Setting a value for a business: It’s more than just profit and loss

When the purchase of an existing rental operation is involved in either getting into or exiting the rental industry, a valuation of the business in question is one of the key ingredients to that process. While the financial element is a key part, it is not the only critical aspect to be assessed when a valuation is conducted.

“There is so much that goes into the assessment of the value of a business,” says John Haener, CPA, president, Vendo Rental Solutions, Rockford, Mich.

Haener says his company’s 10 primary criteria in the valuation include:

Financial performance trending: “This is the revenue and earnings before interest, taxes, depreciation and amortization (EBITDA) performance for the three years leading up to the sale to see whether it is trending up or down. We want to see how the revenue and EBITDA are trending during the sale process, too,” he says.

Revenue base: The level of revenue can have an impact on what multiple is used to calculate the traditional valuation metric of multiple X EBITDA calculation.

Profitability: This includes adjusted EBITDA/CapEx, which is the amount the company is spending on new rental equipment purchases each year/free cash flow. “The profitability of the business measured by EBITDA is very important, but the level of CapEx spending needed to support the business ongoing and the ultimate free cash flow level of the business is how a buyer candidate will assess profitability,” Haener says.

Industry multiple comparisons: “The traditional valuation metric of multiple X EBITDA requires a determination of a multiple. We look at industry comparisons for publicly traded rental companies, their recent acquisitions and our own data for private transactions the Vendo Rental Solutions’ team is exposed to and assess a multiple for any given transaction,” he says.

Buyer return analysis: “We perform detailed financial modeling putting ourselves in the shoes of different types of buyer candidates and assessing their respective expected returns and then compare that to value levels arrived at from the various valuation criteria,” he says.

Asset base: “This includes the rental equipment and other assets. The revenue and cash flow they can generate are an important component of the valuation,” he says.

Strategic factors: This can provide a strategic advantage to a buyer candidate and can impact value.

Niche factors: Assessing whether the business has a unique component to its business model that helps differentiate a business from the competition can impact value.

Geographic factors: “We look at whether the business is located in a certain climate condition or demographic that can impact value,” he says.

Infrastructure factors: “We look at the experience and tenure of a management team and staff, the quality of systems and facilities as well as other infrastructure-related factors that can impact value,” he says.

“The financial performance trending of a business impacts the valuation of a business,” Haener says. “In working with sellers, we emphasize that it is very important for them to stay focused on running the business during the sale process.”

“There is no simple, mathematical formula to evaluate a business,” says Ed Latek, president, Latek Capital Corp., Lake Forest, Ill. “One of the more serious mistakes we see an investor make is attempting to value a rental business based purely on a simple multiple of EBITDA less MCapEx (maintenance CapEx). While EBITDA is of most importance in valuation, it is only one facet of the overall value. Just as grade point, SAT and ACT scores are very important in being considered for admission to top-flight universities, we know well that there are many other factors considered in evaluating an applicant. The same applies for valuing a rental business — attempting to produce such through a computer program is like trying to tell the history of the world by reading Reader’s Digest.”

A critical aspect of the valuation is “whether the business is generating a consistently good profitability margin,” Latek says. “The margin level varies according to whether the business is equipment or event rental, and, of course, by revenue amount.”

Going along with this is whether current ownership/management has built a strong management staff and management structure under him or her. “You have to have strong, competent management for the business to be attractive to investors, be they a private equity group, family finance office or high-net-worth individuals. Most do not wish, nor are they capable of running the daily operations of the business. You need to be building your next person in line who has the education, age and management ability. And of course, it doesn’t stop there. There also must be a strong mid-level management team developing under him. The organization must be solid and strong,” he adds.

There also needs to be a “strong business plan and solid approach to the market being served, operating policies and processes, as well as being located in a facility that properly accommodates the business, allowing for attaining good productivity,” Latek says.

“You could have a $1 million business that is in a small, out of the way area,” says Gary Stansberry, president, The Stansberry Firm, Boerne, Texas. “That makes it difficult to market that business. Or if they have leased a facility from a third party and that lease is about to expire and there is no other place to go.”

Age of fleet is so important, adds Dan Crowley, founder and president, Peer Executive Groups, Coopersburg, Pa.

“A rental fleet is refreshed at a certain rate — usually five to seven years for much of the equipment, depending on asset class. If we discover the fleet age is off from that norm, the owner may face a ‘discounted’ offer due to the buyer’s need to invest more in the short term to get the fleet ‘right.’ I would say, equally, we have discovered a significant percentage of the fleet refreshed in the past couple of years, which would then net the seller a ‘premium’ on their offer,” he says.

All agree that the financials are the most important, but it also is all those other factors that can impact the valuation of a business.