of course want to make sure the numbers in the purchase and sales agreement are legitimate. But between due diligence and the warranties clause of the sales agreement, the buyer should be able to gain sufficient protection from any problems down the road.
One commenter talked about the need to do a multiple regression analysis. Because very few business owners understand how to use these kinds of advanced analysis tools, I find that instead of helping owners understand what a business is worth, they just confuse the situation. (Note to advisers: keep it simple for your clients. Simplicity helps owners understand their options and take action.)
This a pretty simple business that has had consistent sales and profit numbers for at least four years. Regression analysis won?t tell us anything that we can?t learn by looking at the free cash flow and comparing that free cash flow to the cash required to pay for the company. The more that we, as advisers, keep jargon and complicated calculations out of our work, the more value we can bring to our clients and customers. For example, another commenter, Jim Stauder, was straightforward and used simple language in the questions he suggested.
I was intrigued by the comment from Daniel, who compared the asking price multiple with those of public companies. I believe it?s a mistake to try to compare the multiples of public and private companies. The types of buyers they attract are just too different ? it?s apples and oranges. Because businesses of this size are rarely large enough to attract the interest of a publicly traded company, they usually sell to another private owner. The motivations of public and private buyers are very different ? and thus, so are the prices they pay. Advisers who understand this will close many more deals than those who don?t.
Thanks to all who took the time to comment. Your thoughts were interesting and valuable, and I would love to continue the conversation.
Josh Patrick is a founder and principal at Stage 2 Planning Partners, where he works with private business owners on creating personal and business value.
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