07 Jun 2021

Trade Talk | Buying, Selling, and Funding an HVAC Business - Part 1

TradeTalk-Patrick_Brandon-Social

If you've thought about buying or selling an HVAC business, then you need to catch this three-part series episode of the Trade Talk podcast. Patrick Lange from Business Modification Group and Brandon Bolen from Live Oak Bank are answering the questions many of you have regarding this topic. Watch all three parts to learn about the ins and outs of buying, selling, and funding an HVAC business.

In part 1, you'll learn:

  • What business owners need to do with their accounting to make it easy to sell their HVAC business.
  • Why repeat revenue and warranties help sell your business.
  • Why you should minimize involvement in new construction.
  • Why involvement from the owner should be minimized.
  • What to do if you're looking to acquire.
  • What buyers need to know.
  • What to do to get your business listed to sell
  • and a lot more!

 

Connect with Tommy, Brian, Patrick, and Brandon:

Hosts:

Tommy Cue and Brian BohannanJB Warranties

 

Guests:

Patrick Lange, Business Modification Group

Brandon Bolen, Live Oak Bank


 

Read the transcript:

Brian Bohannan:

Good afternoon. Brian, from JB Warranties, back with another edition of the Trade Talk Podcast. Today is going to actually be part one of a three-part educational series we're going to be doing around the topic of how to buy a HVAC or plumbing company, how to sell your company, and how to fund that project.

Brian Bohannan:

Today we've got Patrick Lange in with Business Modification Group, and Brandon Bolen in from Live Oak Bank to discuss basically a Q and A on what you might be thinking about if you were looking at buying or selling your business. Patrick, good morning, sir. How are you?

Patrick Lange:

I am fantastic. Thank you very much for having me. It's a pleasure to be here.

Tommy Cue:

Good morning, Patrick. Could you tell us a little bit about your history, first and foremost, if you don't mind?

Patrick Lange:

Absolutely. I come from a financial background. I owned a financial planning company in my younger years. Some people have a midlife crisis and buy a Corvette. I bought a heating and air company. I've been a business broker for probably 11 years, I guess. Then five years ago, I bought a heating and air company that I had listed for sale, actually, for somebody else. Ran it for two years, realized that I didn't want to be in the service business and have employees.

Patrick Lange:

Shockingly, my oldest son who worked with me in the business, told me he wanted to buy it. So three years ago, I sold it to him. He made his last payment to me probably two or three months ago. So we're still friends. He's running the business today. My office, where I'm at, is actually inside of his company offices. My office, I'm still at a heating and air company office building on a daily basis.

Patrick Lange:

At that point three years ago, I switched my entire business to just selling heating and air companies. Started just in Florida, expanded through the Southeast. And then I've been fortunate, for the last 12, 18 months gone nationwide. Now I sell more companies outside of the state of Florida, probably even within. I'm fortunate, the last three years, to sell more heating and air companies across the country than any one broker. So I've been blessed to be busy and we're trying to keep it expanding.

Tommy Cue:

Again, Patrick, I may have missed it, but what was your company name? Is it Business Modification Group?

Patrick Lange:

Yep. That's exactly it.

Tommy Cue:

Out of Florida. Is that right?

Patrick Lange:

Yeah. In a little town called Horseshoe Beach, Florida, that the bulk of what I do, once again, I spend my weeks and days traveling. COVID has limited a little bit of that travel, but it also makes the planes empty, which has been nice. I seem to be in California once a week, New Jersey. I've been all over the place. Last three weeks. I've been earning my frequent flyer miles, but I'm based actually out of Florida.

Tommy Cue:

All right. Perfect. We'll come back to you. But let's go and get a little bit of history on Brandon Bolen. Brandon, tell us a little bit about your history, if you don't mind.

Brandon Bolen:

Yeah. My name's Brandon Bolen, lender on the service contractor team at Live Oak Bank. I've worked at Live Oak my entire career. We're actually unique as a lender. Most banks will set up a bunch of branches in a geographic region and provide financing to homeowners, consumers, businesses alike with really no specialization in any one product or any one industry. But we're pretty much the exact opposite of that.

Brandon Bolen:

We have one bank branch in Wilmington, North Carolina, and we have teams at the bank that focus specifically on industries using just a handful of products with our main product being the SBA 7A loan, which is a government guaranteed loan. Our team here at the bank exclusively focuses on providing financing to HVAC, plumbing, and electrical home service companies in all 50 states in the United States, mainly through the SBA loan program.

Brandon Bolen:

What that is, is being a government guaranteed loan, we can provide financing to home service companies to expand without focusing on collateral. Your access to capital to grow your company, whether it's by buying the business across town or in a county over to grow your service area or buying real estate. Your chances of getting approved with an SBA loan are greater than with a conventional bank. And because we understand home service companies, they don't have to educate us on that. They were deemed essential last year, and that they only do service repair replacement work.

Brandon Bolen:

Residential companies are going to have a lot of receivables, stuff that a normal bank is going to ask a lot of questions. They're not going to understand. You don't even have to answer those questions because we already get it. That's who we are in a nutshell.

Tommy Cue:

Got you. I would assume you do a lot of deals with Patrick.

Brandon Bolen:

That is. Patrick and I work pretty closely. We talk almost every day. If not every day, every other day, sometimes multiple times a day. But his role, helping home service companies in the heating and air space looking to sell, a lot of times those buyers are going to need financing, and where we fit in is we provide the financing. We're giving that business or that buyer a loan to buy that seller's company. That seller has spent years building value in his business, and we look to be the key to unlock that. But also give a new buyer the chance to get into that business, maintain it, and grow that company as well.

Brian Bohannan:

Very good. Well, guys, thanks for being on today. Again, what we're trying to do is just an educational three-part series. I was fortunate to catch you guys on stage out in LA a couple of months back, and you guys were just dropping pearls of wisdom that I knew our customers could benefit from, and a lot of them are asking us these questions. Particularly, "I do want to expand, I do want to grow. Maybe I don't have the time and the patience to do it in-house organically, but I would like to add a plumbing component to my business." Or if I'm a plumbing company, I'd like to add the air conditioning arm of my business.

Brian Bohannan:

What we want to do is just highlight today, Patrick, we want to highlight you and what you do and how you fit into the equation. The next series we'll do or the next episode would be highlighting, Brandon, what you do and how... We'll gather some Q and A from our customers before we do the second part. And the third part is just going to be really a how to max value your business if you're going to position it for sale.

Brian Bohannan:

Patrick, the first thing I'd like to ask you is if you're a two to four million-dollar air conditioning or plumbing company, what advice would you give to someone in that position that's looking to prop the business up to sale. And then, secondly, if they're looking at acquiring a competitor, different scenario, but if they're looking down the street to add a plumbing component to the business, what are the first steps in getting the ball rolling on that?

Patrick Lange:

Okay. Answer those separately. The first thing, getting it ready to sell, I think there's four things that I stress people to focus on if you're looking at selling and one of them is clean books and records. A buyer is going to come in and want to see what's been going on. And if they need to bring in somebody like Brandon from a lending perspective, they're going to want to see what's going on.

Patrick Lange:

And so, treating your business like a personal bank account makes it challenging. If you're paying all your bills for your house out of your business and then expecting somebody to write you a check for it, it's not going to happen. So the first thing is clean books and records. It's going to dictate what the selling price is going to be and what's a bank able to lend on. And so, we've all as business owners have been ingrained in reduce taxes, reduce taxes, reduce taxes.

Patrick Lange:

And so, everybody does everything to be creative with their accounting and try to minimize the tax exposure. But the reality is, is you're getting paid a multiple, depending on the size of your company, of that net income. Well, if you're saving 15% to taxes by running it through the business and you're losing what could be a three, four, five-time multiple on the back end, it's a foolish mathematical way to do it. So making sure you have clean books and records is the first thing.

Patrick Lange:

Building a business that's built on service. Maintenance agreement service, warranty work, all those types of things is what buyers love to see. They love to see repeat revenue. They don't want to see a marketing budget that's 70% of the business. They want to see repeat revenue, maintenance agreements, once again, warranty agreements in place, so that they know that the customer's going to come back to them repetitively, something that stays away from new construction. Brandon can probably talk about how the bank's perspective is on that.

Patrick Lange:

I don't sell a lot of businesses that are new construction based simply because oftentimes the loyalty of a general contractor's not extremely high. And if they are loyal, they're loyal to the seller. And so when they leave, that loyalty leaves with them, and a buyer doesn't like that. So minimizing new construction exposure's a key. And then, often, minimizing the owner's involvement in the business. And so, if you're the head salesman, the head technician, the head installer, the face of the company, when you leave, that reputation leaves with you and that makes buyers nervous.

Patrick Lange:

So if you do those four things, clean books and records, minimize new construction, business built on service and repair, and minimizing your time in the truck or your time being the face of the company, typically, that will lead to a higher selling price and a more desirable business. That's the first thing. Typically, if you do all those things as well, it leads to a higher revenue business, which is a higher purchase price business. And so, that's a good thing.

Patrick Lange:

The flip side, you're looking to acquire. First thing, I believe, is making sure your ducks are in a row in your own company. If your company is disheveled, and you don't manage people well, and you don't have good systems in place, and you don't have a CRM, like a Housecall Pro, or a ServiceTitan, or something along those lines, you're struggling yourself, buying more technicians and buying the phone ringing more doesn't fix your problems. You need to have your systems in place before you do that. To me, buying that company would only magnify your problems.

Patrick Lange:

And so, making sure you're in a position to acquire a business and have the systems in place to handle that transition. Because, to me, it's so important when you make that acquisition, making sure the employees' stay and the customer stay are so important. If you can't get to your own calls, much less 50 new calls that come in a day, those customers are going to leave. You know what I mean? So you're buying nothing, is they're walking out the door.

Patrick Lange:

So making sure your systems are in place, I think is a key step first. Everybody's talking about acquisition, acquisition, acquisition. Well, make sure your own house is in order before you go out bringing somebody else's in. And then once you've got that part taken care of, then it comes down to dollars and cents and what you feel is a good fit.

Brian Bohannan:

Patrick, what level do you need to engage a CPA on that clean books and records? What do you find or what would you suggest for the guys that maybe are doing the bookkeeping in-house or someone in the office is doing it? How much easier is it to get a better multiplier if you're engaging with the CPA? It's not something we've covered on the podcast really. We've definitely covered getting your processes down, using a field service management platform. We've even established partnerships with many of them. But as far as getting clean books and records, any advice on the first step for that?

Patrick Lange:

Yeah, I think working with a good accountant or CPA is important. I don't fix my own air conditioner because I can't fix an air conditioner. I'm going to pay somebody to come fix it for me, that does it all day every day. Most people that are in the trades are not accountants. They're not trained in that field. And so, I don't believe in blindly giving it to somebody and telling them to take care of it. I think you've got to know what your numbers are and have a good understanding of what drives the business.

Patrick Lange:

But at the same point in time, to know all of the accounting rules and how things are categorized and what you should be doing, most people's time is better spent doing what they do well, and that's servicing the customer and taking care of their employees. So I think that's a huge thing. I think if you can outsource that to somebody that you trust, once again, not giving it away blindly, but having somebody to do the preparation for you that you're reviewing is a huge thing, because then when you're in the due diligence process of the sale, or even when you start with me, it's so much easier for me when I meet with a seller and I say, "I'm going to need a P and L, and I'm going to need X, Y, and Z in order to look at really what the value of the business is," And they say, "Here's my accountant. Call her," or call him.

Patrick Lange:

I can call them, say, "Here's what I need." They send me it instantly. I could and ask them a few questions and they answer. Most business owners, if I say, "Where did you classify your car payments?" They're like, "What? What are you talking about?" That's not where they make their money. And so, I think that's an incredible piece of advice that, once again, not doing it blindly though. I mean, not just saying, "I don't know anything about it," because I think that opens you up to more problems. Having an understanding of your business, but have somebody prepares it for you, whether that's weekly, monthly, whatever it is, depending on the size of your company, is a brilliant thing.

Patrick Lange:

I know, with my heating and air company, when I initially bought it, I had a bookkeeper and I paid her minimum. She came in one day a week for a couple hours a week. And every week, she gave me a financial report. I didn't even know how she did it. I just had to see the results of it. If I had a question, I could say, "Where'd you classify this?" Or, "What did you do with this?" So it was much, much easier for me to go through my bank statement every week and say, "Oh, that was cost of goods. Oh, that was employee. Oh, I have to file a 941 for payroll. What's a 941?"

Patrick Lange:

There's so many better things that you could be doing. It was cheap and it still is cheap. She's still in with the company today. She works more now because the business has grown, but it's a resource that I would strongly recommend delegating.

Tommy Cue:

Yeah. You just mentioned going through the financials. How many years back, when you get a deal together and you're going to bring it to Brandon, how many years back are you looking at financial records?

Patrick Lange:

Typically, three years. Like now, I'll ask for three years return, plus last year's, typically a P and L. Most people don't have their 2020 taxes done yet. And so, I'll get the three previous years of taxes and a P and L. P and L is not always going to match the tax return. I have found that most buyers want to look at three years. Brandon can answer more about that. I find most banks, when Brandon sends me the report, he wants to see three years. So I just get it ahead of time, and that's putting the package together.

Patrick Lange:

And so, when I sent it to him, I'll send it to him with three years. If I don't have the P and L, he may call back and say, "Where is last year's P and L?" 2019 return is not real relevant to last year's figures, specifically with COVID taking place. But, typically, three years.

Tommy Cue:

Got you. Okay.

Brian Bohannan:

Patrick, your target business or what you generally deal in, is, would you say, under five million, companies that are somewhere under five million? I think that happens a lot where a lot of these companies are banding together or merging, or somebody's acquiring the guy down the street. With the influx of all the private equity in the space, is it more competitive or is it harder to find a business like that? You arrange buyers. Have you seen any changes in the trends in the last couple of years, as far as difficulty in finding a company that you could acquire?

Patrick Lange:

Oh, absolutely. I spend 90% of my marketing budget on trying to find a seller, because everybody out there is trying to buy a company or say they want to buy a company. I think that everybody talks about the private equity push and I see a lot of it. I find a lot of those buyers spreadsheet themselves to death and never write a check. They say they're getting in the heating and air space. I interview them before I give them any information. "How many getting heating and air companies do you know now?" "None. "Okay. What's your experience in the heating and air business?" "Well, I worked for a fund that managed a fund that had some heating and air exposure."

Patrick Lange:

And so, I think there's a lot of talk about private equity and there is a big push of private equity, but not every private equity buyer writes a check. Most of your listeners that are in the space can tell you that they're probably getting three or four pieces of mail a week from companies down the street that say they want to buy them. Some of them I think are bottom fishing to see if somebody will just sell. I think some of them are real buyers.

Patrick Lange:

So my job has gotten progressively harder as the market's gotten better. I think the last 12, 18 months the market has been strong for sellers because of the private equity push, because of many bigger company realizing that they can acquire a company cheaper than they can market their way to the volume that the company's doing. They get the employees, they get the vans, they get the equipment, they get the maintenance agreements, they get the service contracts, they get the warranties with it. So it's one-stop shopping from an acquisition standpoint.

Patrick Lange:

My business has gotten substantially harder to find quality listings. Buyers are not a problem for me currently. My average deal, I think I have 14 listings right now, and every one but two are under contract. The two were listed in the last two weeks. One of them, the buyer's currently working with Brandon now to see if they can get approved. So that one may be under contract [inaudible 00:17:59] so maybe one that I don't have. So finding the buyers is not the problem right now. It's finding quality businesses to sell, back to the same four things we're talking about, because I'm looking for that as well as the broker.

Patrick Lange:

I want to minimize my risk. So if it's like Where's Waldo looking at your P and L to find how you're making money, because you're paying your wife this money for this, and you're paying your ex-wife this money for this, and all this money flow to the business, and I've got to try to get creative to find a way to take it to market, it's harder for me. And with the private equity push, many people unrealistically so, think they're sitting on a business that's worth $10 million.

Patrick Lange:

And so, one of the first conversations I have with a potential seller, we'll talk about the numbers a little bit. I'll say, "In your mind, what do you think the check needs to say for you to walk away? If I brought you a buyer today, what does a check need to say?" I can't tell you how many a week that I talked to that are doing a million dollars in sales, gross sales, and they'll say, "Well, I wouldn't leave for under five million." Well, the market's strong, but the market's not that kind of strong.

Patrick Lange:

So it's either an educational process where I say, "I'm not a miracle worker. Nobody's going to pay you that kind of multiple," or, "Best of luck. I'm not the guy for you. See what you can do to get it sold someplace else." I have that conversation a lot. Partially, it's because people don't know where to look for what is the value? I mean, that's the thing for most business owners. They have no clue what's real. People who sell their company, even ones that get bad deals, are not calling their buddies and saying, "Oh, I sold my company and I got ripped off." They're telling everybody what a great deal it was that...

Patrick Lange:

I heard yesterday, 15-time multiple. I said, "Somebody told you they got a 15-time multiple?" "Yep. He was doing a million in sales and he got a 15-time multiple." I'm thinking that that guy's special. I mean, I haven't seen that kind of number. So nobody's going to brag about the bad deal they got. And so, I think by the time the story gets back to everybody, there may be a little fluff that's built into there. And so, I spend a lot of my days trying to be the voice of reason saying...

Patrick Lange:

Because here's the reality. Most deals are done with bank financing, and when I list a business, I'm going to send it to Brandon first and say, "Brandon, here's our listing price. Here's what we're looking at. Here's three years of tax returns. What do you deal?" Brandon knows his bank has to approve it. It's got to go through an approval process and Brandon is probably [inaudible 00:20:38] more about that than I can. And so, he's going to call me back and say, "Yeah, we could probably do it in this environment," or, "No, we can't do it and here's why." Or maybe if it's like this, and Brandon, do you want to talk more about that? You could explain that better than I can.

Brandon Bolen:

Yeah. I mean, simply, from our perspective, as a bank, we don't necessarily assign a value, being a cash flow lender. What we do is Patrick talks with the seller. They determine a price. And then we say, "Okay, Brandon, this is the high watermark. If you have a buyer, do you think that they'd qualify for financing?" Sometimes I'll look at it and say, "Yes." Any type of buyer that comes in the door and they have good credit and they have solid resume. If they own a business currently, do they have a strong foundation? Yes, we can do this. Sometimes it might be an individual. Yes.

Brandon Bolen:

And having an appropriately priced business. It can be on the higher end, and get a little higher with multiple and we can get comfortable with that. There's certain ways to do any deal really from a... You might increase your down payment and debt load might be a little different. But from our perspective, the biggest thing is when we finance the deal, we want to make sure that the buyer's in a position to repay the loan. We don't want to give them a million-dollar business or a million-dollar loan where the business they're buying could only support a half million dollar loan, because they won't repay the loan and they'll be in trouble.

Brandon Bolen:

So our biggest thing is, when we look at the business, we make sure it can cashflow it. I'll tell you, Patrick sends every deal. I've never had a problem saying, "Look, this isn't priced fairly." It's always something that can get done, which I think says a lot about Patrick's role in the process. When somebody is looking to sell their business, ultimately, you're wanting to sell because you want the sale to actually go through. And having somebody with Patrick's experience in the industry, nobody's done as many of heating and air sales as Patrick. He knows the market. He knows what price you're going to get, and be able to have a fair price that's going to get you the value you want.

Brandon Bolen:

But ultimately, you only get that value if the deal closes and the funds either come from the bank or the buyer. And that's where Patrick niche is. That's where he's really helpful in getting... He can be the difference between a deal getting done and a deal not getting done. I know that was long-winded answer to the cashflow topic-

Brian Bohannan:

Yeah, I love it.

Brandon Bolen:

But I think that plays such an important role.

Brian Bohannan:

On that topic, let's say you're an air-conditioning technician who really mastered the craft, decided to start your own business, built it up. Now you're actually looking to sell. I don't know the answer to this. I'm just looking for some education and some knowledge here, but so you can list and sell your business just like your property, correct? So engaging brokers, can you talk a little bit about how that process works, engaging with someone to list the business, and just the first step?

Patrick Lange:

Yeah. Absolutely. There's brokers who do everything. There's a lot of incredible brokers across the country. I chose to focus just on heating and air. Seven years prior to that, I sold everything and I realized that I couldn't add value. If I sold a gas station today and a flower shop tomorrow, I couldn't add value in either one of them. If you come to me with a restaurant, I can't tell you about liquor license laws, because that's just not what I do.

Patrick Lange:

And so, I want to be able to add value. I've found that by looking at as many deals and doing as many deals as I can, I'm able to relatively quickly say, "Here's where I think it will sell, and here's why." I'm based in Florida and I'm on the state of Florida Board for Business Brokers of Florida. And so, we're an organization. We have a [inaudible 00:24:13] list system, just like in real estate. We're the only state that has one, but we track all business sales.

Patrick Lange:

And so, I can look at heating and air companies that have sold in the last 12 months, and it's got to be with a broker. But I can look at heating and air companies that have sold in the last 12 months, what multiple they sold for, what kind of assets was included, were the numbers based off a tax return or a P and L, how many days was it on the market? Just like a house.

Patrick Lange:

And so, in the state of Florida, and I do this nationwide, I believe in co-broking a listing, and some brokers argue, and it shouldn't be an argument, in my opinion. So if another broker brings a buyer to the table, I'm happy to split the deal with them. I'm all about getting the business sold. The faster the business sells, the faster I get paid. The bigger the deal is, the bigger my check is. And so, it's I have a vested interest in selling it at a market value in relatively short amount of time.

Patrick Lange:

And so, if another broker brings somebody to the table, I'm all for that. Some brokers don't believe in co-broking. There's a lot of parts in the country where I'll call them up and say, "I have a buyer for the business." And they said, "We won't work with you. We're going to find our own buyer." I think, if you sell a business or two businesses a year, every deal is important. To justify your paycheck, you can't afford to give away half of your money.

Patrick Lange:

My belief is different. If you do enough of them, it's all about getting it done for that customer and finding them a buyer that's qualified as fast as we can. The reality is nationwide, only 20% of businesses listed with a broker who sell. So 80% don't sell. I believe there's a lot of reasons that go into that. Poor pricing I think is the first one. Many people in my profession will meet with somebody, and they'll say, "I want five million." And they'll say, "Okay." And they list it for five million without ever saying, "It's never going to sell at five million."

Patrick Lange:

And so, it sits on the market. Everybody gets mad and everybody goes away, and then the business eventually closes down. So my belief is price it where the market is, and by able to look at comps, comp data. In addition to the state of Florida stuff that we track, I also subscribe to other services that tracks comp data across the country. And so, I'm able to look at what sells. In addition, selling depending on the year 20 heating and air companies a year, and from Florida to California, to New Jersey, to everywhere else, I have my own comp data too.

Patrick Lange:

I know what makes the phone ring. I know what we've sold for. And so, I'm able to use that stuff as well. Once again, as Brandon said, we're here to get it sold. I mean, people don't hire me to get it listed. I can't feed my family with a listing. My business drives on business sales. And so, I tell them when they come to me, "Here's where the market is, and here's what it's been selling for. Here's where I think it is."

Patrick Lange:

Now, the last 12 to 18 months, it's been a little more challenging because the market's been pretty hot. I've seen a lot of private equity, and I shouldn't probably say this publicly, I pay stupid multiples in my opinion. I think when you look at it from an operational standpoint, if you're an operator in the business, and I've been an operator, and I'm around operators all day long. And you see these multiples that people are paying for them, mathematically, it just doesn't make sense.

Patrick Lange:

Obviously, that's Brandon's job to say, "No, we can't lend on that because you're not going to succeed." But when it's investor money, they're able to do different things. Bigger companies, I've sold several companies, quite a few companies, private equity groups that are doing 80 million, 90 million, 300 million dollars in sales. And so, they have a different purchasing power than a traditional operator. Obviously, if you're buying $150 million of equipment a year, you're buying it probably cheaper than I was at a company doing a million dollars a year.

Patrick Lange:

So there's different economies of scale. What you pay for your CRM system with 50 employees or 150 employees is probably different than what I pay for a CRM system. You take those outliers out of the equation, and there's a certain mathematical way that if you will buy a business, this is what you need to operate under. So the last 12, 18 months has made that a little more challenging, but I base it on real data. What's it worth? It's worth what somebody is willing to pay for it. Right now people are willing to pay a little bit more, but I think because of a lot of reasons.

Patrick Lange:

I think we'll start seeing that come back more to reality. I think driving the push has been low interest rates. I'm sure Brandon could talk more. I'm sure his bank has been doing some record number deals the last year or two, low interest rates. The banks have been willing to lend on companies. We've had some good years economically. And so, I think that that can't continue forever, and the private equity push I think can't continue forever.

Patrick Lange:

So, for those looking to get out, I think it's been a great time the last 12 to 18 months. I think it'll continue for a little while longer. My crystal ball works as well as everybody else's does. Who knows how long that'll last for?

Brian Bohannan:

On your four steps, one thing you said was building your business around like service work, and maintenances, and warranties and stuff. Without discussing the warranty work, because we'll save that for that building your valuation podcast, do you see any trends as far as guys... You also said just try to stay away from new construction. Is there a ratio that you're looking at for service versus installs? Is there a way to max the value when looking at service versus installs versus how many maintenance people? Can you speak a little bit on that, why it's good to just have steady service work?

Patrick Lange:

I haven't seen any specific trends. I mean, most companies are relatively in line with one another, what I've seen. I can tell you, companies that are big on... What I have seen personally on maintenance agreements. We'll use that as the first part of the equation. I see companies that make that a major focus of the company. Maintenance agreements, let me be clear, to do a good job for the customer, not from a selling perspective. But to do a good job and take care of the customer system and keep it running and build a better relationship with the customer and have an opportunity to talk about indoor air quality and those types of things, because the reality is in most parts of the country, 4th of July weekend, when it's 98 degrees outside, that technician is not talking about indoor air quality. They're fixing the part, running to the 50th call they've got that week.

Patrick Lange:

So there's not a lot of time well spent in the customer's home. What I have seen, when they focused on that, going back and finding out what the customer's really looking for, and what makes sense for their home and make sense for them. Typically, I have seen that companies with large amounts of maintenance agreements, thousand, 2,000 maintenance agreements, when we've run the reports from their CRM, typically, 90 to 95% of their revenue is coming from those customers.

Patrick Lange:

Their marketing expense is minimal, almost non-existent. I have seen many quality companies shut off their marketing just because they're getting so many calls from those maintenance customers, because that relationship has been built. I think a buyer sees that same thing. So when a buyer comes in and looks at a company with 50 maintenance agreements, versus a company with a thousand or 2,000 maintenance agreements, I can't say that they're going to pay 50 cents extra per customer on the... There's not [inaudible 00:31:50] equation like that.

Patrick Lange:

But what I have found is the numbers are drastically different. If I had to look at valuation, if I look at a company that's doing $3 million in sales, and if I look at one that has no maintenance agreements or almost minimal amounts of maintenance agreements, versus a company that has 1,500 maintenance agreements, I can tell you the profitability on the company with 1,500 maintenance agreements is substantially higher. Their Google reviews are substantially higher. Their employee retention is substantially higher.

Patrick Lange:

So all of those things feed into one another. Sellers will call me and say, "Well, I want to value it based on my maintenance agreement." And I say, "That's not really the way we do it." But you're getting that value, because if you're doing maintenance agreements, you're having a more profitable company, and they're paying a multiple of your net income. So you're getting paid on that for doing that work. Does that make sense?

Brian Bohannan:

Yeah, absolutely. Kind of shocking, actually. You say 80 to 90% of the revenue is coming from those maintenance customers. Are those customers that are tied to-

Patrick Lange:

No, 90% or more.

Brian Bohannan:

90-

Patrick Lange:

I have found, and obviously most CRMs that they use, and I find that many people pay lots of money for CRMs they're not using, and tracking the data. But when they do track the data, if they look at their maintenance customers, and if they've been on a maintenance program for a number of years. Now, if they just sold manage agreements this year, not the case. But if you're three or four years into being serious about a maintenance program, and you look at those customers that have maintenance agreements, look at the revenue generated from them, I have found typically 90% or above.

Brian Bohannan:

Wow.

Tommy Cue:

Wow. Well, that's the best advice you've given for the day. Build your maintenance agreements. I mean, it really is. It's revenue for the future, and it's what somebody wants to pay for. That may not get you to the 15-time multiplier, but it'll help you. Absolutely.

Patrick Lange:

Well, and the reality that I have seen is every company that I've looked at that had large quantities of maintenance agreements, marketing is substantially less. The referrals are substantially higher. The average ticket per customer is substantially higher. They're not bidding against competitors when it comes time for a change out. I mean, all these things, and it all leads to higher sale price because it's a relationship business as opposed to a transaction business at that point. And it leads to a substantially higher payout.

Patrick Lange:

The business is typically built around that. I mean, obviously maintenance agreements, from a business perspective, is a lot of work. I mean, it's not like, "Oh, we're going to maintenance agreements, and everybody pays 179, it's done." It's a lot of work to get with the customers and put the systems in place and making sure your technician is doing a good job out there, and they're not gassing and going. So there's a lot that goes into that. But I have found a business built around that brings a higher revenue because a buyer comes in and is taking over relationships as opposed to transactions.

Tommy Cue:

Do you typically see the business owner staying involved for a length of time after the sale? Is that pretty highly recommended, I would gather?

Patrick Lange:

Shockingly, I don't see it a lot. I advise sellers, typically... I probably shouldn't say this because buyers are going to say, "You shouldn't tell them that." I advise sellers not to agree to a long-term stick-around, because here's the reality. They're going to come in and they're going to change things that you've spent your entire life building. Many of the sellers I work with, been in the trades or have been in the business for 20 or 30 years, it's their baby. Their kids were raised in it.

Patrick Lange:

They started out of their bedroom and they built it up to whatever level it is now. For many of them, they're proud of what they've done, and they've made a lot of mistakes to get there. The new guy or girl's going to come in and change that. They're going to sit there and watch these changes that they've already made the mistake on. Oftentimes, that's not good for the relationship. I sold my first business, which was financial planning company. I took less money in the sale because I sold it to somebody who I knew that knew how I ran my business, took care of my customers.

Patrick Lange:

The first week, he started changing everything I did. And I'm like, "What are you doing? The reason I'm doing the revenue I'm doing is because of what I do." They didn't agree. They changed it. I think there's two components in the sale process. For me, buying and selling businesses, I built a business and sold it, the emotional part's harder than the dollar figure part, I think. I think a business is worth what it's worth. Once you've accepted the fact as a seller of this is what the business is work, it is what it is.

Patrick Lange:

It's the emotional fact of, tomorrow morning, you're not coming into that office anymore. Tomorrow morning, it's not your problem anymore. Tomorrow morning, those customers are not yours anymore. Tomorrow morning, those aren't your employees. And so, they've built relationships and that's a hard thing to walk away from. And to say tomorrow morning, they don't need you anymore. And so, I think making sure that the buyer is the buyer you want is helpful, but they're still going to change things.

Patrick Lange:

And so, I think you need to stick around for a transition, and I don't think sell it to them on Monday and walk out on Tuesday is the answer by any means, because I think you need to be there for the customers. You need to be there for the employees because it's a shock to them, especially long-term employees. We don't tell them typically that it's for sale. It's confidential. And so, for the owner to walk in, that's been the owner for 30 years, and say, "Hey guys and girls, today is my last day. I've sold it," it's emotional.

Patrick Lange:

And so, it's typically better to say, "Hey, as you know, I'm not 19 anymore. It's time for me to move on. I've found a buyer who I think is going to take care of you guys. And I'm going to be here throughout the transition. I'm going to be here working with you. We're all going to be in this together." I think that helps people stay. But typically, at the end of three months, I believe that the seller knows, "Hey, is the buyer and I a good fit for me to still stick around?"

Patrick Lange:

I've had some stick on a sales capacity role or an advisor role. But I know even the SBA, and Brandon can you talk more about that rule. But the SBA has got rules about how long they could stick around. And so, the SBA doesn't want them there long term. Brandon, can you talk about that a little?

Brandon Bolen:

Yeah. The SBA essentially has a rule, and they leave it kind of gray. But they essentially have a rule where they ask for the sellers to be out of the business within 12 months as a key employee. Such interpretation whether it's a key employee or out in general, but generally speaking. Most of the time, when people are looking to sell their business and they're not carrying any equity over, which isn't allowed with an SBA loan, most people are looking to transition for like two to three months where they stick around, they help out, they make sure the employees are happy.

Brandon Bolen:

Sometimes they'll put together a direct mailer and the seller will endorse the new buyer and they send it out to their customers. But the SBA does have a rule that they don't want sellers sticking around past 12 months. But generally speaking, that's not a huge area of contention. Most of the time, the sellers, they're ready to move on to different things and retire, and the buyer likes to have their new business to grow and do as they please.

Tommy Cue:

Got you. All right. Thank you very much.

Brian Bohannan:

I didn't know that. I honestly never heard that. That's interesting. We learn something new every day.

Tommy Cue:

Yeah. Absolutely.

Brian Bohannan:

A couple of indicators for a witness assessing value, clean and clear books, having a lot of good maintenance agreements, good financials. What about red flags? What are some red flags you guys see, that maybe these guys after hearing this could start addressing in their own businesses? I saw a little reaction from you, Brandon. Any red flags that are worthy of discussion?

Brandon Bolen:

It's a funny one, and it's normally not an issue. But I will always check Google reviews. As a bank, we'll check to see what people's reviews are, what they're Better Business Bureau pages look like. Are there a bunch of complaints? Nine times out of 10, there's never an issue because normally by the times the companies have gotten to a million dollars of sales and more, they're employing some type of customer appreciation reviews with people or where...

Brandon Bolen:

I think I just got my air conditioning unit replaced where I got a survey the next day. I'm pretty sure if I had put less than five stars, they would have been on top of it right away. And so, having good reviews indicates all of these extra steps that are in place already to get there. But then, having a bunch of complaints... There's always going to be complaints, people complaining about pricing, which if I see something like that, I ignore it. Like if somebody is like, "Oh, they're too high." I ignore that.

Brandon Bolen:

But if somebody's talking about poor work or stuff like that, you kind of go, "Oh." It doesn't happen often, but it's something that we do as a bank. You'd think it's funny, but we do go type in the businesses, as I have been, and look at. That's one that we'll frequently see, that we do look for.

Brian Bohannan:

What about you, Patrick? Any red flags other than right out of the gate asking for a 15-time multiplier?

Patrick Lange:

Yeah. I always ask lawsuits. I mean, we know what kind of potential risks, typically, if we do an asset sales, that risk is not necessarily going to carry over. But if there's been a problem in the past... Once again, an employee falling down and hurting themselves, it's not a problem. But if there's five customers that are suing because of something unethical, that's not something I want to get involved in because the reality is, for many people buying a company, it's a huge business decision.

Patrick Lange:

They're taking on a huge amount of risk. They're taking on, oftentimes, a huge amount of debt, and I don't want to be involved in that. I mean, that's just from my perspective. Back to the clean books. I talk to so many people that say... I'll talk to them on the phone. I used to jump in the car and go meet with him right away. And so, now I'll talk to them on the phone. They'll say, "Oh, I'm doing $2 million in sales." "Oh, fantastic."

Patrick Lange:

Well, typically, I have found a company that size, net, all in seller discretionary, it's going to be somewhere around 15%. That's going to be combination of their pay, what the company profit is, add-backs, and appreciation, [inaudible 00:42:19]. You know what? I figure they should make around 300. So I'll say, "What's your income level?" "Oh, I'm making 500,000." "Oh, wow. It's fantastic. You're doing real well. That's great." Or 600,000, some crazy figure.

Patrick Lange:

And so, I'll say, "Okay, great. That's fantastic." "You sure?" "Oh yep. Yep." "And so, now, so great. Just send your tax return." "Okay." They'll send me their tax return. They're doing 1.1 million in sales. You do it on the books, it shows they're losing $25,000 a year. I'll call them back up and say, "What happened to 600,000?" "Oh, I did that out in cash." Well, put yourself in a buyer's shoes. If I come to you and say, "Brian, I've got this incredible business for you to buy. They're doing two million in sales. They're making 600,000, but I only can prove that they're losing 25,000. But you should write a check for $2 million."

Patrick Lange:

You're looking at two heads. So you're not going to buy that. So that type of stuff. Once again, you're doing what you can to mitigate your tax expenses, expecting somebody to write you a check for it, it's just not going to happen. And so, that's really where I look at it. I start with the numbers and lawsuits, I always ask about that. And, obviously, I do the same thing as Brandon does. I'm looking at the reviews. If I can't find you anywhere on Google, makes me wonder what's taking place.

Patrick Lange:

I know buyers love businesses with good customer service, and that's what they're buying. And so, if I go on there, you've got 400 five-star Google reviews, then we're heading in the right direction. If I go on there and there's 50 Google reviews that are one and a half stars, I start questioning, what's this business focusing on?

Brian Bohannan:

Okay. Well, guys, I really appreciate you all being on today. I think that's a good stopping point for us. If you're out there listening, make sure you get your books clean and clear, build up those maintenance plans, and stay tuned for the next episode where we're going to talk about how to finance all this stuff. So until then, guys, I appreciate you joining us and we will see you next week.

Patrick Lange:

Thank you very much.

Brandon Bolen:

Thank you all.