Private Equity: What You Need to Know Now

Posted on:

April 25, 2023

Private equity, or PE, has become a buzzword in the HVACR industry. But what is it, and what do business owners need to know? PE brings the opportunity to make a decent amount of money and take a business to a higher level, but it is not the right choice for everyone.

What Is Private Equity?

PE is a type of investment fund in which the adviser, or PE firm, pools the money from a group of investors to invest back into the fund. In other words, the PE firm acquires a portfolio of private companies and uses the funds to grow each of the businesses with the intention of selling them later at a higher profit.

The PE market is international, so the firm and the acquired business may be in different locations, including different countries, although this doesn’t meaningfully impact day-to-day operations.

Why the HVACR Industry?

The PE market has been growing. According to a May 6, 2022, Forbes article by Rebecca Baldridge, “In the third quarter of 2021, private equity deal value reached a new record, topping $787 billion for the year,” and the HVACR industry has been no stranger to such growing interest.

HVACR is a stable industry with relatively meaningful profits, which makes it attractive to PE firms. The industry is also largely filled with small businesses with local or regional footprints, so there’s room for consolidation, says Doug Hart, CEO of Royal House Partners, an investment company based in Dallas, TX.

Many of the owners of these businesses are nearing retirement, and their children may not be interested in taking over the business, says Ken Goodrich, CEO of Southwest-based Goettl Air Conditioning & Plumbing, so PE firms can fill a need in succession planning.

Ken Goodrich, CEO of Goettl Air Conditioning & Plumbing

Goodrich, who has experience with both buying and selling companies, has observed that, since the 1990s, technology has streamlined the PE process, making it easier to scale businesses and communicate across long distances. At the same time, organizations like ACCA have helped the industry mature by increasing business owners’ professionalism and business acumen.

Benefits to Contractors

PE may be a good solution for a few types of business scenarios:

A soon-to-retire owner who needs a succession solution.

A mid- to early-career owner who wants to transition out of business ownership.
An owner who wants to take their small business to the next level but needs more resources.

Gary Marowske, president of Flame Furnace based in Detroit, MI, says one benefit of PE is that the owner gets paid upfront, whereas a company sale to a friend or relative requires a loan. Flame Furnace is now owned by Heartland Home Services, a PE firm in the Midwest and Kentucky. A PE acquisition brings the opportunity to make money, either in the first or the second sale, allowing owners to afford the kind of retirement (or lifestyle) to which they aspire. In addition, a PE firm can ensure that current employees and customers are taken care of in the long term.

Being part of a larger firm gives small businesses access to resources they might not otherwise be able to afford. Post-acquisition, Flame Furnace offered a better employee benefits package at a lower cost to the business, says Marowske. Flame Furnace also added Heartland Academy inside their building, a job-training program that gets graduates from trade school to a truck in less than 12 months.

Heartland Academy

Heartland Academy

Another advantage to being part of a PE firm is access to more capital and a higher comfort with risk. In addition, PE-backed businesses have a greater advantage in negotiations with vendors and manufacturers, says Marowske.

Businesses within the PE firm portfolio become a network that shares best practices and business strategies, which can come with unexpected benefits. Royal House Partners’ family of companies are in complementary industries: plumbing and electrical as well as HVACR. By using their access to knowledge of a complementary industry, these small businesses can expand by creating their own new services division.

A savvy PE firm will not change everything about a business; however, an acquired business should expect some adjustments.

Downsides to Private Equity

PE is not a solution for everyone. An owner looking for a quick exit should look for another solution as PE firms typically expect the owner to stay on for some length of time to lead the day-to-day operations.

An owner who is happy with the status quo may not want to partner with a PE firm. The point of a PE investment is to grow the business, and the firm may set the growth objective. Goodrich has observed that owners who put in the work of initially growing their business and are enjoying the lifestyle they have created are sometimes surprised by the PE firm’s new growth expectations and the level of day-to-day work that meeting them requires.

It is normal to have a sense of loss of that identity after the sale, even if partnering with a PE firm is a sound choice and an opportunity for the business. As many small business owners consider owning a business to be part of their identity, an owner-operator must adjust to the mindset of the business no longer being fully their own. A PE firm will not change everything about operations, but they still have some say. And Goodrich knows from personal experience that after the sale, a previous owner will need to adjust to their new role, which has shifted to being a manager or executive.

Goodrich predicts that there will always be a place for the owner-operator and does not see large corporations dominating the HVACR industry. While being part of a PE firm brings new knowledge and perspective for business owners in the trades, owners can also stay independent and gain knowledge by continuing their professional education and training, such as by attending ACCA’s annual Conference & Expo and networking in ACCA MIX Groups®.

How to Prepare

If an owner is interested in exploring PE, they should take the mindset of preparing for a job interview, says Goodrich. Ask a firm for their due diligence checklist and start pulling together the relevant information: year-over-year financials, employee information, any legal records, and the business’s systems, services, and geographic footprint (the checklist is practically the same for every firm). Goodrich suggests starting this time-consuming task a year in advance.

In addition, owners should ask around their network—such as their ACCA MIX Group—for recommendations for PE firms. Marowske used a business broker to begin the process, and familiarity with different firms’ reputations helped him narrow down the list of interested firms. Ask firms for a list of former CEOs of acquired businesses, says Goodrich, to contact about their experience. Look for PE firms with a proven track record of growth. In addition, Hart says that a PE firm may reach out to businesses they are interested in acquiring.

The PE firm–HVACR business relationship is a partnership and should be treated as such on both sides. Hart says this partnership means that it is important for both sides to look for a cultural and operational fit. When reviewing potential acquisitions, he also evaluates leadership’s drive toward continual improvement, interest in data-driven metrics, ethics, and appetite for change.

After the initial review, a PE firm usually submits a letter of intent (LOI) and a non-disclosure agreement. An LOI is typically nonbinding but includes the high points of a potential agreement. Once it is signed, the due diligence process begins. At this point, if the business is not already using a broker, it is time to obtain outside counsel. Hart compares this process to buying or selling a home: You can do it all on your own, but a professional makes the process significantly easier. A PE firm will often use outside counsel for its own due diligence, depending on the size of the firm. It is wise for the owner to find their own representation to consider the business’s best interests. The entire process can take anywhere from 90 days to a year before the deal is finalized.

If an owner is interested in PE, the time to explore the possibility more fully is now. At the same time, do not fall prey to the fear that PE will take over everything or sell too early or for the wrong reasons.