Michael Richter and Adam Fiedor: Enhancing the value of the MEP business

Many U.S. businesses across a variety of sectors have experienced new challenges over the last year — this is particularly true for those in the mechanical, engineering, and plumbing (MEP) industries. In early 2022, the MEP sector saw labor shortages and supply chain disruptions lead to increased labor and material costs, while later in the year and early into 2023, businesses are experiencing slowing demand for building and renovation. Unsurprisingly, this dynamic has culminated in constantly fluctuating profit margins for many MEP business owners.

Fortunately, strong, profitable and growth-oriented MEP businesses are still in high demand despite fluctuating economic challenges. Buyers are still actively searching for merger and acquisition (M&A) opportunities in the MEP industry. Today’s widespread buyer/acquirer interest presents an opportunity for companies focused on new builds and renovation, within both residential and commercial end markets.

Major private equity acquirers like Crescendo Capital Partners, Monomoy Capital Partners and Gladstone Investment continue to be aggressive in opportunities with residential housing contractors, building products, and maintenance services thanks to an anticipated, prolonged housing shortage (even with elevated interest rates). Gladstone most recently acquired Dema Plumbing, Denver’s largest new construction residential plumbing services contractor, a transaction in which our team served as Dema’s exclusive financial advisor.

At GLC Advisors, our team is observing a more normalized M&A environment in which acquirers, who are holding record amounts of capital, are actively courting quality sellers. MEP businesses ready to grow, planning for an exit or aligning with new partners should prepare for success by understanding the following key characteristics exhibited by MEP sellers experiencing favorable outcomes.

Track record of success and steady profitability

The most important characteristic an acquirer looks for in a successful transaction is a history of consistent, sustainable profit margins. It is critical to showcase a track record of success and consistent growth in all economic environments, and profit margins are more critical than ever before.

Reliable profit margins demonstrate a combination of value differentiation among competitors, leading market share, long-term, quality customer relationships and tech-supported solutions — qualities that are key in economic expansions and persist through recessions. Acquirers prefer strong profitability that provides a high return on capital, weathers a range of obstacles and requires minimal outside capital investments to achieve growth. The GLC Advisors team strongly advises businesses to prepare a defined plan for sustaining profitability and a detailed financial forecast model with scenario analysis that demonstrates outsized profitability.

Tenured staff and management, deep leadership bench, and self-perform capabilities

MEP businesses are human capital intensive, and culture is a central determinant in an acquirer attributing premium pricing to a seller. A deep management team, qualified staff and low turnover translate to minimal new hire cost, leadership continuity and the ability to grow quickly as the business scales. As the saying goes, “A business is only as good as its people.” A staff that demonstrates a track record of being operationally efficient and focused on progress is likely to do so under new leadership post-transaction.

Frequently, business owners overlook the importance of the management team in favor of technical analysis and financial due diligence. A qualified, proficient team is often just as important and creates a profitable, capable and successful business without depending on the owner. Acquirers want to continue scaling the business and will seek a management team that will continue to operate the business post-transaction and under new ownership.

Prior to selling a business, there is immense value in developing a full management team to perform daily operations without the owner. If an owner controls all aspects of the business, an acquirer undertakes more risk if the customers, staff and success are interwoven with that owner.

A fulsome day-to-day management team ensures the company has leadership continuity under new ownership and usually results in a higher valuation for the seller.

Many MEP companies, especially those focused on new construction markets, operate with support from subcontractors. Subcontractor-heavy companies tend to have less control over quality, are less differentiated than competitors, and consequently, produce lower margins. We see more enthusiasm from acquirers when sellers have in-house teams completing on-site work and who have significant self-perform capabilities, all of which drive better quality, differentiated services and higher margins.

Diverse, recurring customers and broad end-market exposure

MEP businesses with recurring and ‘re-occurring’ revenue models and a diverse customer base are viewed more favorably by strategic acquirers, due to the value of a predictable revenue model. Such models typically produce lower downside risk, fewer fluctuations in results, and more accurate forecast models.

Acquirers prefer contracted, recurring customers to one-time project customers. However, one-time projects from repeat customers are also appealing to acquirers as they are considered re-occurring revenue. Recurring and re-occurring revenue from repeat customers are strong predictors of future success.

Additionally, a diversified customer base will significantly increase the value of an MEP business. Reliance on a small number of large customers, or customer concentration, presents risk of significant revenue loss upon losing just one single customer. Today, acquirers are less risk tolerant, mitigating risk in the form of seeking companies with many customers from a variety of end markets. Specifically, if a customer accounts for more than a quarter of company revenue, the impact on value is significant.

A portfolio of end markets that balance out seasonality or year-round end markets are also critical in achieving high valuations and significant acquirer interest. Broadly, cyclical and seasonal markets introduce higher risk, decreasing predictability in revenue forecasts and thus negatively impacting a business’s overall value.

Telling a compelling story with support from an advisory firm

Serial MEP acquirers see many M&A opportunities each year. When taking a business to market, acquirers want to know the company’s central story. Identifying the most attractive opportunities can be difficult, and if a story is not appropriately positioned, an opportunity can get lost in the noise.

Financial advisory firms such as GLC Advisors have a demonstrated ability to bring to light MEP clients’ acquisition highlights to acquirers’ attention that are often overlooked without financial advisory expertise.

For example, our team has supported many sellers in demonstrating valuable attributes in M&A processes that are often overlooked without an advisor, such as:

Substantial customer concentration that demonstrated highly loyal, long-term re-occurring customers;
Higher-than-peer profit margins that were the result of in-house, self-perform teams, and providing ongoing contracted maintenance alongside project-based revenue; and
Strong, long-term profit margins that translated into pricing power, a top regional market share, and differentiation as the only MEP services provider to take on the region’s largest projects.

As MEP leaders consider taking their businesses to market, it is essential to consider the impact many of these drivers will have on the outcome. It is also critical to consider support from a financial advisory firm such as GLC Advisors, who can help sellers achieve the best possible results.