What’s the Future for Mid-Sized Firms?

Mergers & Acquisitions Supplement - Mergers & Acquisitions Supplement

In this seller’s market, pest management industry consolidation continues to make headlines. How can those companies that choose not to sell compete with larger firms?

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You have likely seen the headline, “[Very large pest control service firm X] acquires [Mid-sized pest control service firm Y]” numerous times in PCT magazine over the past few years. As a result, many names are disappearing from the PCT Top 100 List. This begs the question: Can mid-sized pest control companies continue to compete — and even thrive — in today’s marketplace?

Data confirms that consolidation in the industry continues and the number of mid-sized pest control firms is declining. Over the past five years among the PCT Top 100, the top 5 players have grown their revenue share by a full 5 percentage points from 60 percent to 65 percent and top 10 players from 70 percent to 75 percent. Based on public disclosures and recent activity from publicly traded pest control service firms such as ServiceMaster, this trend is expected to continue.

Further, over the past year, two large pest control service associations/groups (Copesan Services and the Food Protection Alliance) have either been acquired or dissolved once key members were acquired. A core part of their strategy was to provide national scale and deep expertise and capabilities to effectively compete with large corporate pest control firms.

Consolidation is being driven by a combination of factors; a few include:

  1. Scale to Increase Profits. Acquisitions of in-market competitors can drive scale and improve profit margins by lower operating costs through greater route density and purchasing power. Gaining economies of scale drives the logic behind many acquisitions.
  2. Speed Up Expansion. Organically entering new geographic markets or enhancing one’s capabilities to offer appropriate services in certain industry verticals (such as pharmaceutical manufacturing) can be difficult and time consuming. By acquiring a business, the timeline to expand into new markets is shortened and many large companies are under pressure to demonstrate aggressive growth.
  3. Protect Market Share. If one’s market share in a core market is threatened by a competitor, acquiring them will — at least in the medium term — help neutralize that concern and protect profits.

Given these reasons (and others), one might assume that large pest control firms will eventually control and dominate the entire industry. However, in our experience in numerous service industries, mid-sized firms can compete and even thrive in the face of larger competitors. (Cue the soundtrack to “Rocky.”)

Mid-sized firms can and do win in regional markets by offering more personalized, effective and relevant customer service, a committed local presence with “skin” in the community, greater innovation, thoughtful acquisitions and competitive prices. However, building out these competitive differentiators requires committed, continuous investment and assistance from aligned partners that have been there before. (Cue private equity.)

Private equity (PE) investors can be enablers: providing the capital and additional expertise required to execute regional consolidation strategies, to pursue material investments in facilities and equipment, to drive cost efficiencies and innovation, and to scale mid-size organizations through periods of rapid growth. Private equity investors also provide deep experience and expertise in corporate finance activities, helping their partners secure better debt financing packages to further facilitate growth. At the same time, the pest control industry presents attractive characteristics for investors, including accomplished ownership teams, a diverse customer base, predictable revenue, and a healthy cash flow margin and return on capital.

PARTNERING WITH PE. From the perspective of the owner of a pest control firm, private equity can play an important role for both the company and its shareholders. Private equity firms can supply much-needed equity capital to pursue aggressive growth, which can be a capital-intensive endeavor. Further, private equity investors play a key role in addressing the growing need for succession planning within family enterprises, stepping in to purchase shares (or membership interests) directly from retiring equity holders, and, if applicable, partnering with remaining family members who are motivated to grow the business to new heights. Private equity partnerships can provide other benefits to owners, such as:

  • An Energized Team. If an owner sells to a competitor, the executives and managers are often vulnerable to downsizing. Most private equity firms, however, will look to retain the in-place team and provide them with performance incentives.
  • Flexible Liquidity. A private equity firm can give the owners an opportunity to sell their company entirely or reduce their ownership position while continuing to run the business. By seeking some amount of liquidity in the context of a private equity investment, the owners can diversify their personal net worth and thereby increase their comfort in taking bold expansionary moves.
  • Improved Debt Financing Terms. Private equity firms often obtain better debt financing packages than entrepreneurs alone, removing personal guarantees and securing better terms to facilitate growth.
  • Strategic Advice. Private equity professionals can undertake key roles on a variety of projects in tandem with management, such as due diligence research on potential acquisitions, helping implement key performance metrics and activity-based monitoring and provide business advice from working with and being part of many businesses across different industries.
  • A More Valuable Business. Fresh capital can enable a pest control firm to make accretive acquisitions, implement technology to drive higher profitability (e.g., routing software, fleet management), and investment in its asset base (e.g. trucks, offices, equipment).

THE RIGHT INVESTOR. If a firm believes that a private equity partnership is what the company needs, the owner must consider several critical issues before selecting a partner, as having a private equity firm as a shareholder is like a business “marriage.” The factors to consider include:

  • Buyout or Partnership? Are you willing to sell a majority or controlling interest of your company? Will the PE firm consider being a minority shareholder? If so, how many deals have they done in which they don’t have control?
  • Valuation and Deal Terms. Depending on whether the transaction is a buyout of the company or a growth equity financing, is the valuation fair? Are the other material deal terms (e.g., board representation and governance rights, liquidity provisions, etc.) appropriate given the ownership position of the private equity firm? Is the firm focused on true value creation or financial engineering?
  • Size of Deal. Relative to the size of the private equity firm’s fund, what is the size of this deal? Given the size of the transaction, is the company going to be important to the equity firm?

Industry consolidation, succession planning, route planning software and growth of the digital savvy customer are among the developments now impacting the industry. In the midst of this change, private equity remains an option for firms looking for the capital and complementary expertise necessary to become the next generation of great mid-sized firms.

Mohit Kansal, Michael Castellarin and Austin Sinclair lead the Facilities Services investment practice at the Clairvest Group. Clairvest, founded in 1987, is a private equity firm focused on backing entrepreneurial, invested management teams to achieve ambitious growth.