Calculated Growth

April 1, 2002
You've decided it's time to expand your business to the neighboring city. What is the best way to do it? Should you attempt a cold startup or set your

You've decided it's time to expand your business to the neighboring city. What is the best way to do it? Should you attempt a cold startup or set your sights on acquiring Bob's Rental City, which has been operating profitably in that area for the past decade?

There are many advantages and disadvantages to consider for each option as well as many questions that must be answered before you can begin the process. RER interviewed seasoned veterans of both the acquisition and startup games to find out what you should consider before jumping into an expansion with both feet.

One of the things to consider off the bat is whether you can make a return on the investment in the property. The answer, according to David Griffith, president and CEO Modern Group Ltd., must be yes. Another consideration to make is whether you will achieve an incremental business increase from the acquisition or startup.

To buy or not to buy

Acquisitions have many up-front benefits. For example, acquisitions provide you with an existing, pre-established customer base, which can translate to profitability from the day you take over.

“When you make an acquisition you have a faster revenue ramp up time because the phone is ringing immediately,” says Mike Watts, CEO of Sunstate Equipment, Phoenix. “You are developing an existing market share vs. starting from scratch trying to build one.”

United Rentals' president John Milne has a similar outlook on the advantage of existing relationships. “The benefit is that it takes the existing customer relationships and builds them from where they currently are rather than having to build them from scratch while at the same time trying to launch a new business.”

Your business already has name recognition in the marketplace, giving you brand equity. You already have an existing fleet in the rental yard and experienced employees behind the counter, and at all other points of the operation. In some instances the building may be an additional asset you obtain with the acquisition. Additionally, the phone numbers of that newly acquired location are already widely available, used and listed in the Yellow Pages.

“With an acquisition you have an ongoing enterprise that is flourishing from day one,” explains Fred Hageman, Hageman, Stansberry & Associates, Cameron, Calif., and Arlington, Texas, a 2-year-old consulting firm dedicated 100 percent to the rental equipment industry.

One of the drawbacks, however, to making an acquisition is that the buyer will be expected to pay some “blue sky” value, or goodwill, for the business. This value represents any sum paid that is above and beyond what the fair value of the business' assets are worth. Buyers must be careful to avoid paying more than the fair price for the business. Many rental companies employ a professional valuation service to make sure the agreed upon price is a fair one.

Watts suggests that acquired businesses can also saddle an operation with an aged fleet, presenting potential maintenance issues and burdens to the service department. Incompatible computer systems between the two branches may also cause some initial stumbling blocks. Buyers should be aware of IT issues prior to closing the deal. Does the company have the resources to overcome these concerns? In addition, the owner must have enough working capital after making the goodwill payment to run the business efficiently through the transition.

An acquisition also often produces issues of converging company cultures, which can be trickier in some instances than others. The key, according to Hageman, is to integrate the cultures and shape the business to a style that your pre-existing company employs.

“The pros [of an acquisition] far outweigh the cons if you do it right,” says Gary Stansberry, Hageman, Stansberry & Associates.

Starting from scratch

Expanding your business through a cold startup has its own set of advantages and disadvantages. One of the biggest benefits to launching a new branch is that you can do it with your own set of rules, on your own terms, using your own established system. You get to choose the facility and you can design the layout of the store and the yard. In short, you are in control of the look and feel of the whole operation. Plus, you can implement your own company culture from the beginning.

In fact, if you are considering starting a new branch to expand your existing footprint in the market you already have the benefit of name recognition. In addition, if resources permit, you can allocate any surplus fleet from your existing business or businesses to the new operation, which will represent a valuable cash savings at startup. Employees from other area branches can also be put in place to ensure that things get off to a positive start. Take advantage of the assets of your existing business and use those assets to help get your new establishment off to a good start.

“The startups that we do are really just an extension of what we're already doing,” says Bob Kendall, president, Star Rentals, Seattle.

Existing rental companies that expand through new startup ventures offer their current employees some upward mobility within their business. Suddenly, those employees that worked at your original business have an additional opportunity to excel when you launch a new branch.

“With a startup you can potentially have a better business model because you don't have to modify it,” says Milne. “Once you cross over to the critical mass point where you're finally profitable, you have the perfect business.”

Startup ventures do present the challenge of developing your market share from scratch, which is a much slower process. You don't have the benefit of acquiring an established customer base with loyalties already distinguished.

In smaller markets, you may be limited by the size of the market and the competition. Some particularly small suburban or rural areas may not be large enough to support more than one rental business. Likewise, some geographic locations may pose very challenging zoning issues that make settling on a location for your new business nearly impossible. It can also be difficult to find a suitable piece of property.

“A startup needs to be built around a product or service that is very strategic or has a lot of potential,” says Griffith.

“When you're walking into a cold start where the customers don't know your branch there can be 12 to 36 months of challenging times ahead,” says United's Milne. But Watts, whose Sunstate Equipment has opened many more stores than it has acquired, prefers the freedom to develop his own startup with the one stipulation that the process be done with an existing facility.

Star Rentals, Seattle, also prefers startups to acquisitions. “We are profitable with our greenfield startups in a very short period of time,” says Kendall.

But in many instances, according to Hageman and Stansberry, it can take from six to 12 months to move from the red to the black with a startup, and cost overruns are very common.

Getting in the zone

Unfortunately zoning issues can be a prohibitive factor in a rental business' attempt to expand to a particular geographic area. Rental businesses are often perceived as having a visually unappealing appearance, notes Stansberry. Trucks are coming in and out of the yard all the time during operating hours. Loud engines are abundant and one is seemingly always running somewhere on the premises. Dirty, oil- and fuel-contaminated equipment must be cleaned regularly and the wastewater disposed of properly.

“A lot of cities don't want a business like that to be visible,” Stansberry says. “They want to hide it back in an industrial park instead where there will be no drive-by traffic. You may find that you have to go to the next town over to do your startup.”

Stansberry has also noted a trend that more and more areas are anti-growth and especially anti-industrial. When launching a startup, you first must settle on a geographic location, and then select a particular site to build or an existing property to purchase or lease. Once these factors are determined, the challenge of obtaining all the appropriate permits can begin.

The human asset pool

People are often what make the difference between new business expansions that succeed and those that do not. “If you've got great people and good management, you'll be okay,” Griffith says. “But that's true with either method of growth — acquisition or startup. Good people can make things happen.”

If you don't have the right people in place when your doors open on day one, you better think twice before opening on day two without reevaluating your staff. It takes time to find and train the right employees. You want to make sure you have reliable people at each level of your operation, including drivers, mechanics, managers, counter personnel, sales staff and accounting clerks. Keep in mind that these employees will be dealing directly with your customers.

“Employees will make or break your new business,” Stansberry says. “You need to spend a lot of time in this area and get it right.”

His partner Hageman warns, “You'd better have trained people coming in — and they'd better be loyal.” If you're building a startup, he suggests having the people you want to help run the business in mind before you ever even break ground. If you're making an acquisition have some of your own people in mind before you seal the deal.

“We look for people who have done it successfully in the organization before,” says Griffith. “With greenfields we need to find people who are very passionate about the growth strategy. We look for folks who are looking for the challenge or an opportunity for career advancement. Often in the rental business, especially smaller businesses, advancement opportunities don't come up as often as you'd like them to.”

Watts, too, often recruits people from within the company, particularly if they are willing to relocate and be elevated within the company. Sunstate, however, often goes outside the industry in search of a certain type of personality that its management feels fits in well in the rental business also. For example, beer salesmen and ex-professional athletes often have similar characteristics and personality traits, according to Watts, which serve the rental business well.

Many times, good, quality experienced people come from the competition. These employees often have other acquaintances or co-workers with rental experience that are also looking for a new opportunity with a growing business.

You can also consider any outstanding people you've worked with in the past or any people that you know by reputation. “There are a lot of quality people out there who are frustrated with the companies they are working for,” Stansberry says. “Or maybe they are sick of the corporate culture and they want to get back in with an independent.” But, he warns, watch out for the job hoppers, or as Stansberry calls them, the “used tos.”

“You know,” he begins, “they used to work for this guy and they used to work for that guy. Just keep in mind that they used to work there for a reason.”

Avoiding culture shock

Integrating company cultures is often one of the biggest challenges of making an acquisition. Careful planning and a well thought out and proven strategy can alleviate some of the difficulties of integration.

Most successful managers do their homework and due diligence on the front end, according to Hageman. “They know the conversion requirements ahead of time,” he says.

In addition, there are several other things to keep in mind when dealing with converging two company cultures. Start by showing a genuine interest in the employees and listening to their ideas and concerns regarding the new business. Don't be too hasty in your judgments and decisions and be patient with both the people and the integration process. Take your time making adjustments and blend the two cultures over time. Identify the existing best practices of the newly acquired company and choose the ones you can incorporate into your culture. Following these guidelines will help motivate your team and help them buy into your business philosophy, Hageman concludes.

“The ones [integrations] that I have seen done well have done a lot of homework up front; they know the organization structure,” explains Stansberry. “They know the computer system and they talk to employees to get feedback from them. If you go in there with an open mind you may find out that they're doing some things better than you are,” Stansberry says. “You may find that you can learn a few things from how they were doing business before and they may learn some things from you as well.”

“There are probably half a dozen things that one side is doing better than the other side,” Stansberry adds. Take advantage of that. Use it to make your business better and use it to show your employees that you're listening to them and that you respect them.

Stansberry sees mistakes made when the new owners come in and make too many wholesale changes too quickly, forcing their business philosophy on the acquired company. This practice causes high employee turnover and can also alienate customers, he says.

Rental companies with experience making acquisitions generally have an established routine for integrating cultures.

“We are very systematic about the way we approach integration,” explains Milne. “There are certain things that have to be integrated after an acquisition. We do build in some flexibility for the nuances of certain areas but certain things just are not flexible.”

For example, the newly acquired company must be switched over to United's computer system within the first 30 to 45 days. “Otherwise we don't have the visibility of what's going on at the new branch,” says Milne. The acquired company must also operate under the United Rentals brand. Other basic policies and procedures such as billing, cash applications, safety guidelines and all the back office functioning must also be standardized. “Those policies are written so that we have the most efficient ways of doing business,” Milne says.

United Rentals' integration efforts are carried out by field operators and district managers. The company's structure is based around accountability. For example, the district manager is accountable for any new branches that are acquired in his district. He must ensure that those new branches are successfully integrated and he also must be held accountable for ensuring that new branches are contributing to the profitability of the district.

“We have an integration team made up of seasoned Sunstate people that go in and instill our company culture and our core value system into the acquired business,” says Watts. The integration team, which consists of about 10 people, is a combination of operational people and training personnel. The team works well for Sunstate, according to Watts, who notes that sometimes people with poor attitudes that are resistant to change force the team to exercise its right to make changes.

Expansion evaluated

No matter which type of expansion you've decided is right for your business, keep in mind that there are challenges posed by either method. Competition from consolidators, who are often willing to pay higher prices, can drive up the cost of an acquisition.

“Trying to justify the price is the biggest challenge of doing an acquisition,” says Star Rentals' Kendall, who knows what he is willing to pay for inventory and for a building. “It's easier for us to locate underutilized rental fleet to help supply a new branch.” Of its 15 locations, 14 Star Rentals sites were startups and one was an acquisition.

Upgrading the fleet of the business, post acquisition, to bring it up to the standard of your other fleet can also pose a financial challenge.

With startups, narrowing down the geographic region, locating a property and dealing with zoning issues pose some of the most significant challenges. “Finding the right location is the biggest challenge to opening a new branch,” says Kendall. “After that it gets easier.”

Star Rentals found an ideal location for its Olympia, Wash., branch, which will open later this year. Located on a main thoroughfare, where 45,000 cars pass by each day, it is situated across the street from a well-established lumber yard so contractors are already familiar with the area.

Take the time to evaluate your business' strengths and weaknesses to find the right fit. If you find something that works for you, stick with it. Remember that you not only need enough capital to make the acquisition or launch your startup, but you also must have enough capital to improve and grow the business.

Brandey Chewning Smith may be reached at [email protected].