Why High Profit Margin HVAC Businesses May Not Command The Highest Valuation

In the HVAC industry, it’s not uncommon to encounter businesses boasting incredibly high net income margins, sometimes in the realm of 30-50%. Owners of these businesses are often proud of these figures and expect that such profitability will translate into a higher equity multiple, thereby increasing the listing value of their business. However, the reality is quite different—these extremely high margins often signal underlying issues that can actually hinder the business’s valuation.

Let’s break down the issues characteristic of high margin HVAC businesses that hinder valuation.

1. Overburdened and Underpaid Employees

One of the most common issues found in high-margin HVAC businesses is the underpayment or overburdening of employees. In many cases, the seller is wearing multiple hats within the business, effectively not paying themselves or others market-rate salaries. This issue often extends to family members or spouses who are involved in the business. This approach can artificially inflate the profit margins, but it also indicates a business that is not sustainable under new ownership.

2. Unsustainable Market Advantages

High margins may also be the result of an unsustainable competitive advantage, such as operating in a market with little to no competition or benefiting from ‘golf buddy’ style deals where clients are paying above-market rates—a scenario unlikely to persist under new ownership. These factors create a facade of profitability that may not hold up once a new owner steps in.

3. Deferred Capital Expenditures

Another red flag in high-margin HVAC businesses is the lack of proper maintenance and capital expenditures. Sellers can temporarily boost profits by skimping on the upkeep of vehicles, equipment, and other essential assets, leaving the buyer to bear these costs down the line. Savvy buyers are increasingly aware of this tactic, and it can significantly impact their valuation of the business.

The Healthy Margin Range for HVAC Businesses

It’s very rare to find a healthy, stable HVAC business operating at more than a 25% margin. The optimal range for net income margin in this industry is typically between 10-25%, with 10% being on the lower end. The businesses that command the highest multiples are those operating in the 20-25% margin range, where employees are properly compensated, equipment is well-maintained, and the business is thriving in a competitive market.

About the author

You may also like