Written on: June 3, 2024 by Jeffrey Simpson
Winter is behind us, and conference season is upon us. The conversations around the industry naturally include the current challenges, new products and technology, the lack of Winter weather and other standard fare. However, those discussions will inevitably turn to juicier topics: who is buying, who is selling and the “multiples” that the lucky owners were able to secure. Whether you’re thinking of exiting in the near term, considering acquiring a neighboring company or simply looking to continue to grow your fuel and HVAC business and improve your profitability, you’ll benefit from a deeper understanding of how companies are valued and where the magic of the multiple really resides.
To be precise, the multiple that we so often hear about is a financial ratio that compares the imputed enterprise value of a business to its annual cash flow measured as Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA). Business owners often try their best to benchmark their company’s value based on the gossip they hear around the industry, regardless of whether the information is solid or not.
While the chatter about multiples may seem like a solid measuring stick—after all, the fuel industry is a small one with a high degree of trust, even among competitors—the reality is that this gossip often misses so much of what matters most. “Soft” factors, such as company characteristics, seller preferences and buyer desires, can play an enormous role in the enterprise value calculation. This information is usually completely hidden from industry players who try to compare companies that seem similar on the surface.
Getting to a “Good” Multiple
From a buyer’s perspective, arriving at the right multiple is equal parts art and science. Adding to the complexity is the fact that the merger and acquisition environment can materially change in short periods because of variables completely unrelated to a company’s quantitative and qualitative characteristics. Macroeconomic factors, the banking environment, buyer activity in a specific market and the desirability of certain business lines can shift—sometimes very quickly—and have a direct impact on the ultimate enterprise value of a business.
As a business owner and potential seller in the near term or down the road, you can drive yourself crazy if you focus on trying to time the market to be perfect. Instead, you can increase the likelihood of optimal outcomes by focusing on the variables you can control and improve the value of the business to achieve the desired multiple when you eventually reach the point of sale.
Like stacking straws on the back of a camel, value growth—and therefore multiple maximization—is a steady, long-term process. Achieving a more profitable company for you and a more attractive company for prospective buyers involves consistently embracing more difficult, but valuable, revenue opportunities, such as increasing automatic customers, improving install margins on equipment and selling on value rather than price. Conversely, selling on price, limiting service support or avoiding repeatable revenue offerings will achieve the opposite.
What Else Drives the Multiple Calculation?
There are several factors that also contribute to determining the multiple.
Size: Larger companies tend to garner higher multiples because there is more room to absorb operational bumps over time. Larger companies have less “key person” risk, more robust management teams, a large built-in base of customers and the ability to efficiently leverage opportunities for profitability and expansion. As a company’s EBITDA moves above the $3 million mark, it will attract a wider array of deep-pocketed financial and strategic suitors. For this reason, savvy owners will regularly seek quality tuck-in acquisitions and grow new business lines to reach this threshold in pursuit of an eventual sale.
Product Mix: Over the past decade, the kings of the multiple in the delivered fuels and HVAC industries have been propane companies. The buyer pool consists of not only cross-town rivals but also financial buyers and large national consolidators backed by robust pools of private equity. High single-digit multiples are common for quality propane companies. Heating oil has been more of a mixed bag, attracting a different pool of buyers. This includes some larger consolidators and financial buyers, but, more often than not, it is limited to regional competitors. The heating oil industry is highly fragmented, and much of the industry carries earnings levels that are below the $3 million EBITDA threshold. Typically, heating oil company multiples are just half (sometimes less) of what propane companies command. Conversely, HVAC businesses have attracted a much wider range of multiples and financial buyers since the COVID-19 pandemic. Well-run, high-margin HVAC companies generating several million dollars in annual EBITDA are garnering high single-digit or even double-digit multiples.
Qualitative Factors: These key data points can be where multiples expand substantially (or erode completely). Strong gross margins and modern equipment are really just the starting point and a basic expectation for today’s buyers. It’s in the next level of company performance where the wheat is separated from the chaff.
For example, propane companies with high tank control (i.e., customer-leased tanks), high rates of automatic delivery, prevalent use of new technology to achieve efficiencies and ample storage can attract a host of suitors ready to reward that business for its strength and performance. Heating oil distributors with high automatic delivery rates, a profitable and sizeable HVAC division and high rates of budget plan customers command better value in a sale. Cash-on-delivery and will-call heating oil businesses, even longstanding ones, tend to attract an extremely limited set of potential buyers with low multiples to match.
Deal Structure: While the default desire of sellers is frequently to receive 100% cash at close, flexibility in deal structure can ultimately lead to a higher multiple. As the banking environment remains tight and interest rates linger at their highest levels in years, financing avenues for buyers have tightened, as well. A seller’s willingness to finance a portion of a sale via a seller note or earnout structure shows faith in the business and can push the multiple higher. For sellers negotiating with financial buyers instead of strategic buyers, equity roll-forward arrangements where the seller agrees to reinvest a portion of its ownership stake along with the buyer post-sale can result in both a higher assigned enterprise value and an opportunity for a seller to receive a significant “second bite of the apple” down the road as the company’s value continues to grow.
Business leaders who focus on building value in their businesses will always position themselves to maximize their multiple whenever they decide the time is right to exit or recapitalize. Even though you shouldn’t put too much stock in all the gossip about multiples you’ll hear around the industry and its events, we look forward to joining in the discussion with you in the months to come. ICM
Jeff Simpson is the Founder and managing member of Notch Capital, a private investment firm specializing in buyouts and recapitalizations of lower middle market businesses in the heating, cooling and home services industries. Notch Capital also provides advisory services to help these businesses strengthen their performance and analyze acquisitions.
