Acquiring Minds: Bullseye – Buying a $1M SDE Business in a Hot Industry

Release Date: January 9, 2025

Podcast Information:

• Title: Acquiring Minds
• Host: Will Smith
• Description: Buying a business is an amazing path for many successful entrepreneurs. Learn how to buy a business from the entrepreneurs who have already done it. Episodes are released twice a week, featuring stories, insights, and valuable advice about acquisition entrepreneurship. Hosted by Will Smith, who is on his own path to acquire a business.
• YouTube: Acquiring Minds on YouTube
• Episode Summary Sign-Up: acquiringminds.co

Introduction

In the episode titled "Bullseye: Buying a $1M SDE Business in a Hot Industry," host Will Smith engages in an in-depth conversation with Pete Cavarella, the owner of Sharon's Heating and Air Conditioning. Pete shares his journey of acquiring a sizeable HVAC business with over $1 million in Seller's Discretionary Earnings (SDE) using a combination of proprietary search tactics and buy-side advisory services.

Background of Pete Cavarella

Pete Cavarella hails from Ferndale, Michigan, a suburb of Detroit. He holds a degree in Industrial and Operations Engineering and an MBA from the University of Michigan. Pete's early career involved working as a database programmer for Urban Science in Frankfurt, Germany, followed by a five-year stint as a management consultant at KPMG, focusing on IT and back-office functions.

Pete Cavarella [05:02]: "After I wrapped up there I moved back to the US and went and did my MBA also at the University of Michigan...ended up finding and acquiring Sharon's Heating and Air Conditioning, which is an HVAC contractor in the Metro Detroit area."

Transition from Consulting to Business Ownership

Driven by a desire for autonomy and influenced by family members who owned small businesses, Pete decided to pivot from consulting to becoming a business owner. His experiences caddying at a country club exposed him to numerous small business owners, fostering his entrepreneurial spirit. A pivotal moment came when a friend introduced him to the concept of search funds, aligning with his preference for owning and controlling a business without the uncertainties of a startup.

Pete Cavarella [06:24]: "I just wanted to own a small business... I had some family members that were in that realm... and I had never had the type of passion or expertise or skill set to really feel comfortable betting on a startup."

Search Strategy: Proprietary Outreach and Buy-Side Advisory

Pete adopted a "spray and pray" approach to his search, remaining agnostic about industries and focusing geographically within Michigan to stay close to family. He leveraged both proprietary outreach (cold emailing) and engaged a buy-side advisor, Calder Capital, to maximize his deal flow.

Pete Cavarella [13:54]: "They are a whole another team working on your behalf bringing you deals... it's worth throwing in a little bit of money to bring us as many hits as we could get."

Despite utilizing Calder Capital, Pete ultimately found Sharon's Heating and Air Conditioning through his own cold outreach, demonstrating the effectiveness of proprietary search when combined with advisory support.

Pete Cavarella [28:48]: "It was purely through cold outreach...it was purely through cold outreach and it was just good timing."

Deal Acquisition: Finding and Structuring the Purchase

Pete's acquisition of Sharon's Heating and Air Conditioning was marked by significant leverage and strategic structuring. The business, with approximately $12 million in annual revenue and $1.1 million in EBITDA, was acquired for $4.3 million—a multiple of roughly 4x EBITDA. The deal was financed as follows:

• 85% SBA 7A Loan: Facilitated by Live Oak Bank, leveraging Pete's favorable debt coverage ratios.
• 10% Seller Note: A standard promissory note to the seller.
• 5% Seller Standby Note: A deferred payment obligation accruing interest but not requiring immediate cash outflow.
• 5% Equity: Provided by Pete from personal savings, representing about 10% of the total equity needed.

Pete Cavarella [35:11]: "We leveraged this whole thing... 85% SBA 7A loan, 10% seller note, and then the remaining 5% was equity from some cash at close."

Transition and Ownership

Post-acquisition, the transition was smooth, with the former owner, Sharon, and her children staying on to facilitate the handover. Sharon remained with the company for two and a half months, while her son stayed for a year and a half, providing valuable insights and helping stabilize operations during the critical post-acquisition phase.

Pete Cavarella [62:21]: "Sharon stayed on board for about two and a half months before transitioning out... her son stayed on for about a year and a half... was a really good guy, provided all types of valuable insights."

Shifting the Revenue Mix: Residential vs. Commercial

One of Pete's strategic moves was altering the company's revenue mix from 50% residential and 50% commercial to approximately 65% residential and 35% commercial. This shift aimed to leverage the higher profit margins associated with residential HVAC services while maintaining commercial contracts to mitigate seasonal fluctuations.

Pete Cavarella [72:57]: "When I bought the business we were split about 50% residential to commercial construction work. And we're now, this year we're probably going to be somewhere... around 65% residential to 35% commercial construction."

This strategic realignment resulted in substantial EBITDA growth from $1.06 million to an anticipated $1.6 million. The residential side's consistent performance provided a robust foundation for sustainable growth, while the commercial segment offered stability during off-peak seasons.

Pete Cavarella [75:18]: "Our revenue is basically our top line has remained stagnant for almost three years, but our bottom line has been growing by a healthy margin by shifting this business."

Private Equity Interest and Industry Dynamics

Despite acquiring the business in 2021, prior to the HVAC industry's surge in private equity interest, Pete now experiences significant outreach from investment firms seeking to capitalize on the industry's robust performance. However, the presence of commercial revenue poses challenges, as many private equity firms prefer a pure residential focus due to higher margins and predictability.

Pete Cavarella [82:43]: "It seems like there's a new person every week almost... but I think generally speaking, it seems like it's actually not only not helping, it might even be hurting a little bit."

Pete notes that while the commercial segment provides operational benefits, it complicates valuations and attractiveness to PE buyers who favor highly residential-centric businesses.

Pete Cavarella [78:57]: "I view it as kind of a differentiator... Even if they wanted nothing to do with the commercial, there will be people interested in it."

Managing High Leverage and Cash Flow

Acquiring a large, leveraged business as a first-time searcher comes with significant challenges. Pete emphasizes the importance of maintaining healthy debt service coverage ratios to ensure financial stability. Despite the high leverage, Pete has managed effective cash flow management, leveraging the SBA loan's terms and maintaining operational efficiency to avoid major financial scares.

Pete Cavarella [97:58]: "I certainly would not have liked to have used that much leverage... but I felt like Live Oak was comfortable with it."

While heavily leveraged, Pete's strategic shifts and operational improvements have allowed him to navigate financial obligations successfully, keeping debt service from becoming a persistent stressor.

Challenges and Insights

Pete candidly discusses the inherent difficulties in acquisition entrepreneurship, including the constant balancing act between strategic growth and daily operational demands. He highlights the emotional and psychological hurdles, such as moments of doubt and the relentless nature of managing a sizable workforce.

Pete Cavarella [107:07]: "It's been exceedingly difficult... it's contrary to how some people might think it's not been a cakewalk."

Pete's experience underscores the importance of resilience, strategic planning, and leveraging industry-specific knowledge to overcome the myriad challenges that come with acquiring and operating a large HVAC business.

Future Plans and Exit Strategy

With the HVAC industry being a magnet for private equity, Pete remains open to potential exit opportunities, although he does not have a concrete timeline. Balancing immediate operational responsibilities with long-term strategic considerations is a priority as he navigates the growing interest in his business.

Pete Cavarella [109:54]: "Keeping my options open... I do think about that, and you can't help but explore it a little bit."

Conclusion

Pete Cavarella's journey exemplifies the complexities and rewards of acquisition entrepreneurship within the HVAC industry. From leveraging proprietary search tactics and strategic deal structuring to navigating private equity interest and managing a highly leveraged business, Pete provides invaluable insights for aspiring business owners. His story highlights the critical balance between strategic growth and operational management, offering a realistic portrayal of the challenges and triumphs inherent in buying and scaling a successful business.

Pete Cavarella [112:46]: "It's not a get rich quick scheme by any means. It takes some time and a fair amount of stress that goes along with it."

Key Takeaways:

• Strategic Search: Combining proprietary outreach with buy-side advisors can maximize deal flow.
• Deal Structuring: Leveraging SBA loans and seller notes can enable the acquisition of sizeable businesses with minimal personal capital.
• Revenue Mix Optimization: Shifting towards higher-margin residential services enhances profitability while maintaining commercial contracts for stability.
• Private Equity Dynamics: Understanding PE preferences is crucial for future exit strategies.
• Operational Resilience: Managing a highly leveraged business requires diligent cash flow management and strategic planning.
• Entrepreneurial Realism: Acquisition entrepreneurship involves significant challenges and is not a shortcut to wealth.

Connect with Pete Cavarella: For those interested in acquisition entrepreneurship or considering buying a business, Pete Cavarella is open to discussions and offers valuable insights based on his experience. You can reach out to Pete via LinkedIn to connect and set up a conversation.

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