Unlocking Private Equity Opportunities In The Facility Services Sector – Corporate and Company Law

Companies in the Facility Services sector — such as
janitorial, HVAC, alarm security, fire protection and window
washing companies, among others — represent a highly
attractive target for private equity (PE) investors for several
reasons. These companies usually have recurring revenue streams
with long contract terms and contracts that renew automatically.
Some services also provide a relatively recession-resistant
investment since they are considered essential or mandated services
for compliance and other reasons.

The sector is a highly fragmented one, with businesses that
offer a wide range of services providing easy consolidation
opportunities for investors with an eye toward gaining market share
geographically. Combining different services under one roof can
expand business as customers prefer one point of contact for all
their outsourced service needs.

Investors can see the opportunities to drive value through
economies of scale, especially by offering volume-based vendor
discounts.

The size of the Facilities Services industry, which includes
both soft services like janitorial work as well as hard services
like HVAC and fire safety, is estimated to be $1.33 trillion in
2024 and reach $1.66 trillion by 2029, indicating a compound annual
growth rate of about 4.66 percent.¹

Transactions across the industry have been trending upward over
the past several years, reflecting the attractiveness of
value-driven opportunities and growth through roll ups and
synergies to PE firms.

Growth in Facilities Services Dealmaking

PE investors are finding they can infuse further value into
consolidated businesses by employing technology to predict
maintenance demand, monitor energy consumption, track assets and
optimize other areas of the portfolio company. Small improvements
in technology can significantly enhance the overall delivery and
performance of the business, especially as some PEs expand their
investments from commercial to residential services.

Finally, the ability to buy and grow the business in a short
window of time, depending on the level of integration, can make a
big difference when it’s time to consider exiting the
business.

The Three Main Areas to Evaluate a Deal in This Sector

While PE investors must consider many factors when conducting
due diligence, these three areas can indicate the attractiveness of
the acquisition target and highlight the best opportunities to
drive value after a deal is completed.

Financial

• Customer wins versus losses run rate: Evaluate
  the stickiness of customer relationships. The characterization of
  the typical Facilities Services business is a recurring and
  automatically renewing revenue base, so significant wins or losses
  in customer retention during recent periods can result in
  meaningful differences between historical and future earnings.
  Run-rate considerations for material wins and losses should be
  weighed when assessing the value of the business.




• Margin analysis: Differences in how a business
  classifies certain costs can drive wide disparities in how gross
  margin is evaluated or compared to peers. For example, whether a
  business locates supervisory managers within the cost of sales or
  under operating expenses can impact gross margin. When adding on a
  target to an existing portfolio company, buyers should ensure that
  a detailed analysis of the cost structure and the classification of
  those costs is performed so that there are no surprises in gross
  margin pre- versus post-acquisition.




• Revenue recognition: In services businesses
  where revenue is recognized over time based on percentage of
  completion, a full historic analysis should be performed using
  cost-to-cost comparisons, expended efforts evaluations or
  units-of-delivery methodology. Depending on the level of accuracy
  in management’s estimation methods, there could be material
  differences in revenue recognized.




• Risks of poor financial controls and quality of
  information: Smaller, founder-owned businesses tend to be
  less sophisticated and have looser financial controls in place. In
  order to fully understand the target’s cash inflows and
  outflows, a cash proof or reconciliation exercise is typically
  called for during the due diligence process. Focus a higher level
  of scrutiny around the balance sheet to confirm proper recognition
  and reconciliation.

Human Resources

• Employee retention: Within the industry,
  certain sub-sector populations such as janitorial services have
  turnover rates of more than 100 percent. Workers are often
  performing second shift work with limited ability for measurement
  or recognition. Buyers should ensure that the business can sustain
  its current headcount and growth trajectory without incurring
  material additional costs.




• Unionization: Building services, janitorial
  work, security services and other sub-sector industries are
  commonly unionized outside of right-to-work states. Union
  populations are often party to union-sponsored benefit plans, which
  can be more generous than non-union programs or multiemployer
  pension plans (MEPs.) MEP participation carries the risk of
  significant financial burden due to withdrawal liabilities in the
  case of a union exit. Buyers should quantify these contingent risks
  and determine any impact on overall valuation.




• Employment classification: Facility service
  employees are commonly operating at the direction of their
  employer, utilizing company equipment and uniforms. In situations
  where employees are misclassified as contractors and source their
  own teams for staffing, compliance issues can arise.




• Wage and Hour laws: Employers with large
  hourly populations can often run afoul of complex and changing wage
  and hour laws when expanding into new states. These can include
  overtime or spread hours rules, meal and wage breaks and changes to
  minimum wages. We recommend an investor complete a comprehensive
  diligence exercise to ensure no past risks or high costs to correct
  procedures.

Tax

• Sales Tax: States have disparate treatment
  regarding the taxability of different facility and environmental
  services. For smaller targets, they often do not have a dedicated
  team or deep knowledge on taxability across multiple jurisdictions.
  Rapid growth across state lines may also result in errors. While
  sales tax is collected by the vendor, it would ultimately be paid
  by the customer prospectively. However, this creates a risk of lost
  revenue if a customer refuses to pay tax or procure services due to
  additional cost, which generally can be 7 to 8 percent higher with
  sales tax. The vendor may also be liable for any amount that it had
  an obligation to collect and report but did not.




• Payroll Tax: The nature of this work often
  lends itself to large work crews that may travel across state lines
  and have significant per diems or expense reimbursements.
  Additional work focuses on nonresident state withholding and
  controls for traveling employees as well as documentation and
  support for per diems and expense reimbursements.




• Transfer Tax: For small targets, the
  transaction is often structured as a true asset acquisition. Asset
  acquisitions are generally subject to sales tax — including
  motor vehicle sales and excise tax and real property transfer tax
  — unless a separate exemption applies. For many facility
  service businesses, there are significant vehicles that will be
  transferred as part of the acquisition and transfer taxes may be a
  significant expense of the transaction. Buyers should focus on
  evaluating and quantifying any transfer tax that may apply.




• Tax Opportunities: Work Opportunity Tax
  Credits often apply to large labor workforces and may provide tax
  savings or benefits for hiring and retention. These tax savings may
  result in meaningful value to a buyer and help pay for growth.

Consolidation in Facilities Services Will Continue to Grow

The opportunities for PE investors within the Facilities
Services sector are abundant, and there’s still extensive room
for consolidation and good valuation in some subsectors —
like janitorial, security, roofing, electrical and plumbing —
according to investment banking advisors TM
Capital.²

Some subsectors have had very little PE deal activity while some
are at very favorable valuation multiples compared to others.
Thorough evaluation of the target acquisition’s unique business
environment, recurring revenue streams and geographic contexts are
needed to select the right company to add to a portfolio
company’s mix.

PE investors with knowledge of the sector and a nose for adding
value through efficiencies, technology and leveraging different
services under one brand will be rewarded.

Footnotes

1.
https://www.mordorintelligence.com/industry-reports/facility-management-market.

2. 2023 Facility Services Report, TM Capital.

Originally published by 02 April, 2024

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
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