Making Sense of M&A: How to Increase Your Valuation

• How to prepare as a buyer

• How to prepare as a seller

• Contractor M&A: How to protect your market share

• How to increase valuations

• Legal and regulatory concerns

• M&A Alternatives

• How do Investors evaluate wholesalers?

• How to execute Day 1 and integrate

• What can go wrong

• Any other topics members feel are important!

Below I will explore a topic with massive ramifications: How to Increase Your Valuation. If you are looking to sell your HVACR distribution business, this is a topic of utmost importance that if done incorrectly, can leave millions on the table. Even if you are not seriously considering selling or even selling at all, several of these steps can be a good temperature check for how you are running your business. There are a thousand variables that go into a merger or acquistion transaction, but ultimately price is going to be the most important thing.

Know that valuations are not an exact science. Ten different investment bankers or consultants will give you ten different valuations. (The days of 5x EBIDTA are over.) Price is also in the eye of the beholder. Other businesses and firms will care about your business for different reasons. One may want your salespeople, another would cut that entire division and use their own people. One may care about breaking into a geography you play in, another may be established there. One may covet your DC, another may view it was outdated. One may be interested in an exclusivity agreement you have with a manufacturer, another may worry this will be a future hurdle. Different buyers will value you very differently. However I’d be willing to wager there IS consensus that the following steps can help you maximize your valuation.

1. Do your honest assessment initial valuation.

Think of this is a before picture before starting a weight loss plan. This where you currently stand, love handles and all. A perfect tool for this is the DPD Report that HARDI provides that gives you the valuation relative to your competition. In our industry, this should be used in every member evaluation. In addition to this, compile your EBIDTA, SWOT analysis, performance vs your benchmarks, and your overall financial and legal profile. There is no gain in gussying this up. Be as honest as possible and be brutally honest about the good, the bad, and the ugly.

2. Past > Present > Future.

Though you may be very proud of your company history and where you stand today, your valuation is based on your future. That’s why you see companies like Rivian have a market cap of 32 BILLION despite have sold ZERO cars. Your valuation is based on what you offer in the future. Any potential buyer will want a to see a multi year roadmap that’s believable. (If you declined year over year, a 10%+ future growth plan will be met with eye rolls.) A robust and detailed growth plan that shows how you are differentiated against your competition immediately increases your value beyond what’s on your balance sheet. This plan should encompass everything; team development, innovation, marketing plans, geographic expansion, strategic initiatives, etc. There is no crystal ball, but the more you can paint the future picture of success, the higher the valuation.

3. Prepare to show the Big Three; Company Comparison/ Comparable Transactions, Asset Valuation, and Discounted Cash Flow (DCF.).

COMPANY COMPARISON/COMPARABLE TRANSACTIONS

This is what deals to similar companies have looked like recently. You may not know what these are, but investment bankers, consultants, and PE firms certainly will. It is VERY important to know these as best as humanly possible. It will be the starting point in many valuations. Do as much research as you can to understand what the recent benchmarks are. Leverage your network, scour the trades, and don’t hesitate to flat out ask the makeup of other deals they are pursing. You’ll have to show why you are more valuable than the previous deals. It’s what Deloitte calls “Secret Sauce”. Show what your Secret Sauce is relative to prior deals.

ASSET VALUATION

If you have a lot of fixed assets, and the HVACR distribution industry has many, this will be a massive part of your valuation. Your physical assets (property, plant, and equipment) will come under scrutiny. If your family, REIT, or another organization owns the property and it is leased back, this will be analyzed. Make sure all these are in tip top shape and ensure you can show their value. This is more complex, but intangible assets are part of this. This is not only patents, brands, customer lists, etc. but the overall “Goodwill”. Goodwill includes vendor relations, trade secrets, reputation, etc. Ensure you can also show the value within each. These are often an afterthought, but are what can set you apart and make you rich. Lastly, ensure that you can show how they all can persist, even if you are not part of the future equation.

DISCOUNTED CASH FLOW

Hope you paid attention in accounting class! This is the most common and standardized method of valuation. By definition, this is the projection of your company’s free cash flow discounted to the present and summed to project future value. Why does this matter so much? The buyer will own the future cash flows by your continued operations. This is the cash that is left over after expenses including COGS, operating and overhead expenses, interest and tax expenses, and CAPEX. Typically, this is viewed over a five-year period. Now, how do you maximize your DCF? Please see #4.

4. Take a hatchet to any costs that don’t drive value.

This is the textbook “Control what you can control”. This may not be intuitive but in the M&A consulting world, cost cutting sits within the M&A division, and the reason is because valuations sit within M&A. You become a samurai in improving cost line items. Here are metrics to dig into, some easy, some very difficult.

TRAVEL AND EXPENSE

This is the lowest hanging fruit there is and is typically a first place an outside consultant will hunt. Are people booking flights last minute? Is too much being spent on meals? Is every decision being made with an ROI mentality? Many companies are very sloppy on this front and the standard needs to start at the top. Not only can this be a big P&L bad guy, but it can also be a red flag that your company isn’t being run well.

OFFICE EXPENSES

Do you need three floors of a building? Are you spending too much on office supplies? Can you go paperless? I know this may seem like small potatoes, but it can really add up and you can really keep this expense down. When you are thinking about multiples, the lower these are, the better your valuation.

INSURANCE

Are you constantly vetting and shopping your insurance expenditures? This isn’t just medical and dental, it’s auto, dismemberment plans, business interruption insurance, and property insurance. It’s everything.

LICENSE RENEWALS

Off the top of your head, can you name EVERY software subscription you have? Every single one? These really balloon. Some of top of mind, some you may have forgotten about.

PERSONNEL COSTS

This is the most difficult as there is a human element to this, but SG&A costs are a massive part of any balance sheet. Do you have underperforming staff that aren’t essential to your strategy? Can roles of current high performers be expanded to achieve the roles multiple individuals are doing? Can part time or outsourced workers fill the roles of employees with full benefits? By no means do you have to be cruel or reckless with this, but if you are looking to maximize your valuation, it’s an essential step. Also, if you do not manage these decisions internally, the purchasing organization will likely perform these same steps, and they will likely not do it as delicately as you would. As a consultant, I have seen entire divisions be deemed inessential in a one-hour meeting. Doing some of the dirty work on your own is the fairest way to accomplish this.

PERSONAL COSTS

These are any costs that solely apply to you and would not benefit the future organization. Say through your organization, you are in possession of a boat that you use to entertain customers (using it every once in a blue moon to fish). You should consider transferring this out of the company’s financials to remove the cost.

5. Market your company.

In the same way you effectively market your services, do the same when marketing your organization for valuation. Even if you must spend money on marketing agencies or consultants, there can be a massive ROI in making your company look as attractive as possible. This can be highlighting your achievements, having very polished pitch decks and materials, generating good PR, or having a great digital profile. These steps can also help attract the attention of potential buyers. An example of this was when a consumer products company was looking to sell their tea division, they curated an event for perspective buyers will a full experience curated by a tea sommelier that walked the group through a full tasting of their teas and what made them unique and better than their competitors. It created a buzz and a hook that wouldn’t come across from just the financials. In many ways these will be the biggest pitches of your life, so go all out.

6. Show the synergy.

It’s important to know everything about the perspective buyer’s vision and how you can fit into that. If you can fully illustrate a multi-year vision around how your business will mesh with theirs seamlessly, you’ll greatly stand out from the competition. This also is a sign of good faith that you’ll be easy to work with. M&A is a grueling process and showing that you are not just a seller, but a partner, can up your price. The HVACR industry is a very murky one for buyers in the grand scheme of M&A. Oftentimes, HVACR companies are private, family owned, lack analyst and press coverage, and may not have robust reporting. The more you can share about your company and how it is it complimentary to theirs, the higher price you can ask.

7. Max your margins.

Several of the previous points accomplish this, but take extra focus on the margins of your business. Nail your pricing, ensuring you are driving the best bargains from your suppliers, have a sharp cash conversion cycle, reevaluate your relationships with low margin customers, and overall max out every decimal of margin you can. Yes, these are all easier said than done, but when selling, every bsp of margin will be multiplied for your sell, so everything counts.

8. Be patient.

Try to cast a wide net and receive as many offers as you can. As I said earlier, every organization will value your company differently, so the more of a cross section you can get the better. If your valuations are coming in short of what you had hoped, sit back, continue to do your internal improvements, and pull every lever you can to achieve your goal. You only get one chance to sell.

I’m sure it seems like the California Gold Rush right now with valuations across all industries, but with the current economic conditions worsening, it likely won’t last. The previous outlined steps will positively help you achieve a strong valuation. I encourage all members do take the time to participate in our DPD (it’s been used by several members in their pre-sale valuations before). If your score isn’t what you had hoped, or your valuations are coming up short of what you had hoped, please reach out as I am willing to confidentially assist in any way I can.