Buying a rental business
QUESTION: I currently own and operate several rental stores. I’m thinking of buying a competing store in a nearby town, but I’m not certain where to start. What should I be thinking about as I attempt to move this process forward?
Answer: In general, acquiring a rental business can be preferable to opening a new store for a number of reasons. Established sellers may have prime locations, facilities, staffs, software, customer bases and other established relationships that can make expanding into new markets much quicker and easier than attempting to grow organically into such markets.
Since the early 1990s, I’ve worked on dozens of rental company acquisitions and sales. Each transaction is different — stock vs. assets vs. merger; cash vs. seller-financing; equipment vs. party; heavy equipment vs. general tool; owned vs. leased real estate, and more. This makes the work interesting, but also tends to make it virtually impossible to rely heavily on document templates or “one-size-fitsall” approaches.
That said, there are some basic rules I generally recommend to prospective purchasers. Though it would be impossible to adequately address all of them in a single article, there is some basic information, excluding legal jargon to the extent possible, those interested in buying a rental business should know.
Transaction process. The acquisition process usually takes at least several months and, broadly speaking, tends to follow a path similar to this:
- An initial discussion, often initiated through a business broker or attorney with contacts in the industry, but casual conversations can generate valuable leads as well.
- A confidentiality/non-disclosure agreement is signed.
- Initial due diligence is conducted, usually consisting of a review of an offering package, summary financial statements and basic information pertaining to the company and its assets.
- A letter of intent, preferably non-binding, except with respect to confidentiality, setting forth basic deal terms prepared and signed.
- Commencement of “due diligence” inspection, which is the buyer’s examination of the seller and seller’s business in earnest.
- Negotiation of transaction documents, such as a purchase and sale agreement, assignments of equity or assets, real estate lease or sale agreement, noncompetition agreement, employment/consulting agreement(s), escrow agreement and financing documents.
- Completion of due diligence investigation, legal compliance, lien clearances and finalization of closing documents.
- Closing, which is the consummation of the transaction and payment of funds.
- Post-closing purchase price adjustments and related activities
Where to start. Now that you know what to expect by way of the mechanics of an acquisition, let’s back up and address some issues that factor into the decision to purchase a rental company in the first place. For a buyer, some of the most common — going from general to specific — are: industry and type of business, including equipment and customer mix, fleet size and overall growth prospects; market size, location and prospects; long-range planning, such as finance or strategic buy, roll-up and exit strategy; competitive environment; regulatory environment; efficiency enhancements and possible accretive value; tax implications; capital requirements; return on investment (ROI); managerial expertise, available and required; workforce quality and availability/company culture; intellectual property rights; vendor and supplier relationships; research and development capabilities; customer base; contracts, such as dealership agreements, real estate leases, floor-planning arrangements, maintenance contracts and more; outstanding debts and potential claims; price; purchase and sale terms; and, often most importantly, the desire to purchase a specific rental operation.
Haste makes waste. Though buyers are well-advised to consider at least the above factors, the reality is many are driven by only a few, or perhaps only one, overriding objectives. For example, the 1990s saw waves of optimistic buyers paying inordinately high prices based on “accretive value/roll-up” strategies, often having given little consideration to the true viability of the business or its assets. This proved a recipe for disaster in some cases. Whatever your primary goals may be, considering as many factors as possible can pay enormous dividends, particularly when doing so reveals an unanticipated problem or leverage issue. For example, even though “accretive value” may be the primary goal of a strategic acquisition, if a Phase I environmental investigation reveals high levels of contamination under the seller’s rental facility, the only way to realize the potential accretive value may be to require the seller to perform the necessary remediation before closing. Otherwise, “joint-and-several” cleanup liability may extend to the buyer, limiting or perhaps eliminating the accretive value proposition or worse.
He who hesitates is lost. Counterbalancing the call for caution is the need to move quickly to avoid forfeiting buying opportunities. Ultimately, buyers do best when they enter the market prepared. Knowledge of the industry, the market and the competitive environment in which the target business operates is critical. Having an established set of criteria for assessing different target businesses can help identify the best opportunities on an “apples-to-apples” basis, remembering that each operation will likely be substantially different from the others. Once a target is identified, knowing which areas of the business to focus on and asking the right questions of the seller can make the due diligence process far more helpful and far less time consuming. This knowledge also can help an astute buyer distinguish between reality and the wishful thinking that sellers sometimes understandably engage in. In any event, if investors and/or lenders are to be persuaded to provide funds for an acquisition, obtaining this information early on will go a long way toward both providing them the requisite level of comfort and establishing management’s credibility on the buyer’s side.
Trust but verify. Buyers should not be shy about requesting information before signing any documents beyond a confidentiality agreement. Potential pitfalls abound, making it essential to make a number of your own determinations as early in the process as possible, such as:
- Is the seller’s price reasonable?
- How do you, as a potential buyer, value the business? Is there a reason the business might be worth more to you than to the seller, for example, as an equipment hub or central showroom or warehouse? Can you realize any economies of scale and/or other efficiency enhancements by integrating the seller’s business with yours?
- What assets will you actually receive? Are those assets actually owned by the seller or perhaps another company owned by one or more of the seller’s principals?
- Are those assets sufficient to generate the revenues reported by the seller? Or, as suggested above, might some critical assets be owned by another party, such as delivery vehicles owned by one of the principals of the seller and used in, but not owned by, the business?
- Are the seller’s inventory counts accurate?
- What is the actual state of the equipment — age, hours, environmental compliance, maintenance, etc.?
- Has the seller been maintaining its equipment fleet and facilities or attempting to save money and inflate its income by, perhaps, foregoing important service and/or maintenance issues? This can be important because it may understate the actual maintenance and/or repair expense required to operate the seller’s fleet, it may result in material assets being unrentable and/or in need of disposal after closing and it may result in a significant overstatement of the value of the seller’s business — remembering that every dollar of unspent maintenance and repair cost goes to the seller’s bottom line profitability, which is then typically multiplied by an industry multiple — usually between 4 and 6.5 for privately held rental companies — to arrive at a sale price. So, $200,000 in unspent maintenance and repair costs could yield a sale price overstatement of $1,000,000 at an EBITDA multiple of 5 or more.
- How good is the seller’s location in terms of such considerations as access, potential for growth, visibility, traffic, crime, existing or potential use restrictions, infrastructure, and environmental compliance?
- What is the seller’s reputation in the industry?
- Are the seller’s financials credible, accurate and reliable, and can they be verified?
- Are any payables or receivables significantly overdue, and have any scheduled receivables been paid in advance?
- Do any “off-balance-sheet” liabilities, such as synthetic leases, unfunded pension, payroll, accrued vacation or sick leave, exist and, if so, how much/many?
- Is the seller’s market expanding or contracting? Are the seller’s customers knowledgeable and reliable or are they troublesome and/or slow-payers? Does the seller rely on any one customer or small group of customers for a significant portion of its revenues?
- Are new or large competitors entering the local market?
- Are the seller and the seller’s business currently in compliance with all applicable laws, rules, regulations, codes and ordinances?
- Are any proposed new laws going to affect the business, such as zoning changes, environmental laws, building and fire codes, use, height, noise, weight, capacity, lighting, security and/or other restrictions?
- Have all taxes on the seller, the business, the real estate and the assets of the business been paid in full?
- Is the seller’s real estate adequate and legally compliant?
- For instance, does it have wash racks?
- Does it contain asbestos or mold?
- Does it have adequate power, plumbing, heating, ventilating, air conditioning, security and right-of-way access?
- Is any of that likely to change in the near future?
- Is the real estate subject to any liens, claims, unpaid owners’ association fees, special assessments (current or proposed) and/or unpaid tax liabilities?
- Will you be buying or leasing (and for how long) the real estate?
- How will the purchase be financed?
- What key employees must you retain after buying the business?
- What contracts are critical to the continued operation of the business, such as dealership agreements, software and data provision, parts and supplies, equipment maintenance and floor-planning, and can such contracts be assumed by the buyer?
- Is there any litigation pending or threatened against the seller and/or the seller’s business?
- What, if any, insurance claims have been or will be submitted by the seller?
- What licenses and permits are required, and are any of those which are currently maintained by the seller transferrable to the buyer?
- What will the tax effects of the transaction be? This can differ substantially among transaction types and may well affect the purchase price.
- How easy or difficult will it be to integrate the seller’s business with your current business?
Many prospective purchasers feel uncomfortable requesting the information necessary to answer these questions, or they may simply not know what questions to ask. An attorney experienced in buying businesses will, however, know the right questions to ask and will have little problem sending a “Due Diligence List” to the prospective seller. Sellers sometimes chafe at providing the requested information, but persistence can pay big benefits — and if a seller ultimately refuses to provide it, the buyer should think carefully about whether proceeding with the acquisition is prudent.
Buying an existing business can be an effective means of entering or expanding a business within the rental industry, but it can be nightmarish if it is not done with a great deal of care. That starts with obtaining the information about the target business necessary to make an educated decision regarding whether and how much to pay for it. The information discovered in the “due diligence” process can be crucial and virtually always necessitates modifications to the price, the terms and the documents.