Post 8: Comprehensive Guide to Performing Due Diligence on a Residential HVAC Business

If you have spent any time on SMB Twitter or the SMB network more broadly, if you’re trying to find the winner of the business popularity contest, HVAC companies are invariably close to the top due to the long-term regulatory and consumer tailwinds as well as the potential for operational value creation.

To increase the potential of a successful investment, potential buyers must ask targeted questions across several critical areas. This primer consolidates essential inquiries to help you navigate through the acquisition process, helping you to develop a better understanding of the business financial health, operational efficiency, team dynamics, and growth potential.

Financial Insights and Revenue Streams

Begin by examining the business's revenue composition:

• Determine the balance between subscription-based revenues, which provide a steady cash flow, and one-time sales from new construction, retrofitting, or maintenance. Your lenders will attach more value to the recurring revenues as well as retrofits for current customers. They will attach much less value to new construction installations due to the variability in those cashflows

• Understand the cyclicality of new construction revenue and how it impacts valuation - a higher proportion of new construction revenue will make the business more difficult to finance (banks typically do not want to deal with the cyclicality in new construction) Buyers with excess cash may pick up such businesses at a discount

• Investigate the factors driving historical growth and what plans are in place for sustained expansion

• Typical positive signals include:

  • Setup of a CRM which has driven growth with the base of customers

  • Purchasing improvements (decreasing average order price)

  • Writeup of installation guides for each SKU

  • Scripting provided to the contact center and HVAC tech teams increasing the consistency of experience for all customers

• It's also crucial to understand profit margins, especially the contribution of service offerings and the business's pricing strategy in comparison to its competitors

Team Composition and Licensing

The expertise and stability of the team are important signals as to the long-term viability of the business. Without the appropriate licensing (which may vary between states), it may not be possible to remain open.

• Delve into the licensing credentials of the team members

  • Ensure the possibility of securing long-term agreements with key personnel to ensure there is always a licensed professional on staff

  • Explore the company's history regarding staff turnover: Given the demand for HVAC service, wages have increased and non-compensation related factors come into play (e.g., work life balance, ability to take company cars home, etc)

  • Recruitment trends: ease of recruitment of techs in the market

  • Compensation strategies for new hires: what is a reasonable starting compensation and bonus

Operational Efficiency and Customer Engagement

Operational practices significantly influence profitability.

• Explore how dispatch and pricing decisions are made, including the extent to which technicians are expected to upsell during service calls

• Understand the use of sales scripts by technicians and call center representatives to encourage additional sales

• Inquire about the success rate of these strategies, including the variance in performance among individual employees.

• Often there is a meaningful opportunity to build better systems to report on these metrics, as well as to incentivize the appropriate behaviors with the team. Providing infrastructure such as appropriate scripting and technology can provide a jump in revenue

Reporting and Accounting Practices

• Assess the effectiveness of the business's communication with customers, particularly in reporting service outcomes and financial details.

• Evaluate the internal reporting mechanisms for financial and customer metrics and how these insights inform managerial decisions.

• Understanding whether the business uses accrual or cash accounting will give you insight into its financial management practices.

• Additionally, ask about cash flow management tactics, such as the timing of payments to suppliers and collection from customers.

• This tends to be a big weakness of single owner practices - who tend to rely on having “cash in the bank” rather than thinking carefully about unit economics and economies of scale. Providing an intuitive way to visualize and/or gamify this data can be an unlock of value among staff members

Strategic Potential and Growth Opportunities

• Consider the contractual terms of customer maintenance agreements, including their duration and any incentives offered due to their importance on the business recurring revenue stability.

• Probe into future investments that could expand the company's capabilities or market reach and how these investments could transform the business model.

• Other operators have universally installed remote monitoring devices in their customers’ units in order to remotely monitor the performance of their customers. This tends to reduce the revenue from emergency repairs, but increases customer stickiness and loyalty, and simplifies the dispatch and scheduling workflows for the team.

Competitive Positioning and Market Analysis

• Understanding the company's pricing strategy relative to its competitors, both in the immediate vicinity and the broader market, is helpful. This will help gauge the business's competitive stance and its ability to maintain or grow its market share.

• Single owner-operators tend to underprice relative to corporate owned businesses - while they make up for margin in lower administrative costs, the price and customer service differences may impact owner operators’ value perception, locking them into a “lower value” tier independent of competency

By systematically addressing these areas through your inquiries, you will likely gain a better understanding of the residential HVAC business you aim to acquire. You will be better-equipped to make an informed decision, highlighting potential opportunities and areas for improvement that could influence your investment's success.

Tweets from the Streets

• On your professional/acquisition “edge”: https://tinyurl.com/post8tweet1

• On platform risk to your business: https://tinyurl.com/post8tweet2

• On increasing marketing effectiveness: https://tinyurl.com/post8tweet3

Check out a pair of my previous posts below

Manufacturing company due diligence: https://tinyurl.com/post8previous1

Service company due diligence: https://tinyurl.com/post8previous2

Parting Thoughts

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If you have any questions about this article or about financial metrics in general, shoot me an email at [email protected]. I will be happy to respond to all the notes that I can. Look out for a follow up post soon.

If you are looking for a thought partner with whom to think through the growth of your business, I’m also happy to chat. Again, I’m an email away.

Until next time…Keep building!