Selling a Rental Business – How Hard Can It Be?

Question:   I’m thinking of selling my rental business, but frankly, I don’t know where to start.  Who should I contact, and what should I do (and what I not do), to prepare my business for sale.

Answer:

You are not alone.  Selling a business is complicated, so knowing where to start is critical.  I’ve bought and sold many equipment rental and other businesses over the past 20 years.  Although each transaction is different, some common planning issues should be considered by virtually all potential sellers.  Here are the most important in my opinion:

  1. Consider Your Personal Objectives.  You don’t necessarily have to make final decisions about everything before getting started, but it’s good to have a general idea of what you’d like to accomplish in terms of:
    1. Sale price – how much and when the sale proceeds will be paid to you;
    2. Continuation of the business – will it continue in its current form, be dissolved, or be absorbed into the buyer?;
    3. Continuing, or not continuing, to work in the business after the sale closes (what do you want to do after the deal closes?);
    4. Working for someone else (perhaps a competitor?) at some point after closing (knowing that you will almost certainly be required to sign a non-competition agreement as part of the transaction);
    5. Providing for your employees – i.e., continued employment, wages, salaries, insurance, bonuses, benefits, promotions, and/or perhaps even a portion of the sale proceeds;
    6. Liability issues – usually involving efforts to avoid or limit existing and potential liabilities and critically, eliminate personal guarantees of company debts and contract obligations;
    7. Post-closing income – for example, real estate which continues to be owned by the seller and is leased to the buyer after closing; and 
    8. Tax effects – these can be very different, depending on the structure of the deal (e.g., assets vs. equity; cash vs. installments; employment vs. consulting vs. earnout vs. lease payments).
  1. Measure Twice; Cut Once.   

After making preliminary decisions regarding the issues raised in Paragraph 1, but before spending a great deal of time and money preparing your business for sale or contacting brokers and potential buyers, contact your accountant or a business valuation consultant, and get a realistic assessment of what your business is worth.  It makes no sense to spend valuable resources pursuing an unattainable target.  

  1. What Light in Yonder Window Breaks?…

So what is “attainable?”  It depends to some degree on the current state of the market, your location(s), your asset ages and values, and your business prospects (and beauty is in the eye of the beholder, not to mention the beholder’s financing sources), but in my experience, most equipment rental businesses have generally proven to be worth somewhere between 4.0 and 6.5 x EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), which in this industry, often works out to be fairly close to 1.0 to 1.2 x Annual Revenues (Note: Valuation experts may argue about this, and they sometimes manipulate the numbers to get closer or further away from it, but in my experience, this is a good place to start if what you need is a general idea of what your business is likely to be worth).  

So, take your last three years’ net earnings, and add back any “extras” like salaries, bonuses, perquisites and perhaps rent you paid yourself and/or your family members that are, in fairness, more than you’d pay to third-party employees in the same roles.  Then, also add to that number the interest, taxes, depreciation and amortization you took.  Now: (a) divide the total by three; (b) multiply the quotient by 5.25; and (c) compare it to your average total annual revenues for those three years.  If the two numbers are very different (by more than about 25%), stop and contact a business valuation professional before proceeding further.  If they’re fairly close, this is a reasonable starting point for assessing the likely sale value of your rental business (Note:  Several different types of valuation methods have been proposed over the years, including EBIT multiples, discounted cash flows, net asset values, etc., each of which has some merit, but at the end of the day, the EBITDA multiple is the one that is virtually always at least referenced, if not primarily relied upon).  

  1. Hold That Ferrari Order:  If, based on your initial (rough) valuation, you decide to proceed, do so with the knowledge that only a small part of the work has been done, and that the “due diligence” process (the potential buyer’s investigation of your business) may substantially affect the final purchase price.  Consequently, some early preparation can add a great deal to your ultimate sale price (remember, at a 5 multiple, $200,000 in expense reductions will yield $1 million in additional sale proceeds, other things being equal).  With that in mind, here are some steps to take to prepare your business for a sale:

(a) Remove real property and assets used primarily for personal use from the business

(i) Purchase these personally used assets from the business at book value (e.g. car, computer, etc.);

(ii) Consider transferring out of the rental business any real property and putting it into an LLP or LLC, so it will not be included in the sale (real property can often be leased to the buyer, thereby providing an ongoing revenue stream, after closing; it can also be invaluable as leverage in the event of a post-closing payment default by the Buyer, not to mention as a jumping off point if you ever buy/take the business back);

(iii) Discontinue running personal expenses through the business;

(b) Clean up the business (physically and figuratively)

(i) Discard scrapped equipment and clean, service and update your records on all remaining equipment;

(ii) Make certain all usable assets appear on your books;

(iii) Make certain all licenses and permits are up to date;

(iv) Ensure parking areas and landscaping are in good order, condition and repair;

(v) Limit, but don’t discontinue or substantially decrease, fleet purchases (this is a red flag for business buyers);

(c) Address and, where possible eliminate, potential liabilities

(i) Negligence and products liability claims;

(ii) Environmental issues (get a Phase I Environmental Study, make any changes/corrections as required in the report);

(iii) IRS audits;

(iv) Employee lawsuits;

(v) Insurance disputes, etc.

(d) Recast financial statements (P&L and Balance Sheet), and in doing so, discuss each of the following with your accountant or valuation expert to see which, if any, of the following he or she recommends:

(i) Recasting and depreciating capital expenses which may have been expensed;

(ii) Adjusting for personal expenses run through the company;

(iii) Adjusting for over or under expenditures in officers’ or owners’ salaries, automobile expenses, retirement plans, life insurance policies, rent (if you own your building and lease it back to your company);

(iv) Removing expenses or income that will not continue after the sale (e.g. discontinued products and services, gains or losses from the sale of business assets, etc.)

(v) Removing interest payments for any business loans not to be assumed by the buyer;

(vi) Removing owner/officer loans (on the balance sheet) to/from the company;

(vii) Removing assets not included in the sale;

(viii) Removing slow moving, obsolete inventory;

(ix) Valuing assets at replacement value;

(x) Writing off accounts receivable that are uncollectible; and

(xi) Removing other debt the buyer will not assume.

(e) Prepare financial projections for next 3-5 years;

(f) Make certain all employment documentation is up to date for each employee; and

(g) Make sure any new contracts you sign can be transferred to a buyer at a later date

  1. Settle Legal Claims.  As suggested above, the existence of litigation or potential litigation can weigh down a sale price substantially.  Even though a seller may be intimately familiar with a given case, a prospective buyer will not be, and the “risk of the unknown” (particularly if the claim is large, irrespective of its legal merit), can create more concern than is justified (which can stall or kill an acquisition).  This is even true, though to a lesser extent, in asset sales, where, despite the usual “cutoff” of liabilities associated with purchasing assets alone, an “entity transfer” or other similar legal theory might be used by a plaintiff to pursue some or all of those assets.  If any outstanding litigation can be settled on reasonable terms before marketing efforts commence, sellers are wise to consider doing so.  Remember, the savvier plaintiffs’ attorneys out there know the rules too.  If a potential sale has already been publicized or become the subject of the industry rumor mill, the price of settlement may go up (and your sale price may go down by as much or more).  If any litigation remains outstanding as of the closing date, the seller can expect, at a minimum, to have to provide a broad indemnity to the buyer.
  1. Hire a Professional.   Rarely do I encounter a client who wouldn’t prefer to forego paying a commission or consulting fee (or legal fees, for that matter) in connection with the sale of a business.  But it’s just not realistic in most cases, unless you’re one of the lucky few who happen to encounter a buyer who is both willing and able to pay the price you want (it happens once in awhile, at a convention or a trade show, but it’s definitely the exception).  To begin with, time (yours and the buyer’s) is limited, and neither of you has the time to investigate and pre-qualify each potential buyer or seller.  Secondly, negotiating a business sale requires a great deal of experience and knowledge.  Few buyers pay cash at closing anymore.  Beyond negotiating the base sale price (which itself, can be a weeks or months-long exercise), a number of questions must be answered in order to move the deal from an idea to a closing (take a look back at the list of objectives in Paragraph 1 for a partial list of issues that will likely have to be negotiated and factored into the deal).
  1. Don’t Believe Everything You Hear.   The world seems to be filled with “experts” and “critics” these days, and both tend to use jargon like “MBOs,” “LBOs,” “reverse mergers,” “earnouts” and “clawbacks” as if anyone who isn’t familiar with those terms must have been living under a rock for the last 50 years.  Don’t be intimidated (or particularly impressed) by the use of industry-speak, and be cautious of people who overuse it (particularly if they do so incorrectly) and/or offer you strangely optimistic promises; for example, “buyers who are ready to close within 30 days, if you’ll just pay us an ‘onboarding fee’ of $25,000 up front” (Note: A small fee for some preparatory work such as a valuation and/or some marketing might be in order, but for small and mid-sized rental companies, it’s generally not more than a few thousand dollars, and can often be waived).
  1. “Three Can Keep a Secret … if Two of Them are Dead” (Benjamin Franklin).  Finally, never enter into extended discussions with potential buyers who haven’t signed a properly written Confidentiality Agreement or NDA (“Nondisclosure Agreement”) which prohibits not only further disclosure, but also the prospective buyer’s use, of your confidential information (remembering that some buyers may, now or in the future, be your competitors).  It is generally also a good idea to be extremely discreet about disclosing to customers, vendors and/or employees the fact that you are considering and/or negotiating a sale of your business.  Some will be threatened; others will see it as an opportunity to seek raises, promotions, additional benefits, and/or price increases.  Don’t ask for trouble. You will busy enough with the preparation and due diligence investigation involved in your potential sale.

Conclusion:

Selling a business can be immensely rewarding if done properly.  It can also be a massive drain on profitability, not to mention your relationships with vendors, customers and employees, if done improperly.  So, consider your options carefully (and quietly), and if you decide to proceed, feel free to call us.  We can help.  

About the Authors:

James R. Waite is a business lawyer with over 20 years in the equipment rental industry. He authored the American Rental Association’s book on rental contracts, and represents equipment lessors throughout North America on a wide range of issues, including corporate law, employment issues, negotiating and drafting rental contracts, purchase options and other rental-related agreements (including Damage Waivers), as well as buying, selling and financing rental companies and their equipment.  He is a veteran of the United States Air Force, has a BBA in Finance from the University of Texas at San Antonio, a Juris Doctor from St. Mary’s University, and an MBA from Northwestern University.  He can be reached at (866) 582-2586, or via email at j.waite@wwlegal.net. 

Co Authors:   Bryan D. Biesterfeld, Esq.; Peter T Moore, Esq.