The mechanical trades are primarily an industry of owners/managers and most of them have a trade background. Oftentimes, the focus ends up being on running the day-to-day operations of the business. Few, in my experience, have a business background. The greatest strengths of these owners/managers are their technical knowledge. Many have good management skills and, unfortunately, many don’t have good people skills.
In Canada, as of 2021, there was a total of 15,039 companies within the plumbing and HVAC/R industries, according to Statistics Canada.
Ninety-six per cent of these contractors have fewer than 50 employees. Smaller businesses do make up the bulk of these companies, with 55 per cent having no more than four employees and another 22 per cent with five to nine employees. That means that 77 per cent of the industry is operated by very small companies. By my calculations, that means that with very few exceptions, all these companies are doing less than $2 million in annual sales.
From 1997 to 2019, I completed an annual financial analysis of HVAC contractors, sponsored by the Heating, Refrigeration, and Air Conditioning Institute of Canada (HRAI). I found that 25 per cent lost money, 25 per cent made somewhere between zero and five per cent profit, 25 per cent made between five and 10 per cent, and the top 25 per cent made over 10 per cent, with several recording more than 20 per cent operating profit on a fairly regular basis.
In recent years, I have become increasingly involved in helping owners exit their businesses. Some had great success, and some really struggled to either sell their business or pass it on to employees or family members.
Uncertain times
There is also a large risk in selling the business to employees as they tend to have little available cash and the owner ends up carrying most of the selling price.
The ones that had the most success in selling are those with 10 to 19 employees. When you take the owner out of the picture with the smaller contractors, there is a major vacuum in leadership and management.
The uncertainties created by the impact of COVID-19 have made it very difficult to define a fair market value for businesses. If you can wait two to three years before selling your business, you will likely get better value for it. However, this means working on the business rather than spending all your time working in the business.
We will break this topic down into several parts. The first is to remember that you are in the business of making money, not in the business of plumbing or HVAC/R. The conduit is our plumbing and HVAC/R business and the expertise that comes with it. Additionally, you need to know the ideal size for your business and how to maximize the benefits of the size that works for you. Finally, there needs to be an exit plan.
Valuing your business
We will explore succession strategies and how to value your business. Fewer than 40 per cent of listed businesses sell and there needs to be a plan in place to prepare the business selling and getting the best return on it.
It is a particularly valuable trait of the owner/manager of a smaller contracting company to focus on day-to-day operations instead of focusing on the bottom line. This should be done for the long term and not just for the year.
Your goal should be to prepare the company so that you can sell it for the highest price and enjoy your retirement without financial worries. This means fighting your Canadian roots of being nice, and focusing on being realistic.
Most contractors could easily increase their charge-out rates by $10 per hour without losing any, or, at the very most, very few customers. Key customers will still be there. For 2023, the lifetime capital gains exemption for selling the shares of a small business is $972,190. Double that if the business is owned by you and your spouse or other partner. Would it be nice to have all that tax-free money?
When determining the ideal size of a business, ask yourself “how much more work can you do without adding overhead?” If adding one more technician.
When contractors ask me what the ideal size for their business is, I ask them how much more work could you do without adding overhead? If you could add one more technician and do around an additional $300,000 in billings, then do it. However, if you must add another manager, don’t. If you are at capacity and can’t take on any more work, you have the option of increasing your prices. Do less for more.
It’s complicated
If sales are under $1 million annually, it is very difficult to make money. You have a job, not a business. If sales are from $1 million to $3 million, the business can run effectively with one good manager. If sales are over $3 million and you start to drop the ball and need another manager, this will likely mean that until the business earns over $4 million, there won’t be any addition profit.
Likely, the profit would go down due to the additional overhead. These are broad guidelines based on experience with plumbing and HVAC/R contractors.
At the end of the day, you have three choices. Sell to a third party, sell to family or employees, or close down the business. Selling to a third party is the best option as it carries the least risk, has the fastest payout, and is likely the better price. Your buyer is most likely someone in a complimentary trade or a competitor who would gain from the synergies of combining the two businesses.
A family member or employee likely would have less capital, so you will have the risk of carrying the financing. Winding the business down can be expensive and it takes time to wind down, with little or no income. Ongoing overhead also eats into your retirement nest egg. It’s okay to love your business, but your business won’t love you back. Visualize your retirement and plan for it.