If you read the first part of “How much is your equipment rental business actually worth”, welcome back! In the first blog, we talked about general principles of how to value any small business. Now we’ll try to apply this knowledge specifically to equipment rental companies.
The good news is the equipment rental industry is showing healthy signs of growth and that fact doesn’t seem likely to change for a number of years. A fundamental shift in the equipment rental market happened after the great recession of 2007 to 2009, when equipment users realized there were many advantages to renting equipment instead of purchasing new units. There were a number of reasons but I think many contractors found themselves with having a lot of idle construction units and some serious bank loans. Auction houses became very busy.
If any industry segment is growing and profitable, there will be buyers. The equipment rental industry is no different as acquisition is the easiest and fastest way to show growth for the consolidating entity. I am sure you have noticed there is a press release almost every month about either United Rentals or Sunbent Rentals picking up another rental business and they are not the only ones. Some rental industry leaders seem to make a living out of starting a rental business, selling it, and then waiting for the expiry of their non-compete clause in order to start up a new rental business.
You are in an excellent space. This document will provide you with some rental-specific information to use when doing a self-evaluation on your rental business and getting it ready for sale.
Divestopedia.com released some interesting statistics in February, 2017. They didn’t give any details regarding the period of time covered by the numbers but they are still useful for comparison to your situation. They noted the following:
- 60 total sales of equipment rental businesses
- Average sale price of $302,457
- Median sale price of $202,500
- Total value of all businesses sold was $18,147,400
- Average earnings multiple used for valuation purposes was 2.25
You might be disappointed to see the average sales price of $302,457 but everything is based on the size and profitability of your company, which we discuss in the following paragraphs.
First, let’s review the calculation details from Part One of this blog.
At this point, let’s remind ourselves again a business is only worth what someone else is willing to pay for it. Nothing else matters when selling your business. Even if you don’t need to sell immediately being objective is a necessary first step in helping you to set an appropriate value and prepare your business for sale. If you want to maximize your value, you will need to show consistent growth and profit for a three year period, which might mean you need at least that long to prepare to sell.
Use an earnings multiplier method to value your equipment rental business
We covered the earnings multiplier method in part one, but it bears repeating here. In plain English, this means you are looking for a multiplier to apply against your projected earnings, which are usually based on historical earnings. Based on the Divestopedia number mentioned earlier, equipment rental companies have a multiplier of 2.25. If you had a three year earnings average of $100,000, your company would be worth $225,000.
The 2.25 is not a fixed number. Your goal is to improve your business and adjusted earnings to get to the higher end of multiples for your business.
Factors increasing your multiplier include:
- Showing consistent growth in sales and profit over a number of years, usually a minimum of three.
- A strong reputation in the industry and community.
- Strong economic climate, even if this is out of your control.
- Better than average assets including real estate and equipment.
- Formalizing as many of the intangible assets as possible, i.e. trademarks, branding, etc.
- Positive reason for sale as any hint of forced sale for reasons such as health of a principal can seriously reduce the value, so sell before you have to.
- Strong internal systems as the user will want the business to run smoothly when you stop managing it.
Three Steps to valuing your business
1. Calculate adjusted or discretionary earnings
As good as your accounting records may be, prospective buyers will not use your reported earnings to calculate the business value. Instead, they will start with those numbers and “normalize” them to get something called Seller’s Discretionary Earnings (SDE), which better represents the business’ true profit potential. The following items are some adjustments that might be made to get to SDE.
- Non-cash expenses including depreciation and amortization.
- Financing expenses such as interest on short and long-term loans.
- Any personal expenses included in the calculation of income.
- Arbitrary expenses such as excess entertainment or travel.
- Charitable donations.
- Owner’s salary and benefits, although if the owner is actually managing the business, a reasonable amount may have to be added back to hire a replacement manager.
- Any family salaries not required in the new business.
- Any one-time expenses or revenue unlikely to recur, such as the settlement of a lawsuit.
Generally, most of the adjustments will increase your SDE, and therefore your business valuation, so don’t be shy about digging out those numbers. The prospective purchasers are not the tax auditors!
2. Determine the final SDE multiplier
You have a number of 2.25 but keep that in your back pocket when talking to prospective purchasers. If they offer more, you’re good. If they offer less, you know to ask for more.
3. Adjust SDE for other business assets and liabilities
The SDE obtained may not include all assets or liabilities so adjustments may need to be made.
In many cases, purchasers won’t want to assume possible liabilities your business may have incurred and this results in many purchases being treated as an “asset” purchase in order to freeze any potential liability. As a result the business liabilities may be retained by the original owner, who will be responsible for settling them. Another example is the SDE may not include the value of inventory so this may need to be adjusted. Or there may be excessive real estate holdings. You get it. There can be many possible adjustments but the following example is a good starting point.
For a business with a three year average of $200,000 net income with the following details:
- Annual depreciation and amortization of $25,000
- Annual mortgage interest of $25,000
- Personal expenses of $25,000
- Owner’s compensation of $125,000
- New business manager’s salary of $100,000
The calculation of SDE would be:
- Net income of $200,000
- Plus: $25,000 + $25,000 + $25,000 + $125,000 = $200,000
- Minus: $100,000
SDE = $200,000 + $200,000 – $100,000 = $300,000
For a business with an SDE of $300,000 with the following details:
- Multiplier of 2.25
- Net equipment of $400,000 excluded from multiplier
- Accounts receivable of $100,000 excluded from multiplier
- Cash of $50,000 excluded from multiplier
- Accounts payable of $75,000 excluded from multiplier
The calculation of the adjusted valuation would be:
- SDE of $300,000 x 2.25 = $675,000
- Plus: $400,000+$100,000+$50,000 = $550,000
- Minus: $75,000
Final calculation = $675,000 + $550,000 – $75,000 = $1,150,000
Here’s a few points to consider, when you actually get around to selling:
- The bigger your business, the larger multiplier you can ask for.
- Businesses with under $1 million in sales are better off being sold through a broker.
- Larger businesses, up to $50 million in sales are better off with merger and acquisition (M&A) specialists.
- Much larger businesses should probably be sold through investment banks although the M&A people will have a different opinion about that.
- Make sure your sales agency is experienced and ideally with equipment rental companies – each industry niche has its own contacts and unique twists.
- Legitimate growth is very attractive to prospective purchasers as they are looking for ways to leverage the purchase to drive even more growth – don’t just sit on your laurels, keep driving for change and growth.
- Make sure you are one of the top market leaders in whatever space you choose to occupy.
- Make yourself, as an owner, dispensable – the new people will want to run the business without you.
- Make sure you have solid processes and system in place – no one wants to take over a mess or too many manual processes.
- Strive for a unique value proposition that is not easy to copy by your competitors.
- Make sure your fleet is as up-to-date as possible and with service up-to-date.
- Make sure there are no surprises for the person reviewing your books – they don’t want to find a bunch of hidden personal expenses or shoddy bookkeeping.
- Make sure your books are as clean as possible and remember that removing doubtful and discretionary expenses will only serve to drive up your net income and therefore your business valuation – this is one time you want to maximize your income, not like when you file your tax returns .
The general principles of how to value an equipment rental business are the same as any other small business. What is different is the amount of equipment involved and the general profitability of the sector.
Make sure you know exactly what is included in the SDE, whether the offered multiplier is 2.25 or something else. Purchasers can have their own definitions of what is included in the SDE. There is no firm industry standard so make sure you talk to experts who represent your best interests. People will often focus on the SDE and the multiplier, two numbers relatively easy to understand and apply, but if the SDE includes or excludes something major you weren’t expecting, you can be out hundreds of thousands of dollars. Call in the tax planning experts.
You get one shot at this. Do it right and good luck!