Interest rates ebb and flow. But today, they seem to be doing more flying then flowing. Rising interest rates affect material, equipment, and loan prices. When it comes to acquisitions, rising interest rates could affect a buyer’s ability to acquire.

“Interest rates, at the very least, indirectly impact the market because they impact the demand drivers that ultimately relate to purchases of HVAC equipment or installation,” said Ted Polk, managing director and co-head of Capstone Partners’ industrials group.

However, they might not necessarily impact a seller’s decision to sell. Other factors, in addition to interest rates, play a role in the increasing number of acquisitions in the HVAC industry and can help entice an owner to buy or sell.

Interest Rates and Acquisitions

Lower interest rates mean cheaper prices across the board; when they rise, it means higher prices. This includes loan prices.

“You may have enough cash to cover 10% of the purchase price, but then you would have to go and find different lenders to loan you money. And if so, that would be based on how quickly you are able to pay those loans back,” said Peter Flippen, managing partner at IEI Advisors.

When loans are more expensive, generally a buyer would pay less for a business in order to make the returns happen in the necessary timeframe, Flippen said.

The price for debt goes up, but the price of the business goes down.

Polk mentioned the Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) method to measure profits.

“In the past few years there's been a lot of acquisition activity, because the lending institutions have been aggressive in providing debt at attractive multiples of EBITDA to support the transactions.”

Brandon Bolen, head of service contractor lending at Live Oak Bank, said interest rates can often impact the buyer or seller’s decision. Since an environment with rising interest rates ultimately causes an increase in a buyer’s cost when acquiring a business, it could impact the valuation at which they apply to buy a business.

“It might impact their ability to pay a certain type of multiple for the business or what they are willing to do,” he said.

Rising interest rates can also impact negotiations between the buyer and the seller, as both parties may have expectations on what they’ll profit from the acquisition, which is impacted by cost increases.

Other Factors

Another factor attributed to the uptick in acquisitions is the growing awareness of the necessity of the HVAC industry, specifically in the residential market. Homeowners will need to get their a/c units fixed no matter the economy. Private equity firms have gotten more and more involved with the HVAC industry through leveraged buyouts because it’s not only recession resilient, but generates an attractive amount of cash flow, said Polk.

Bolen sees a lot of small businesses choosing to grow their businesses via acquisitions. Many business owners within the HVAC space are reaching retirement age and looking to transition their business to the next set of owners.

Flippen said the uptick in HVAC acquisitions is a classic one: Investors are looking to take a very fragmented industry made up of small businesses and put them together to create economies of scale. And when one person succeeds, others follow. It’s a sort of copycat phenomenon.

Today’s approach is a bit more sensitive than the acquisitions in the ‘90s. If businesses do change, they often change slowly over time.

“And they are really trying to keep ownership and management invested in both the local business and the success of the larger consolidator,” Flippen said.

Deciding on Acquisition

When it comes to deciding on an acquisition, it really comes down to the owner of the business, or whoever is controlling the company.

Along with the aforementioned “retirement age,” another factor that may entice someone to buy or sell is they may have reached a point where they feel they’ve really saturated the current market and an acquisition is the only way to grow. Acquisitions are also an option when a business only wants to sell part of its shares.

“So if an owner sells … say 70% of the shares and partners with a capital provider, like a private equity firm, then that capital is there to make acquisitions and they can expand at the rate that owner wants to,” Flippen said.

Bolen said in his experience, a lot of owners in the heating and air space don’t realize there are banks out there that finance acquisitions helping existing owners expand.

“For some it’s a matter of, ‘We need to continue to grow or we need to sell out.’ So, do they know all the avenues of which they can use to grow their business?”

For a lot of HVAC companies, the right opportunity to buy is purely opportunistic, Flippen said. It’s hard for a smaller business to buy up other companies. So, HVAC companies can look for an opportunity to partner with someone in an adjacent field — like plumbing. It’s about finding the right fit and relationships for what the contractor is trying to do.

“If you're growing as a contractor and making a lot of money, that's another time to potentially see that capital you're accumulating as an opportunity to make acquisitions,” Flippen said.

An owner may also choose to acquire another business in order to make their business more attractive by expanding their services, Polk said.

Another tip-off as to whether or not a company should look to be acquired is if the owner’s phone is ringing off the hook with calls from buyers.

What’s to Come

Right now, there’s really no end in sight when it comes to acquisitions in the HVAC industry. The capital and interest is certainly out there. As long as owners keep wanting to sell, acquisitions will keep happening, no matter the interest rates.

Flippen sees a lot of add-on acquisitions happening: one firm buying a business, growing it in revenue for a few years, and then selling it to another private equity firm.

“The shift to more energy-efficient equipment creates stability for the demand of these types of products,” Polk said.

Acquisitions provide an opportunity for innovation within the HVAC industry and for partnerships and for businesses to grow together, Flippen said.

With small business acquisitions, a lot of times that looks like a succession plan. These aren’t large multimillion dollar deals. It’s your average HVAC business owner selling to their longtime manager or a family member, Bolen said.

“A lot of their net worth is in the value of the business. And having that next generation of buyers in the industry is really important … to at least have [acquisitions] as a way to transition a business, and get the value that the sellers created. And then the next generation takes over and is able to continue their legacy.”