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Backflow poses significant health risks as it can introduce harmful substances, such as bacteria, chemicals, and other pollutants, into drinking water, making it unsafe for consumption. A backflow preventer is a device installed in plumbing systems to ensure that water flows in only one direction, preventing contaminated water from flowing backward into the clean water supply.

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There are two types of backflows – back pressure and back-siphonage.​​

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Back Pressure. Occurs when the pressure in the downstream side of the water system exceeds the pressure on the supply side. This can happen in systems that involve pumps, boilers, or other devices that increase water pressure. When the downstream pressure becomes higher than the supply pressure, it forces water to flow in the opposite direction, potentially brining contaminants from non-potable sources into the clean water system.

• Example – A boiler system generates steam pressure. If the pressure inside the boiler exceeds the supply pressure, water can be forced back into the clean water pipes.​

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Back-Siphonage. Happens when there is a sudden reduction in water pressure on the supply side of the system, creating a vacuum or negative pressure.  This pressure drop can occur due to events such as a water main break, firefighting efforts, or heavy demand on the water system. The negative pressure can cause contaminated water from connected systems (like irrigation systems or industrial facilities) to be siphoned back into the clean water supply.

• Example – A garden hose submerged in a swimming pool can cause back-siphonage if there’s a sudden drop in supply pressure, pulling pool water back into the drinking water supply.

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Typical Service-Line Breakdown

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Backflow providers provide a broad set of services relating to backflow preventer testing, repair, replacement and installation as well as cross connection surveys.

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Replacements (~1/3rd of Revenue). Professional replacement (majority of volume) or installation of backflow prevention devices to maintain compliance with regulations and safeguard water quality. Backflows are required to be replaced once they are beyond their ~10-15 year useful lives.

 

Testing (~1/3rd of Revenue). Routine inspections to ensure backflow prevention devices are functioning correctly, protecting the public water supply from contamination. Required annually by law in 47 of 50 states.

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Repairs (~1/3rd of Revenue). Expert repairs to fix any issues with backflow prevention systems, ensuring they meet safety standards and operate effectively. A properly functioning backflow is required to pass annual testing. Repairs are typically required annually/bi-annually post year 2 of a backflow’s useful life.

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Cross Connection Surveys (Anywhere from 0-10% of Revenue). Cross connection surveys are systematic evaluations performed to identify and assess potential points within a water distribution system where non-potable water or contaminants could enter the potable water supply. These surveys are crucial in preventing backflow incidents by ensuring that all connections between potable and non-potable systems are properly protected and that backflow prevention devices are correctly installed and maintained.

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Investment Highlights

 

Target Rich, Fragmented Subset of the Industry Relatively Untouched by Private Equity. Backflow testing providers must be certified in each state and county they operate in. Providers are listed on each individual municipality’s website, allowing for efficient, location targeted add-on outreach.

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Regulatory-Driven Re-occuring Revenue. Demand for backflow testing services is legally mandated annually as a public safety requirement for 47 out of 50 U.S. states. Alaska, Hawaii, and Vermont are the only states without the requirement. Mandated testing also drives repairs and replacements as test failures must be fixed and re-tested before the backflow preventer device can be used again.

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Favorable Regulatory Tailwinds. In July 2024, California enacted stricter regulations that increase the focus on maintaining the safety of backflow systems across the state. These regulations will drive increased activity in future years as more states are expected to mandate replacements of single swing check valves in potable water systems with backflow assemblies over the next five years.

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Low-Hanging Fruit from Operational Improvements. There are numerous opportunities to both optimize and grow these businesses once acquired, whether by increasing efficiency through the implementation of technology, optimizing pricing, adding sales and marketing capabilities, capturing additional replacement/install work, and by entering attractive service adjacencies (fire safety, home sprinkler service, etc.).

 

Investment Thesis

 

Strategic Acquisitions. Pursuing add-on acquisitions lies at the core of the backflow testing investment thesis. Like many roll-ups, success rests on adding scale, expanding the business geographically, and adding adjacent services. A decentralized operating model should be utilized, allowing local brands to be retained while centralizing back-office operations. Targets should be identified and pursued for their cultural fit, personnel profile, geographic focus areas, service offering, and/or customer specialization.

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Implement Software. Most backflow service providers are paper-based operations. Key business processes (e.g. job scheduling and spare parts inventory management) are completed manually. There exists an opportunity to introduce technology like Service Titan and a sophisticated CRM to improve productivity and free up internal resources to handle additional volume growth.

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Professionalize Outbound Marketing. For most mom and pop backflow providers, historical customer growth has been achieved with rudimentary marketing efforts. Relying on inbound requests from company listings on water company approved tester lists and sending upcoming test reminders to customers are the typical strategies. An opportunity exists to acquire a backflow service provider and professionalize the marketing efforts to (a) beef up outbound marketing, (b) add internal sales resources, and (c) more proactively mine existing customers, all of which should drive future volume growth higher. Most repair and replacement / install customers consume multiple services in any given year. 

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It’s understood that a lower % of test customers consume other services in a given calendar year since backflows have a 10–15-year useful life, which translates to 10–15 annual tests but only ~4-7 repairs and 1 replacement over that entire 10-15 year period. According to the few providers I’ve talked with, about 2/3 of replacement/install jobs are sourced from existing customers, so acquiring a larger platform would derisk some of the necessary growth because there is essentially already a built-in pipeline of future replacement/install opportunities as these customers’ backflow preventers start to age out.

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Deliberately Target Higher-Margin, Stickier Multi-Location Customers. While testing costs are slightly lower for multi-location customers because of the volume discounts built into most pricing models, these multi-location customers tend to have larger facilities with much more complex backflow systems vs. single location customers. This structurally drives much higher average revenues per repair/install (and thus higher margins).

 

Multi-location customers are also stickier compared to single location customers, with retention rates typically increasing linearly with the # of locations serviced. The lifetime value of a backflow customer is pretty high depending on the number of facilities served, with the majority ~$1,000 and the larger multi-location customers in excess of $5,000.

 

Customers that have >5 backflows tested per year tend to have the highest lifetime values on average given the increased likelihood they will use other services (i.e., repairs and replacement/installations). Customers who remain customers beyond a single year tend to stay customers for a while, which drives significant lifetime value. Given the wide disparity between a single one-off testing customer and a multi-location customer, there is significant margin pickup to be had by aggressively targeting larger multi-location customers through SEO, PPC advertising, and other direct marketing channels.

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Optimize Pricing by Leveraging the Pricing Power Inherent in the Backflow Services Business Model. Like any business, there are opportunities to further optimize pricing over time. Depending on the size of the platform, larger players likely have some room to increase prices in select geographies depending on the competitive set in that specific locale. While value-based pricing is exercised to a degree for repairs and replacements/installs, there is likely a lot of low hanging fruit in increasing the consistency of pricing between customers.

 

Both home and commercial services have demonstrated real pricing power across almost all sectors over the last decade, with average annual price increases readily outpacing annual U.S. inflation over the last ten years.

 

The repairs side particularly has seen a lot of growth in the last few years, in part driven by the aging stock of backflow preventer devices in use around the country, and customers seeing cost inflation in other areas of their businesses, which has lessened a lot of the typical push back.

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Aggressive Approach to Growing Replacements and Installs. Like any product over a long enough period, backflows are ultimately consumable. Since bigger, multi-crew providers touch a larger number of unique properties, they are better positioned to capture additional replacement and install work in future years. Additional emphasis should be placed on first acquiring a big enough target to take advantage of this dynamic, and then focusing on optimizing internal customer services and sales efforts to better capture that future replacement and install work.

 

Most backflow providers have seen replacement/install volumes drop a bit over the last few years despite a significant increase in testing and repair volumes. This decline has been driven by two main factors: (a) New regulations in several states and more stringent enforcement from 2009-2011 saw an increase in the number of new backflow devices installed around 2010-2014 (useful lives are typically 10-15 years), and (b) Customers typically prefer elongating the life of a backflow preventer instead of doing a costly repair and tend to avoid expensive replacement CapEx when possible.

 

Value Creation

 

A conservative approach should be taken to get a platform ready to capture the numerous value creation opportunities, both from an organic perspective and via M&A. The phases of optimization and growth would likely include:

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Phase 1 – Identify and implement the appropriate software solutions to prep the platform for further scale. This would most likely include Service Now and a CRM if not already in place. Implementation would center around training office and tech staff on the systems. A digital footprint is required to increase productivity of the existing employee base, who are largely preoccupied with outdated paper-based processes. Software would also allow for more robust KPI reporting purposes as the platform scales and acquires other companies.

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Phase 2 – Capture the low hanging fruit. Grow customer volumes, capture additional share of wallet (particularly replacements/installs) and improve pricing methodologies.

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Phase 3 – Targeted M&A focused on geographic and service offering expansion. Depending on the size of the original platform, complete 5+ smaller tuck-in acquisitions to build geographic and service-line scale.

 

Phase 4 - Exit once EBITDA scale target and back-end systems integration is complete. Once the combined platform is north of $5M+ of EBITDA, it’s at a large enough scale where lower middle market private equity firms will start to get excited. This is the size you’d need to fully capture the benefit of multiple arbitrage, with an even bigger benefit if you can get above the $10-15M EBITDA level.

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Key Risks

 

Labor Difficulties. Attracting and retaining talent will be crucial for maintaining service quality and client relationships. High turnover or difficulty in hiring skilled technicians could lead to operational disruptions, the potential loss of customers, and an inability to scale. 

Potential Mitigants Include: 

• Don't Make Changes Too Fast – Most importantly, don’t screw up the existing culture (if it’s a good one). Future operational improvements should be implemented at a comfortable pace and not cause undue disruption or concern among the techs.

• Management Equity Roll-Over – If possible, have existing sellers remain involved as advisors and have them roll equity to have a strong economic interest in ensuring the success of the enterprise post transaction. Keeps incentives aligned and also reduces risk of any key employees exiting day one because of loyalty to the prior owner.

• Invest in Your Employees – Develop in-house training and apprenticeship programs to cultivate talent and reduce dependence on the external labor market. Ensure competitive compensation packages, including benefits, bonuses, and career development opportunities are offered to retain staff. Build relationships with local vocational schools and trade programs to create a pipeline of future employees. Profit sharing or equity incentives should be offered to the most important staff as recruiting and retention tools.

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Technology Implementation. Transitioning from familiar paper-based processes to new software systems like Service Titan will probably be met with some resistance from existing employees. Operational disruptions like data migration issues and downtime is also possible.

Potential Mitigants Include:

• Service Now Implementation Consultant – Appoint a highly vetted, dedicated tech consultant that has implemented Service Titan at similar businesses to assist with the changeover and ensure the process is managed professionally, avoids common pitfalls, etc. The transition should be implemented in phases, starting with non-critical functions, to minimize any operational disruptions. Comprehensive staff training programs should be conducted on the new software, emphasizing the benefits and offering ongoing support.

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Obsolescence Risk from Smart Backflow Devices. Emerging technologies like smart backflow preventers or IoT-based products could reduce long-term demand for traditional testing, repair, and installation services.

Potential Mitigants Include:  ​

• Still Subject to Same Regulation. While smart backflow preventers can help reduce backflow incidents from occurring by providing early warning signs, smart backflow preventers still operate in the same manner as analog devices. Most importantly, they are still subject to the same rules as analog backflows. These “smart” devices require the same cadence of repairs and replacements as analog devices given their exposure to water corrosion.

• Cost Prohibitive. Smart / IoT-based backflow preventers cost 2-3x more than already expensive traditional backflows given the technology, software integration, and monitoring fees associated with these devices. This significantly limits their appeal in the market. Customers seek to elongate the life of existing backflow devices to the extent possible to reduce capex spend on new (in most cases analog) devices.

• Invest in Training to Expand Service Offering to Include Smart Devices. To further mitigate the risk, providers should train staff in the latest technologies so that they can offer both traditional and connected backflow solutions to customers as appropriate. This could also have the positive of expanding the service offering to include monitoring and management services for smart devices, creating a recurring revenue stream through maintenance or subscription-based monitoring services.

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In summary, backflow services represent a unique investment opportunity due to their recurring revenue, regulatory-driven demand, and low capital requirements. By pursuing strategic acquisitions, implementing technology, professionalizing operations, and targeting high-value customers, significant value can be unlocked. The ultimate goal is to build a scalable platform that appeals to both quasi strategics and lower middle market PE firms, creating a clear path to exit.

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