The valuation of privately held businesses is sometimes confusing. But fortunately for heating, ventilation and air conditioning – HVAC – businesses, we have valuation formulas that will yield a pretty close approximation of value. In determining how to value an HVAC business, let’s take a look at two valuation formulas.
Two frequently used formulas that professionals use to value an HVAC business involve (1) a percentage of gross annual revenue, and (2) a multiple of discretionary earnings.
First, let’s consider the formula that uses a percentage of gross annual revenue. One widely respected reference source says that HVAC companies are worth somewhere in the range of 35 to 50 percent of annual revenue plus inventory stocked for resale at cost. Where within this range a particular business falls depends on several factors discussed below.
The other formula maintains that HVAC businesses can be valued by using a multiple of yearly discretionary earnings. What are discretionary earnings? The number is sometimes also sometimes referred to as adjusted cash flow.
One easy way to define discretionary earnings is to explain that it is the total financial benefit to the business owner from his/her ownership of the business, regardless of how he/she takes that benefit out of the business. For a more detailed description of the term, take a look at this article.
So with the term defined, let’s again quote a respected industry source which asserts that HVAV businesses are valued at 2 to 3.5 times discretionary earnings plus inventory for resale at cost. This valuation based on a multiple of discretionary earnings is generally considered more accurate than the formula that uses a percentage of revenue. After all, earnings are more important to value than revenue.
The formulas do not include the value of any real estate. Any realty included in the transaction should be added to the final formula result, and as stated above, the cost of any inventory which is on hand for resale should also be added.
So where in the two ranges quoted above would a particular business fall? Listed below are some of the factors to consider:
- Location in a growing area with a strong local economy adds value.
- A clean set of books and tax returns bring value to the company.
- A trend of growing revenue and profits definitely creates value.
- A good staff including a general manager and well-trained technicians adds value.
- Conversely, an overreliance on the owner for management lower value.
- A large number of annual maintenance contracts for recurring revenue adds value.
- A significant portion of income derived from new construction lowers value.
- Higher revenue and profits command higher multiples of discretionary earnings for valuation purposes.
However, an HVAC company, like any business, is worth what a willing seller and a willing buyer, with no undue pressure on either party, are able to agree upon as the market value of the company.
If my firm can assist you with your valuation or transfer of ownership processes, please don’t hesitate to contact me. My office is 251-990-5934 and my email is Will@WilliamBruce.org.
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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership. He currently serves as president of the American Business Brokers Association. His practice includes consulting services nationally on issues of business valuation and transfer. He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.