Don't Sell your Business Short

Feb. 1, 2000
If you're thinking of selling your equipment rental business, you must present yourself and your company in a clear and organized fashion so that a buyer

If you're thinking of selling your equipment rental business, you must present yourself and your company in a clear and organized fashion so that a buyer can fully understand the potential of your business.

I'll explain some of the definitions used during the evaluation process and give you some tips that will help bring value to your company, as well as offer an idea of what buyers are looking for. As a former rental company owner, I've been onboth sides of the table, so I can provide tips.

I won't tell you what you can expect to get from a buyer, or go into the details of valuations and multiples. But I will show you how to improve the likelihood of a successful transaction for both the buyer and the seller.

Before you get to the transaction process, the first question you want to answer in this: Should I continue to operate the company or look to divest?

So let's discuss exit strategies. People do not think about exit strategies when they start their businesses. It's the last thing on your mind. If you started your company back in the '60s and '70s, you may have reached that time in your life when you're considering retirement and an opportunity to monetize all the hard work of so many years.

Perhaps you have no succession capability. Sometimes family members aren't interested in or qualified for succession roles. Or perhaps the current managers or employees are not qualified to grow your business and keep it competitive. Those that survive will have to change and adapt and employ people capable of taking the company to the next level.

We're operating in an evolving, competitive environment. The threat of new competitors - distributors such as Komatsu, Caterpillar and Case - are taking a share of the business. You also may be facing competition from hardware chains and other areas. Although this in itself may not be reason to sell your business, you should consider some "what if" scenarios:

* Anticipate new competition and its impact on your business and the marketplace in which you compete.

* Decide if the "what if" scenarios will provide an acceptable return for you.

* Will an increase in competition also bring about an increased pressure on pricing?

* Is a possible increase in the cost of doing business likely relative to your future competitors?

* What's the cost of your fleet going to be in the future?

* What will be the cost of your delivery vehicles?

* What about the cost of insurance? Take into consideration the cost of health, liability and workers compensation insurance.

* Cost of wages. Cost of acquiring qualified employees, training them, retaining them.

* Land costs. If your leases are close to expiring, try to get an idea of renewal costs. If you own your own property, what could you rent it for? What is the opportunity cost, especially if you are charging back to the company lower than market leases?

* Cost of capital.

Along with your decision process, think about the capital requirements. Do you have sufficient access to capital to keep your company competitive and expanding? To generate another million dollars in revenue, you may need to spend up to $1.6 million in capital expenditures to buy new equipment. Perhaps you need new delivery vehicles, or another mechanic to keep it up and running. These are things you want to build into that model.

Also consider other investment opportunities. Not only is our industry changing, but the economy itself is as well.

At the core, I want you to remember to look at your business as an investment even though many intangible benefits to owning your own business include having stature in the community. It was sometimes difficult for my family to be objective because our company had our name on it, and it was something we enjoyed and took pride in. Take a look at the return of the capital that you have tied up in assets. Is it an acceptable return for you?

Terms of evaluation It's a tough decision, but once you've made that decision, you need to become familiar with some terms you'll hear often during the valuation process.

Two terms you'll hear often are EBIT and EBITDA and free cash flow. EBIT is earnings before interest and taxes, it's also known as operating profit. EBITDA is earnings before interest, taxes, depreciation and amortization free cash flow. These are the key evaluation parameters used in this industry. EBIT is often used in evaluating trench plate or barricade rental companies that may use a different depreciation schedule. For example, trench plates may have a useful life of 40 years. Barricades are the exact opposite, lasting just a few months. So depending on the type of company, there may be a different valuation model.

For most rental companies, EBITDA is the typical multiple to build that valuation. It helps give us a clear picture of that company's cash flow and what we can anticipate.

LOI: A letter of intent that basically outlines the structure of the asset or the stock purchase agreement. It memorializes any verbal agreement to dollars paid and the form of payment. It will also talk about lease terms, employment, or consulting agreements and transaction dates. The seller will sign a binding non-solicitation period to ensure the buyer and seller an exclusive time period to work out the details of the contract.

GAAP: Generally accepted accounting principles. Typically buyers like to see financial information based on GAAP rules. If there are any exceptions, your CPA should be able to explain what the differences are and why your financials don't conform to that.

Due Diligence: This is an investigative process between buyer and seller. It varies between buyers, but here's some of what we at United Rentals typically ask for:

* Corporate matters - minute book, stock transfer records, stockholder agreements, ownership structure, prior mergers or acquisitions.

* Financial matters - three years of financial statements, tax returns, complete list of assets owned and leased, depreciation schedule, inventory items, accounts receivable aging reports, list of excluded assets, insurance policies.

* Employment matters - employment agreements, retirement plans including 401 (k) and SEP IRA's, lists of employees and their compensation including any special agreements, employee handbook.

* Litigation/Regulation - Reports, pending and threatened claims, copies of judgments, documentation of waste materials pertaining to disposal and handling, copies of federal, state and local permits, any regulation involving your business (applicable if involved in industrial business), and environmental reports.

* Real estate - complete list of property owned and leased, including copies of all leases, grant deeds and zoning.

* Sales and marketing - list of the company's top customers, and dealership agreements.

Stock or Asset Purchase Agreement: Most commonly used for corporations.

* List of names of corporations for buyer and seller.

* Holdback structure - The holdback is a dollar value held back from the total sale price of the business, typically 10 percent of the gross purchase price, held back for about 180 days to verify inventory, rental fleet assets, condition of the fleet, and collectibility of accounts receivables.

* Additional purchase price adjustment for current position.

* Allocation of the purchase price.

Representations and warranties: An important part of the stock purchase agreement. No matter how good the due diligence process is, you can only discover a certain amount of information about a business. It is difficult in a matter of days to go through all the aspects of a 20- or 30-year-old business. Representations are statements of past or existing facts. Warranties are promises that existing or future facts will be true. Both the buyer and seller will make representations and warranties.

For the seller, representations and warranties are the sellers' formal description of the acquired company and its business. Examples may include financial information, books and records, title of the company, accounts receivables, inventory, compliance with the government, legal proceedings, employees and environmental and other items.

For the buyer, it's primarily stating that the company is duly organized and has the power to execute the acquisition.

Indemnification: Rental businesses are often acquired for up to 100 percent cash, so the buyer seeks to hold the seller financially responsible for breaches of the seller's representations and warranties in the stock purchase agreement for the operations of the business prior to the acquisition date.

Bring value to your company The most important point I want to make is this: If you decide to sell your business, hire experienced counsel. Make sure your attorney has plenty of "deal" experience. You want an attorney who has experience with mergers and acquisitions, with buying and selling businesses. The attorney who helped you form your corporation and helped you with legal matters as far as employees or collections, may be wonderful, but he may not be the right attorney to sell your business. Look for an attorney who understands selling a business. Don't be afraid to ask your attorney how much experience he or she has regarding those types of transactions.

Involve your traditional lawyers in the process - they will be invaluable for due diligence - but leave the contract negotiations to the experts.

Organize your financial reports. Not only are you selling your business, but you need to market it. Present your financials in an organized format. Go over your financials with your CPA. Make sure they conform to GAAP rules and if not, point out the discrepancies to the buyer. If you haven't taken a look at your financials recently, now is the time to do that. Even if you decide not to sell your business, it's a good step you should take.

Review your accounts receivable aging reports. This is something we often overlook in our busy operations. We often focus on customers day to day and don't go back and review these reports. Make sure they are up to date and if they aren't, fix them. Clean up old debt - collect it or write it off. If you decide to write off old debt that you haven't been able to collect for a while, make sure the buyer understands any impact this will have on the bottom line. If you have taken the appropriate steps to pre-lien job sites, make sure you have the documentation to back it up.

Real estate The buyer will look for a clean title, so make sure there are no liens against the property and all permits are in place. It also may be in your best interest to conduct a physical survey of your property. Many rental center owners have owned their properties for many years and precise boundaries are open to question. In such cases a survey could be an eye opener.

Is the property owned inside or outside the corporation? If inside, you'll need to deal with these property issues immediately, especially if you decide not to sell the real estate with the corporation. There could be major tax ramifications.

If the property is held outside the corporation, the buyer will need to know if you've been charging market rate, below market rate or above market rate.

You might want to conduct a Phase One environmental study. The buyer will typically do that, but you may choose to do one before the process starts, especially if there have been problems in the past. This is important especially if you want to lease the facility back to the buyer. Environmental issues are a hot button for all buyers and won't be overlooked.

Read contracts carefully. Don't enter long-term leases or debt contracts that have low interest rates but large prepayment penalties, or a change in control provision. That's a cost that could come back to hurt you if you sell your company. So whether or not you want to sell the business today or two or five years down the road, take a close look at those contracts and make sure they give you the flexibility you need.

Take inventory If you are considering selling your business, conduct an inventory of rental fleet assets and inventory/parts items. This is an area often overlooked by owners who have so many demands on their time. As an owner, I admit I always put off doing inventory. Nobody enjoys it. But if you are considering selling, it will bring great benefit to both you and the potential buyer. It will benefit you whether you decide to sell or continue to operate.

When conducting inventory, make special note of any consigned inventory that may belong to a manufacturer or third party. It's important to let the buyer know about this. Identify and repair or dispose of equipment that may be in the back lot and hasn't been operated for a while. It will help provide a good image to any prospective buyers that may tour your facility.

The presentation of your company is important. Buyers are sophisticated enough to know the difference between a new coat of paint and a new piece of equipment. But the presentation you're offering has a psychological impact. Is the equipment neat and lined up? Are trucks looking nice with new decals, or are broken down, cannibalized pieces of equipment strewn around the yard? Overall, does your team of employees carry on their business in an organized and professional manner?

When you review the financials with your CPA, identify any non-business-related expenses or any non-reoccurring expenses such as financial statement adjustments, building remodeling or expenses incurred by the corporation. Often shareholders that own the property have the corporation take care of these expenses.

The idea here is that these expenses impact the bottom line and may not reflect the true picture of your profitability and cash flow. You need to give a true picture to the buyer what your business is capable of generating. Is there an owner's salary that will not continue? What about owners' life-insurance expenses, personal toys that are charged as expenses to the corporation, or other perks and bonuses? Identify and itemize those items.

If these expenses are truly personal in nature or non-recurring, the buyer will add-back the costs to the financial model, thereby increasing the EBITDA number. This is often referred to as adjusted EBITDA.

Identify excluded assets and keep in mind how they would be distributed especially if the real estate is held within the corporation. The decision can have a large impact on the bottom line and income tax.

Also be aware of add-ins. Buyers incur additional costs: for example, the additional training of employees, compensation to bring employees up to market rate perhaps, profit-sharing packages, capital expenditures for the fleet if the fleet is older, or an under-market real estate lease.

What buyers look for What creates value for a buyer? Number one, reliable quality revenue and earnings stream. That's what the EBITDA formula and cashflow projections try to evaluate. And buyers look at the cash flow. At United Rentals, we like to see a rental/sales revenue mix of more than 65 percent rental. Presence in the marketplace is important, as are the fleet's age and conditions. Buyers have to decide what kind of capital expenditures will be necessary from the day after acquisition to build the fleet. What is the ongoing maintenance expense?

Another item that attracts the buyer is the facility. Equally important is the location and the size and configuration of the facility. Is it big enough? Is there room on the property, or on an adjacent property for potential expansion? Not only is the buyer looking at a business today, but they are thinking about where they can take the business in the future.

Don't overlook people. Good employees are an asset that is difficult to acquire in today's environment. Tenured, experienced employees who have solid client relationships is something all buyers are.

Acquisition process I'm often asked about the acquisition process itself. Either party can make the initial contact. It can be handled directly - which often results in better communication - or through a broker.

During the initial contact, both sides of the table will qualify the other. The seller asks: Is the buyer someone I want to be associated with? The buyer asks: Does the seller fit into our marketplace and organization? The first meeting would typically be face to face, on-site or off-site. Buyers generally work discreetly, but still want to look at the locations and the equipment.

As the seller, you should be prepared to describe the history of the company, the market in which you compete, and your competition. And be prepared to offer an accurate "SWOT" analysis - strengths, weaknesses, opportunities, threats. You should be able to speak articulately about these issues to the buyer. Remember, sell your business to the buyer; let them know what you do well.

At that point a confidentiality agreement is often signed. This includes the buyer's statement that he or she cannot disclose or use information obtained from the seller to compete against or harm the seller. So, for example, any financial information that the acquisitions team at United Rentals receives will not be handed over to the operations people, to be used in competition with the seller. Our acquisition team is separate and independent from the operations side of the business.

After that, we would build a financial model to determine the projected cost of acquisition and our anticipated ROI. We would then put the deal parameters, including the proposed purchase price, in the form of a letter of intent. After a letter of intent is signed, one of the first things that takes place is the discreet completion of a Phase One environmental inspection. Due diligence on the remainder of the business will proceed simultaneously. Much of the due diligence process will be completed off-site with the buyers financial, operating, fleet, risk management and legal personnel reviewing information received from the seller. Legal documents will be prepared, including any stock purchasing agreements, lease agreements, and employment or consulting agreements.

All of this leads up to the execution of a definitive agreement, which often coincides with the closing.

Taxes When evaluating the decision of whether or not to sell your company, you should always focus on the net number, not the gross number.

These are some points you should review with your accountant. Find out what impact the proposed structure will have on the net number. Examine opportunities to modify the structure to enhance your estate planning. The timing of the transaction could be extremely important. For example, would you want to close before year-end or in a new tax year?

Method of payment is another important consideration. Do you want all cash or a cash/convertible bond mix? Do you prefer a time sale paid out over a certain amount of time? If it's not a 100 percent cash sale, consider the creditworthiness of that buyer. Also, what would the interest rate on the note be?

No matter what you do, whether you decide to sell your business or not, spend some time on estate planning. Even if you aren't selling your business now or five years from now, take the time to look into this issue. If you wait until you're ready to sell, it may be too late.

Additional points Make sure you clear up any outstanding issues with management or partners, such as any verbal or written - whether they were formal or informal - promises for bonuses or equity in the business to your management or longtime employees, far in advance of any negotiations. This could really stall a deal. Make sure you involve your legal counsel.

Consider issues of employment post-closing. Do you want to work after the sale? If so, where do you see yourself fitting into the new organization? What do you enjoy doing? Personally, United was a perfect fit. I enjoyed the equipment rental industry but needed a new challenge, and United's acquisition department was a perfect opportunity for me. What possibilities are available - where might you fit into that organization?

Look at employment agreements and non-competes for your key employees. Employees are important to the buyer.

The transition from private to public company can be a challenge. A good buyer will spend considerable amount of time on these issues.

How will they handle your MIS and data management systems? What kind of training will they provide for your employees post-closing? Make sure all union agreements are taken care of and understood ahead of time.

Look long and hard at the company you're talking to. Make sure the culture will fit your company. Present yourself and your company in a clear and organized fashion so that the buyer can fully understand the potential of your business.

* Hire experienced counsel.

* Organize financial reports.

* Prepare accounts receivable aging report.

* Address real estate issues.

* Conduct a current inventory.

* Identify/repair rental fleet.

* Cut non-business related expenses.

* Reliable, quality revenue and earnings stream.

* Rental/Sales revenue mix.

* Presence in the marketplace.

* Fleet age and condition.

* Facility.

* Location.

* Size and configuration.

* People.

* Initial contact.

* Qualification by buyer and seller.

* Confidentiality agreement.

* Buyer builds financial model.

* LOI.

* Phase One environmental inspection.

* Real estate appraisal.

* Due diligence.

* Stock purchase and other agreements.

* Simultaneous sign and close.

* Asset versus stock acquisition.

* Timing of transaction.

* Impact on personal income taxes.

* Method of payment.

* Estate planning.