It's not news the rental industry has been growing and thriving over the past several years, with rental penetration and overall growth projections increasing year over year since the economic downturn of 2008-2009. The ARA's Rental Penetration Index reports that rental penetration (amount of equipment working that is on rent vs. owned) has been increasing over the past 10 years, with 2014 reported at 53.9 percent, a significant increase from the 2005 Rental Penetration estimate of 40 percent.
According to the latest ARA's Rental Market Metrics reports, growth in construction and industrial rental in North America is expected to continue with a compound annual growth rate from 2014 to 2018 of 8.5 percent (10.3 percent in the U.S.). Bottom line is if your rental company isn't growing by 8 percent per year, consider yourself down.
These overall industry performance metrics have fueled the increased growth strategies of national, regional and local rental companies through acquisition, cold start and rental fleet purchases, but have also attracted significant interest from the financial markets. At The Stansberry Firm, we exchange phone calls and emails on a daily basis from various private equity firms and individual investors seeking opportunities within the rental industry. This financial market interest trend has been on the upswing especially in the past two years; and, unlike past "merger-and-acquisition booms" we have experienced, such as in the late 1990's to mid-2000s, these financial buyers are not only qualified, but are serious about their inquiries, with each party drilling down to very specific and well-thought out investment criteria.
With the rental industry's economic environment thriving, independent rental owners are presented with an excellent opportunity to explore avenues for securing additional capital, whether to facilitate a sale of the business as means of an exit strategy or to fuel ongoing company growth. At the moment, there are several paths business owners can take to gain additional capital outside of traditional means of bank or equipment lenders offering financing or seeking acquisition by a strategic competitor. One such path is tapping into the capital markets to explore a full or partial share of the equity in their business.
For owners exploring the possibility of a sale or those working to execute their business' expansion plans, it is essential to develop a clear and believable strategy for the company's long-term goals. Developing such a strategy requires the establishment of a sustainable business model through improving company financial reporting and performance and, instituting a solid foundation for proven and demonstrable operational practices that can be leveraged for future growth.
As The Stansberry Firm has advocated over the years, a good first step in this process is to focus on industry metrics and benchmarks such as fleet utilization, payroll and EBITDA margins. Rental business owners that are ready to explore these new capital sources will find achievement of these benchmarks is very similar to the investment criteria of these investors.
When considering alternatives for capital in today's market, business owners should ask themselves, “which type of investor or acquirer is best for my business?" And, possibly most important, "what type of investment or acquisition opportunity is best for my future and the future of my company?"
To answer these questions, owners must also evaluate their personal goals and their desires for participation in the ongoing operations of their companies post-acquisition. To do so, it is crucial to gain a full understanding of the types of acquirers in today's markets, as well as their investment criteria, transaction processes and long-term objectives in order to keep the owners' personal and professional goals in line with future objectives.
In an effort to assist independent business owners in their business planning, we have compiled a basic outline utilizing our experience and our extensive network of acquirers, both strategic and financial, to explain: who the financial buyers are, why they should be considered in acquisition opportunities and what to expect in a potential transaction.
Who are the financial buyers and how do they compare to strategic acquirers?
There are several types of financial buyers interested in the rental industry: private equity, high-net-worth individuals, and lenders willing to provide capital for growing companies. Compared to strategic buyers, many of the financial acquirers look at minority and majority interest in companies looking to sell or looking for additional growth capital, essentially "partnering" with the owner or management team of the company who will remain post-acquisition. In these instances, owners can take advantage of what we call "the second bite of the apple," profiting in the second sale of the company in future years, after the company has realized more of its growth potential.
Some financial buyers however, do look for full acquisition in order to build a multi-location regional or even national rental "platform" to diversify their current portfolio. For example, we recently completed an acquisition with a private equity group focused in the energy industry that bought an aerial equipment rental company in order to diversify its portfolio into a profitable, growing rental industry and decrease its investment concentration in the more volatile energy sector.
Debt financing has been another subject with increased attention from financial institutions, with private equity and investment banks seeking out competitive, growing rental companies with increasing debt caused by rapid growth. This debt may take the form of an asset-based loan where the company's rental fleet and other tangible assets have sufficient value to back the debt. In cases where a company is looking for capital to grow the business beyond its current asset base, often investors will "loan" the money on terms that reflect the risk of not having the assets to support the additional capital. Usually, this type of debt carries a higher cost, both in interest, as well as the investor potentially participating in the upside by being granted an equity position in the company, usually via an equity conversion feature.
What does the financial market offer and what does the transaction look like?
Typically, private equity investors plan to divest or sell their investments at a significant profit within a three- to seven-year time span, with five years being an average investment lifetime. In order to gain proper return, financial buyers seek out very well performing companies preferably with a solid competitive advantage, strong management and promising growth opportunities to guide the company on a desired revenue growth plan.
As mentioned, many times financial acquirers will require current company owners to retain ownership interest in the company, minority or majority, and may require ownership to carry a note or receive his or her funds via a pay-out plan based on pre-determined financial goals over a specific time period, generally two to five years. Regardless of the mechanism used, the practice of owners retaining an interest in the business via equity, note or other deferred consideration (referred to as "keeping some skin in the game”) is meant to ensure leadership's attention and focus with everyone benefiting through an increased business valuation at the time of the second sale.
In return, financial buyers provide selling entities with greater access to capital for more rapid growth, such as geographic expansion, increasing rental fleets and the related infrastructure necessary to accommodate such growth. In addition to being able to provide needed growth capital, the core competency of financial buyers is developing complex growth strategies; they typically have an extensive finance-oriented team to support the growth plans.
However, more so than with strategic buyers, financial buyers often rely on and retain the company's current management to provide the much needed operational expertise and experience within the rental industry to implement the growth strategy. The company's original employees, culture, and most practices will still remain essential under new ownership, resulting in fewer short-term changes than may be experienced with strategic acquirers.
What do financial buyers consider before pursuing an opportunity?
The uniqueness of the financial buyers we are experiencing now compared to those buyers of the rental industry in the past is the focus of each potential acquirer's interests. Today, investors are very educated on the rental sector and look for very specific attributes to pursue what they see as their best investment opportunity. Common characteristics of what nearly all investors look for include:
Strong competitive advantage: A differentiation factor YOUR company holds above its competition. What makes your company successful above others? This may be superior customer service, geographic market, sales and marketing practices, specialty equipment or a differentiating service or product offered.
Strong, capable management: A knowledgeable, experienced and successful management team is a key for all acquirers, financial or strategic. Any acquirer will look for competent management and support staff to remain in place post-acquisition; and, lack thereof will result in little or no interest from investors.
Reliable financials: Financial buyers especially will be very thorough in investigating and understanding a company's financial statements. Consistent and reliable balance sheets, income statements and asset listings (minimum three years) are essential.
Solid growth opportunities: Whether these opportunities are geographic expansion, increased market share through sales efforts, incremental rental fleet, or all of the above, financial buyers need to see a strong company with a promising future ahead.
Other important factors include: Location(s) in strong, growing markets; a well-maintained, quality, late-model rental fleet; reasonably low customer concentration and a reasonable debt-to-equity ratio.
What to expect in the due diligence process and post-transaction?
As compared to strategic buyers who employ experienced and proficient acquisition teams, financial buyers are more comprehensive, and often tedious, in their due diligence process. Private equity firms are essentially looking for high return on investment for their investors, to whom they ultimately report financial performance. In order to ensure a successful investment, financial buyers will typically attempt to structure the sale with terms most favorable to the acquirer, with financing terms and allocation of purchased assets strategically structured to minimize risk and costs to the acquirer.
The process can last 60 to 90 days or more, especially when outside lenders or partnering financial groups are involved. Financial data, asset valuations and other data items will probably take longer to review and will require patience from all involved. If notes and pay-out plans are included in the sale, various technical caveats will be implemented and these terms will require much more extensive negotiation than with a strategic buyer. Language in such negotiations can become complex and professional assistance from CPAs, lawyers and experienced sale representatives are essential in achieving a proper agreeable structure and to ensure the best possible outcome for the seller.
Post transaction, some company practices may be altered, such as purchasing processes and frequent operational and financial reporting to new ownership in order to ensure the company remains on path to achieve incremental revenue growth and improved margins. Some of these changes will be implemented immediately, while most will be evaluated in depth and implemented over a period of time.
The bottom line
In times of strong industry growth such as these, independent rental business owners should be looking towards the future, strategizing on how to improve all aspects of company performance and ensuring ongoing company growth. Considering important benchmarks and criteria demanded of acquiring parties will guide owners in developing a strategy that will fit their personal goals and guarantee company legacy, whether that plan involves selling or growing the company.
Working with financial buyers rather than strategic acquirers in acquisition can offer huge upside for independent rental owners, including securing the legacy of the company, facilitating more rapid company growth and offering opportunity for additional profit from sale at a future date. All transactions require significant amount of thought, consideration and negotiation, but transactions involving the capital market can prove even more complex and will likely require an experienced professional to navigate the nuances of the process. Whichever direction an owner takes, he or she can only expect to profit upon the level of effort put forth in the strategy and planning processes.
Carolyn Stansberry is the Director of Strategy at The Stansberry Firm and serves as the primary contact point at The Stansberry Firm for equity investors looking for investment opportunities within the rental industry. The Stansberry Firm, LLC specializes in business sales, fair market business valuations, operational consulting and positioning businesses to increase their value. More information on the company can be found at www.thestansberryfirm.com. Carolyn can be reached at (817) 965-9838 or by email at [email protected].
