Pantheon keynote speaker John Holsapple shares tips on how to measure business value and staying power in the home services industry.
In the early 2000s, John Holsapple boarded a plane and moved to the other side of the world to live in Beijing, China. He was on an entrepreneurial mission to start a school, but he had a few obstacles.
“I did not speak Chinese, I had no business experience, no college degree, I had never taught before, and—to top it off—I had no money,” Holsapple told a virtual audience as part of ServiceTitan’s Pantheon 2020 of those early days as a business leader. “The deck seemed pretty stacked against me, and I should have failed right then.”
Despite the odds, the business took off but made him miserable. Holsapple describes feeling every day as “it can’t get much worse than this,” but it somehow did.
“Life was pure chaos, because the foundation I had built was completely rotten,” he says. “My workload increased, my stress increased, and not surprisingly, the business completely and spectacularly failed.”
Holsapple, now CEO at Stanley Ruth Air Conditioning Company in New York City, credits that failure with forming his business philosophy: How do I build a business with the right foundation?
Following those years as a scrappy entrepreneur overseas, Holsapple gained experience as an M&A (Mergers and Acquisitions) practitioner who worked in venture capital, private equity, and received an MBA from a top business school. He has reviewed the financials for hundreds of HVAC companies and acquired several A/C companies.
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How do you build a rockstar business?
Put simply, Holsapple defines a rockstar business as one that does not need you, the owner or CEO, to stay alive. That doesn’t mean you shouldn’t work on the business or be a valuable contributor. However, knowing the business can lose its owner and still keep its heartbeat is the best way to evaluate whether your company has staying power and value.
To understand what positions a company to better weather a crisis like Covid-19 or survive another generation, Holsapple explains the framework for how an M&A practitioner would value a home service business, then breaks down the ways you can measure your business’s performance and improve potential value.
“Keep in mind, most businesses do not survive generational transfer,” Holsapple warns. “That could be you.”
Increase your business multiple to drastically improve potential value
In M&A terms, a service company’s business value equals adjusted profit times a multiple, which represents an expected rate of return for an investment. For example, if your adjusted profit totals $1 million and your multiple is four, your business would be valued at $4 million.
The measure most used for adjusted profit is adjusted EBITDA, which stands for earnings before interest, tax, depreciation, and amortization. Many people, like your own accountant, and business valuation tools can help with figuring EBITDA. Holsapple advises business owners to work on increasing their multiple, and here’s why: A typical multiple for a service contractor ranges between two and seven. For a company with $1 million of adjusted EBITDA, the business could be worth $2 million or $7 million.
“That’s a 250 percent difference in value for a company with the same profit,” Holsapple says. “The value of your business is also a great proxy for measuring the strength of your company and the staying power of your business.”
Focus on these five levers within your control, listed in order of importance, to increase the multiple of your business, and therefore the overall value of your company.
1. Revenue quality
Revenue quality gets measured on two fronts: stickiness and growth. According to Holsapple, the best revenue is sticky revenue that’s contractually obligated in the form of recurring payment. For a service company, this usually takes the form of a maintenance contract.
“You’re looking for predictable, recurring, and growing revenue,” Holsapple explains.
Repeating revenue represents the second-best revenue stream, like a customer coming back to replace an old piece of equipment you installed a decade ago. Finally, there’s new installation revenue. While usually considered the lowest quality of revenue sources, Holsapple views it as a necessary evil.
“You need to reframe how you think about new unit installations,” he says. “View the revenue as future recurring and repeating revenue. Track the conversion of that revenue to those recurring and repeating buckets.”
Why is recurring revenue so important? It means you’re building a business on a foundation of customers who are a lot less likely to disappear. It increases predictability, and it also helps you make decisions around fixed costs related to the business.
“When the economy hits the brakes, as it has in recent months, you in essence have an insurance policy to fall back on,” Holsapple says. “When things are good, you can more confidently invest in your business.”
On the second revenue front: Growth.
“This is pretty simple, you want a business to grow,” he says. “Companies that command the highest multiples show a trend of growth.”
Holsapple advises business owners to keep perspective during hard economic times, like with Covid-19 and the 2008 financial crisis, when business may contract.
“Don’t sweat it too much,” he says. “But if you’re not performing consistently better during good times, you’re obviously going to struggle more during bad times, and that’s what you want to try to avoid.”
Takeaways: Think about your revenue from the perspective of how to increase your recurring revenue. Recurring revenue is the single-most-important measure you should be tracking toward your business. If you have a KPI (key performance indicator), get a recurring revenue KPI.
Also, always try to keep growing.
“We’re not talking about double-digit growth, even modest growth is fine,” Holsapple says. “You just want to avoid a business that’s contracting or showing a trend of contraction, which is even worse.”
2. Customer Quality
Closely tied to revenue quality is customer quality. There are three main parameters that dictate quality of customers:
Do they keep coming back? If you convert new customers to contracts, how long do they stay under contract? What else do they buy when under contract?
“You want customers to stick around and to increase the customer lifetime value of each customer,” Holsapple says. “Stop thinking about the dollar you earn today and start thinking more about that present value of the customer you have today.”
He defines “present value” by the types of profit streams a customer brings, in future dollars discounted back to today. For example, if a customer is likely to spend $100 with your company for the next five years for a total of $500, then maybe in today’s dollars that value is closer to something like $300 or $400—not just the money they spend now.
“You’ll need to think through your own methodology for discounting back in today’s dollars,” Holsapple says. “When you’re choosing a project or focusing on an advertising campaign, pick the opportunity with the higher present value and not the literal cash value today. Present value and customer lifetime value are extremely important.”
Do they prioritize quality over cost? Are they bargain shopping? Did they call 20 different people today to get the lowest dollar value possible for an HVAC system?
Also ask yourself: Are you the highest-priced provider in your space, or the lowest in the area? Aim to be a higher-priced, higher-quality provider.
Customers who discriminate based off of quality rather than price are less likely to switch to your competitors, and will stay with your company if you continue to provide reliable service.
“This customer will allow you to make more money off fewer folks. You also have a better experience and so will your customer,” he says. “Your profit margins will be higher, you will work less, have more resources to deliver, and will likely feel better about the end result.”
How much of your revenue is tied to your top customers? Do your top 10 customers represent more than 10 percent of revenue? If so, losing a few customers can lead to significant revenue decline.
“It’s definitely better to have a lot of customers,” Holsapple says. “Because if you have few customers, they have significant control over you and that translates into stress and lower margins. Focus on getting thousands of recurring and repeating customers.”
He points out that if your service company has a certain fixed-cost structure associated with serving customers, you could actually lose your business if you lose a couple of those key clients tied to significant revenue.
Think about whether or not you can afford a large customer. As a rule of thumb at Stanley Ruth, they don’t take on projects or customers who will account for more than 10 percent of their revenue.
“As you might imagine, there’s a lot of that opportunity sitting here in New York City,” he quips. “If you look for a high number of customers with high customer lifetime value, you’re going to be better off for it.”
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3. Financial quality
You need numbers you can trust. Those numbers should have robust, underlying processes, and sign-off from an accountant. Holsapple says this is where most HVAC and other service companies make the biggest mistake, which “comes at a tremendous cost.”
Audited financials represent the gold standard with third-party verification by CPAs, but are difficult to achieve and require solid systems and processes. Holsapple recommends getting reviewed financials instead, which still require some tasks completed by CPAs to verify numbers.
“Reviewed financials offer a much better bang-for-your-buck, but even that’s difficult to get,” he says. “What you really just want to get are financials that are not self-prepared, but are prepared by an accountant with some sign-off by an accountant.”
Financials that cause problems
Often, problems with the financials indicate underlying business problems and a reactive approach to handling issues. Proactive businesses prove more valuable with more staying power.
With poor financials, you might even be reacting to a tax audit, Holsapple explains, “but the IRS might be the least of your problems.”
Financial reports should track recurring and repeating income, and new installations. When preparing financials, make sure you’re also tracking the right types of expense categories and revenue categories, so you can monitor and improve your business growth.
Takeaways: Financials are very important, and Holsapple recommends getting reviewed financials. That effort will naturally force better accounting processes to track and measure the performance of your business.
“While verified financials show the kind of enterprise you’re running, a strong leadership team shows the kind of company you are building,” Holsapple says.
Holsapple describes the worst type of business as owner-managed, meaning the owner makes all of the day-to-day decisions, serves as their lead salesman, or manages 10 or more direct reports.
“You need a great hired gun at your company,” he advises. “The owner should be focused more on that long-term strategy.”
Companies with strong middle management and a hired CEO or GM exhibit well-defined, documented, and robust processes. Also, businesses with a history of hiring a CEO and managers are more likely to successfully repeat that process if something happens to a business leader.
“Remember, every business transfers, every business may also close,” Holsapple says. “Work to replace yourself. You'll be better for it, and so will your staff.”
5. Your engine
Holsapple describes the metaphorical engine that powers your business: your team and the systems they use to do their jobs.
“To exhaust the engine metaphor, you can have ample high-quality gas—that’s your revenue and your customers,” he says. “You can have an accurate and thorough speedometer and odometer, which I view as your financials and KPI; and a great driver—your management team, your middle managers—but it really doesn’t mean a thing unless you have a great engine.”
Before adding ServiceTitan field management software at Stanley Ruth, Holsapple spent hours each day looking for customers’ paper folders to get more information on the client and current job.
“It was so frustrating,” he recalls. “Was the folder in the filing cabinet, in the service department, on someone’s desk, in the shop…does this file even exist? Are they an important client? When was the last time we were there? Did we bill them for the last visit? What were we doing during that last visit?”
An enormous stack of paperwork for each client represented less than a quarter of a percent of the company’s revenue. The office housed roughly 5,000 square feet of filing cabinets for the business.
“This isn’t the way to do things today—it was the way to do things, but it’s not anymore,” Holsapple says.
Look for systems and processes that are:
Anyone who looks at your customer records should easily find answers to certain questions:
How long does it take to understand a complex installation? What have we done there recently? What are we going to do there? Who’s engaged in the process? What is our communication history? What is the contract, invoice, payment and equipment history?
If it takes you a long time to get those answers, Holsapple encourages you to rethink how the company organizes data.
Your files should give you insightful, actionable information. Is the job profitable? Is the client important? What products should we be selling? How do we increase our performance? How do we increase our profit? What is the customer’s lifetime value?
Examine the scalable portion of your systems. What are the bottlenecks that will stop you along the way? What is the maximum capacity of those bottlenecks? Does this process rely on one person? Will the process fail at 10-, 20-, 50-percent growth?
Your business system and processes must be well-documented. Can a new hire follow documented directions to perform most of the core functions in the organization? For roles that require significant experience, can someone be trained for that job within the company. If so, how many months does it take?
Other specific examples of documentation to consider: What processes do you use for preparing an invoice or contract, offering a new contract, and tracking and following up with sales leads?
How quickly can you invoice a job, generate a contract, offer maintenance services, return to do an installation, hire staff, find customer information, or track a customer’s issue?
“These are all really key areas, because long-term, efficiency is the thing that can really allow you to differentiate against your competitors,” Holsapple says. “If you invest at the right stage of your business and can achieve better margins for the same work, you can out-compete your competitors—while providing a better experience along the way.”
Holsapple suggests picking examples in each of the above areas that are most meaningful to your company, and look for incremental improvement. At Stanley Ruth, they aim for two-week timelines for most changes. While not all changes happen that fast, think of it as a sprint to accomplish the short-term goal, which can be part of a bigger picture.
“Try to determine a baseline for today and the performance of your company, and set achievable goals,” Holsapple says. “Don’t reach for the stars. Shoot instead for changes you can make on short timelines. You don’t want a sea of change at your business overnight, you want that incremental improvement.”
How ServiceTitan helps Stanley Ruth hit revenue goals
Holsapple credits ServiceTitan with introducing the efficiency and data tracking necessary to achieve the company’s overall goals.
“I swear, ServiceTitan doesn’t pay me—we pay them actually,” he says. “ServiceTitan is unequivocally the best contractor software out there.”
He recommends fellow clients use ServiceTitan’s Titan Score to measure business progress on systems and processes. Beyond the Titan Score, Holsapple says key performance indicators (KPI) tracked by the integrated system also give a reliable indication of business performance.
Important aspects to consider when it comes to key performance indicators:
First and foremost, track KPI.
Don’t try to track too many KPI.
Focus on the mastery of one before you move onto the next.
Cash flow is a pretty good one to start with, so are contract sales.
“Do you track KPI? What KPI do you track? Make sure you’re tracking at least a few,” Holsapple says. “Avoid the noise, don’t look at too many indicators right out of the gate. Master comprehension of one, then slowly add more to your bucket.”
Holsapple believes cash flow is the best key indicator to track at first. He ranks contract sales a close second for tracking KPI. Once you add to your KPI list, also think about a few other key factors, like frequency—how often are these key indicators updated, and how often are you checking (daily, weekly, or monthly)?
Other questions to ask: What’s the quality of those KPIs? How reliable is the underlying data? Do you have a system for tracking and verifying reliability?
“Think about it like an install in the field. You wouldn’t just do an installation without having some quality-check process,” Holsapple says. “In this case, it’s a lot more important because you’re going to be making tons of management decisions based on those KPI. If they’re misleading you, you might be leading the business down the wrong path.”
When staffing your team, you look for experienced, positive, well-trained, long-term, technologically savvy, competent staff. Should be really easy, right?
Holsapple knows it’s a tall task. His high-level advice? Pick some qualitative and quantitative areas to measure performance of your staff and aim for incremental improvement. For the engine to operate optimally, there’s no magic number or measure to achieve.
The goal is simple: Incremental progress.
“Eventually this change will lead to significant change,” Holsapple says. “I don’t suggest trying to change everything overnight. I’m a big believer in that incremental progress.”
Takeaways: Many businesses become fixated on profit expansion, and while Holsapple doesn’t discount that important goal, start to think more about expanding your multiple.
Tips for achieving a higher multiple for your business
Think about your revenue from the perspective of how to increase your recurring revenue. It’s the single-most-important thing to track.
Always keep growing. Even if that growth is modest, you need to show a trend of progress and avoid a decrease in revenue.
Think about high-end customers who favor quality over price, and think about customers from the perspective of lifetime value. Look for a large number of high-end customers with high customer lifetime values.
Get reviewed financials. It will force the development of better accounting and systems, and your business’s performance will be better tracked.
Remember, every business either transfers or closes. Work to replace yourself. Your business will be better for it.
Create comprehensible, insightful, scalable, documented, and efficient systems and processes.
Track KPI, but focus on mastery of one KPI first.
For your team, pick some quantitative and qualitative areas to measure performance. Look for incremental improvement.
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