Blue-collar service businesses have seen a notable increase in M&A activity in recent years due to their steady cash flows, the essential nature of their services, fragmented market dynamics, and opportunities for operational and financial optimization. In this article, we outline common financial due diligence topics and themes when performing a quality-of-earnings (QoE) analysis on founder-owned and/or privately held blue-collar services businesses.

Overview

“Blue-collar services” typically refers to industries that involve manual or skilled trades performed on site or at a physical location. These often provide recurring and/or project-based services to residential, commercial, and industrial customers. These sectors have gained prominence in the M&A landscape due to their resilience to economic fluctuations, fragmented market structures, and growing demand for essential services. Common examples of these businesses include:

• HVAC (Heating, Ventilation, and Air Conditioning)
• Plumbing
• Electrical
• Restoration and remediation
• Roofing
• Property management and landscaping
• Fire safety
• Pest control

Who Is Selling These Businesses?

Sellers in blue-collar services are often founders who have built their businesses from the ground up, starting as skilled tradespeople in the field before growing into owner-operators. They are typically hardworking, detail-oriented, and deeply involved in the day-to-day operations of their businesses, often managing client relationships and overseeing critical decision-making processes.

Sellers usually enter the M&A process seeking one of two outcomes: a growth partnership or an exit strategy. In the case of a growth partnership, sellers are looking for a buyer who can provide resources and expertise to scale the business, such as investments in infrastructure, technology, or expanded service offerings. Sellers pursuing an exit strategy often do so to transition into retirement while ensuring the continuity of their business post-sale.

Most sellers remain involved for a transitional period or have rolled-over equity to participate in the upside opportunity.

As one seller we worked with noted, “My business partner was nearing retirement, so I began exploring the sale of my HVAC services business, which I started 15+ years ago, as I determined it would be the best way to facilitate the transition and find a new partner while keeping my business running.”

Who Is Buying These Businesses?

Buyers are typically private equity-backed platforms. These buyers are seeking to leverage the acquisition to achieve objectives like geographic expansion, adding complementary services to create a bundled offering for customers, and driving operational efficiencies to improve margins. Many buyers also focus on scaling the acquired business by investing in areas such as sales and marketing or modernizing infrastructure to accelerate growth.

Buyers value businesses with strong customer relationships, established local reputations, recurring or predictable revenue streams, and cultures that will integrate well into their organization.

One buyer we talked to explained, “Finding the right acquisition opportunity for our roofing business requires a lot of work. In addition to checking the right boxes from an operational and financial standpoint, it is crucial that we connect with sellers on a personal level to ensure our company cultures align.”

How Do the Sellers Manage Financial Reporting?

Although sellers often excel in managing their operations, their businesses frequently lack sophisticated financial reporting systems and processes.

For example, their Finance and Accounting teams tend to focus primarily on maintaining basic books and records, with limited emphasis on advanced financial planning, forecasting, or strategic decision-making. These teams are typically small, often comprising roles such as a Controller, a Staff Accountant, and AR/AP Clerks. Further, accounting practices can be inconsistent, with many businesses operating on a cash-basis or modified accrual-basis with the objective of tax avoidance rather than adhering to Generally Accepted Accounting Principles (GAAP).

This can lead to challenges such as inconsistent revenue recognition, unclear job profitability tracking or expense categorization, and discrepancies in working capital management. Buyers are aware of this and make these areas a key focus of their due diligence. For these reasons, sell-side due diligence is critical before engaging with buyers.

A proactive approach in preparing a sell-side QoE can help identify risks and opportunities early, allowing sellers to determine mitigation strategies prior to going to market, which can help streamline buyer due diligence and preserve deal value.

Approaches to Common Financial Due Diligence Issues

Common financial due diligence issues in blue-collar services businesses can be grouped into several categories, each requiring a tailored approach to ensure accurate financial evaluation and decision-making.

Modified Accrual / Cash Basis Accounting

Sellers in this industry often have less sophisticated Finance and Accounting departments, and financial statements are typically not audited. As a result, the financial statements are typically reported on a “modified accrual” or cash basis. This approach can create timing differences between revenue and cost recognition. For example, costs for a job, such as materials or subcontracted services, might be expensed in one month when a vendor invoice is received, while the associated revenue is recognized in a later month when the job is invoiced to the customer.

To address this during a QoE assessment, it is important to obtain and analyze detailed financials at the trial balance account level to identify period-over-period anomalies and inconsistencies, and at a job level to assess the actual margin at a job and customer level (discussed further below).

Furthermore, given the lack of an audit, a proof-of-cash analysis should be performed by comparing the revenues and expenses per the financial statements to the cash receipts and disbursements per the bank statements for the periods under review. Discrepancies should be investigated to ensure revenues and expenses are complete and reconcile to the cash activity of the company.

Business Performance Reporting and Forecasting

Many sellers do not have formal processes in place to track or analyze historical business performance at the customer or project level, nor do they prepare financial budgets or forecasts. To address this during a QoE assessment, gather and aggregate historical project-level data (“job detail”) with revenue and margin information for the past three to four years and the current year to date.

This data should include details such as customer, customer type (e.g., general contractor versus facility owner), service type (e.g., maintenance/repairs, preventative maintenance, installation), location, and project start and end dates. Once aggregated, this information can be used to perform various analyses, including assessing the following:

1. Customer performance (focus on customer concentration and profitability, existing customers versus new/lost customers, customer end-markets, etc.)

2. Service / job type performance (focus on segmentation of recurring/maintenance work versus new build/replacement projects)

3. Job size and job profitability stratifications (focus on understanding composition of revenue based on average job size and margin)

4. Branch/location performance (focus on comparability of branch performance and growth opportunities)

Percentage of Completion (POC) Accounting

POC accounting is an especially vital issue for businesses that perform long-term service projects with specified contract values. GAAP typically requires revenues for such projects to be recognized over time, but many sellers instead recognize revenue upon invoicing. This mismatch can cause significant margin fluctuations over the life of a job when invoicing cadence does not align with the costs incurred.

To address this, a POC normalization lookback analysis is performed using the previously discussed aggregated job detail. This analysis recalculates revenues retrospectively, ensuring that an individual job reflects consistent gross margins over its duration based on actual costs incurred. This normalization process is often one of the most critical and complex elements of a QoE assessment for blue-collar services businesses.

Read more about this topic in our Percentage of Completion Accounting in Project-Based Businesses article.

Other Diligence Topics and Their Potential QoE Impacts

There are several other diligence topics that can have significant QoE and purchase price impacts. By addressing these systematically through diligence, stakeholders can get a more transparent evaluation of the target company’s health.

Owners’ Compensation Changes

These often require adjustments, as sellers may pay themselves above or below market compensation — or no salary at all if they receive distributions instead. A QoE adjustment is typically proposed to normalize EBITDA based on a market-appropriate compensation package.

Personal Expenses

This is a common adjustment, as sellers typically run personal expenses through the business (e.g., country club fees, sports tickets, vehicles, vacations, etc.). These expenses should be identified and adjusted for purposes of analyzing a normalized level of EBITDA.

Related Party Transactions

Sellers may own property/buildings leased by the company at rates above or below market. All related party transactions should be identified and assessed on their continuance going forward and whether such historic rates charged to the business were “arm’s length.” Any deviation in rates/costs going forward compared to those charged historically to the company should be reflected in the QoE.

Employee Compensation Accruals

These may need adjustment, as payroll, bonuses, commissions, and retirement contributions are often expensed when paid rather than accrued as earned. Often, owners will have family members on payroll who are not actively involved in the business. During diligence, these individuals along with their costs should be identified and considered for an adjustment to the QofE.

Inventory / Equipment Purchases

Typically, a portion of the revenue generated for blue-collar service businesses is derived from the use of materials and a mark-up on installed equipment. As such, it is important that the costs associated with these material and equipment purchases are appropriately expensed to jobs so that revenue can be recognized accordingly when the costs are incurred.

Furthermore, for equipment which has been expensed to a job but not yet installed (commonly referred to as uninstalled materials or uninstalled inventory), GAAP stipulates that the revenue recognized on the equipment yet to be installed match the cost incurred on that equipment, resulting in zero margin. Upon installation of the equipment, the remaining revenues can be recognized.

Vendor Rebates

These often require a QoE adjustment, as rebates are recognized as income when received from vendors, typically annually, as opposed to accrued over the period earned. Furthermore, it is important to understand how the rebate programs are structured (i.e., as a percentage of purchases, year-over-year volume growth, tiered systems, etc.), as this will ultimately have implications on the level of rebates that will be earned in future periods as the business grows.

Backlog

Represents future revenues under contract on jobs that have yet to be recognized. It is important to assess historical backlog trends and compare to current backlog. For example, if current backlog is less than historical levels, this may be an indicator that EBITDA will decline.

Customer Deposits

Blue-collar businesses frequently receive cash in advance of performing a project. It is important to understand how these deposits were accounted for (i.e., revenue versus deferred revenue), as these likely represent a liability for a future sale commitment, where the buyer will not receive the cash. Assuming a cash / debt-free transaction structure, these deposits are typically treated as Indebtedness, reducing the sale proceeds.

Vehicle Leases

Scrutinizing these is needed to ensure accurate classification as either operating leases (which impact normalized EBITDA as expenses) or capital leases (which are treated as debt payments and do not impact normalized EBITDA).

Earnouts

Earnouts have become increasingly common to bridge valuation gaps in an M&A environment shaped by rising interest rates and inflationary pressures. Earnouts are agreements where a portion of the purchase price is contingent on the future performance of the business.

It is important to ensure the calculation of the earnout is well defined in the purchase agreement to avoid disagreements in the future and to ensure consistent application. Additionally, a QoE analysis is often used to establish the historical EBITDA baseline against which future performance for the earnout will be measured, ensuring consistency and fairness in the arrangement.

Key Considerations for Sellers and Buyers

Preparation and attention to detail are needed for a successful transaction since blue-collar businesses often have unique financial and operational characteristics that require careful consideration from both sellers and buyers.

If you are considering selling or investing in a blue-collar services business, there are several key factors to keep in mind to ensure a successful sale process and value maximization.

Sellers of Blue-Collar Services Businesses

The issues and diligence topics previously discussed will be on buyer’s radar as they engage in due diligence. A seller that is unprepared for the process will significantly extend the due diligence timeline, burden the finance and operational team, cause buyers to walk away, and potentially negatively impact deal value.

Sell-side due diligence should be performed prior to going to market to help minimize surprises and optimize speed to close. More specifically, sell-side due diligence:

• Applies a “buyer’s lens” prior to going to market for purposes of identifying potential issues ahead time, thereby allowing seller to prepare and mitigate in advance of buyer diligence
• Provides clarity over the EBITDA being presented and guides buyers to their bid
• Provides a fully vetted set of financial information to reduce the amount of time buyer diligence is performed
• Reduces the timeline of buyer diligence and the burden on the finance team
• Seller can control the access to information and only provide the required data based on the phase of the sales process

Buyers of Blue-Collar Services Businesses

Buyers should work with an experienced financial due diligence provider who is knowledgeable about the industry and familiar with the sellers, and who understands the financial and operational reporting dynamics of blue-collar services businesses.

Equally important is establishing a structured finance integration and reporting process to deploy post-close, which helps minimize disruptions to the business. These post-close processes typically include transitioning from modified accrual or cash basis accounting to GAAP for audit purposes, integrating finance systems and potentially transitioning to a new ERP system, creating a robust forecasting and budgeting framework, and making strategic investments in the Finance and Accounting team.

Investments for achieving a smooth transition may involve hiring additional personnel or utilizing temporary resources to support the transition and implement new processes effectively. Taking these steps ensures a smoother transition and positions the business for long-term financial and operational success.

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