SO, YOU WANT TO SELL YOUR LEASING BUSINESS By Bruce Kropschot There comes a time in the life of most entrepreneurial business owners when he or she starts to think seriously about an exit strategy. The owner may be contemplating retirement, doing estate planning or having health concerns. Sometimes the owner just becomes bored with the business or is suffering from burnout. In other cases, business factors, such as severe competition or lack of capital, may make a sale advisable or even imperative. Individual owners of equipment leasing businesses face special challenges in selling their business in today’s environment. Small leasing companies and lease brokerage firms face their own unique issues in finding a buyer willing to pay a premium value for the business. This article will provide some historical perspective to the acquisition market for leasing companies. I will then share with you some tips that I have found to be important in my many years of helping leasing company owners maximize the fruits of their labor; I hope they will help you in planning your exit strategy. Historical Perspective on Leasing Company Acquisitions The 1980s and the 1990s were decades of tremendous consolidation in the equipment leasing industry. The proverbial whales seemingly had an insatiable appetite for eating the minnows. The three largest equipment finance and leasing companies in the U.S., GE Capital, CitiCapital and CIT, are the surviving entities of what once were dozens of independent equipment leasing companies. Much of the earlier acquisition activity in the leasing industry involved either the large diversified financial service companies buying niche businesses or new entrants to leasing acquiring a platform business. The acquisition of small leasing companies and lease brokers did not become popular until the mid 1990s. The acquisition market necessarily follows the law of demand and supply, and the market is most vibrant when there are both many interested buyers and many motivated sellers. Of course, the relative motivation of a seller is generally heavily dependent upon the selling price that can be obtained, although the need for competitively priced funding has become a contributing factor for many sellers. Two factors combined in the mid 1990s to make small leasing companies and lease brokers more attractive to buyers. First, lease securitization became a popular method for larger leasing companies to finance small ticket leases, and many of these companies used gain on sale accounting to recognize much of their profits on securitized leases at the time of securitization. Second, the initial public offering market was receptive to leasing companies, and a number of small ticket lessors took advantage of this 2 opportunity to access the public equity market. Such companies included Granite, First Sierra, T & W, LINC and UniCapital, all of which were active acquirers of small leasing companies and lease brokers and all of which initially used gain on sale accounting for lease securitizations. These 5 companies made approximately 60 leasing company acquisitions in the mid to late 1990s. The acquisition of leasing businesses that had previously sold or brokered most of their leases was particularly attractive to the newly-public lessors because they could finance the leases originated by the acquired companies at substantially lower interest rates through lease securitizations. This advantageous financing and gain on sale accounting allowed the acquirers to recognize greater profits at the time of securitization than the acquired companies had recognized upon their sale or brokering of leases. However, in the second half of 1998 the gain on sale accounting method lost favor among investment analysts who follow leasing companies, and the 4 newly public leasing companies (excluding Granite, which was acquired by Fidelity National Financial in early 1998 and closed down in 2001) succumbed to pressure from the investment community to discontinue the use of gain on sale accounting for securitizations. This greatly reduced these companies’ earnings and had a dramatic adverse impact on their stock prices. The diminished stock values of First Sierra, LINC, T & W and UniCapital and the inability to show immediate increases in earnings per share by using gain on sale accounting for acquired companies’ lease originations combined to bring the small leasing company acquisition binge to an abrupt halt. Soon their rapid growth and problems related to the management of the growth led LINC, T & W and UniCapital into bankruptcy; SierrraCities.com (formerly First Sierra) survived by being acquired by American Express for less than its IPO price. The demise of most of the aggressive acquirers of small leasing companies and lease brokerage firms ended the short era of huge acquisition premiums being paid for such businesses. The market value of leasing companies that have little or no retained lease portfolio is not likely to ever recover to the acquisition pricing levels experienced from 1995 to 1998. Sellers of such companies must realize that most of their earnings are now recorded at the lease inception, but most acquirers will recognize income over the life of the lease. Thus most acquired companies without a portfolio will produce a loss for their parent company in the first year or two. This is unacceptable to many acquirers, and those acquirers willing to accept start-up losses will certainly discount their acquisition valuation accordingly. Who are the acquirers of leasing companies today? The large leasing companies are already in most of the markets they desire to be in, and many of the major bank leasing companies are busy integrating the leasing businesses that came together in the wave of bank consolidations. Despite the reduced demand for leasing company acquisitions and prices that are down from the peak, acquisition prospects for successful leasing businesses are not totally negative. A number of community and regional banks are 3 exploring opportunities in the leasing industry for the first time, and they could be good matches for smaller privately owned leasing companies and lease brokerage firms. Many such banks are very liquid, and the yields available in equipment leases are attractive to them. Also, private equity groups and venture capital firms have substantial funds to invest, and a few of these groups have recently considered investments in well-run equipment leasing businesses. For lease brokerage firms, other lease brokers or small leasing companies are potential acquirers, although an acquirer in the same business generally does not pay as high of a price as a buyer that does not have similar expertise. Timing of the Sale Since the business owner often does not know in advance when a sale of the company may become desirable or necessary, the owner should constantly be prepared for that eventuality. Furthermore, by planning for the eventuality of a sale as part of the company’s strategic planning process, the owner will be better able to optimize the timing of the sale. The owner who retains timing flexibility is better able to maximize the value of the business than the owner who is forced to make a quick sale for personal or business reasons. The optimum time to sell a business is generally thought to be when earnings are approaching their peak. However, it could be a mistake to wait until the company’s growth rate has slowed down and it no longer has the momentum that justifies a high price/earnings multiple. Buyers are most interested in companies that have several years of impressive growth and good prospects for the future. The owner should also remember that most buyers would want the top one or two executives to commit to a three to five year employment agreement. The value of the company will be diminished if an owner/CEO waits until retirement to sell. The timing of a sale can be influenced by factors not directly related to the company being sold. In periods of high interest rates, buyers generally pay less for companies than when interest rates are low. Similarly, demand for acquisitions is usually less during recessions, causing a softening of selling prices. Competitive conditions and industry trends can also be important to a seller in determining the appropriate time to sell. A business owner who has planned ahead will likely have a business that is ready to sell and more attractive to buyers than the owner who has not prepared for an eventual sale. Preparation for the Sale Following are some suggestions for owners on how to prepare their equipment leasing company for sale, whether that sale is expected in one year or ten years: 4 • If necessary, strengthen the management team. Much of the premium the buyer pays is for management expertise. Make sure there is both quality and depth of management, including one or more individuals with the potential to succeed the chief executive officer. (Of course, this may not be possible in a one-person lease broker business.) Buyers fear that an owner/CEO will not be as effective or as motivated to stay with the company after receiving a substantial amount of cash upon the sale of the company. • Try to sustain a stable growth pattern. Buyers are much more likely to pay a premium based on projected future results if the historical trend is one of steady growth instead of many ups and downs. • Become an expert in one segment of the market. Equipment leasing companies that specialize in one or a few market niches and service those niches well attract a wider range of prospective acquirers and sell for a higher premium than companies that are generalists. Also, companies that provide value-added services are more attractive than those that are in a commodity-type business. • If you do not have a lease portfolio, try to develop non-recourse or recourse borrowing relationships so that you can retain a portion of your lease originations. Some funding sources will provide servicing, and there are also firms that provide servicing on an out-sourcing basis. However, you should develop your own servicing capability as soon as your portfolio reaches a size where it is economical to do so. The more capabilities you have in-house, the more valuable you will likely be to an acquirer. • Obtain an audit of the year-end financial statements by a CPA firm if you have a retained lease portfolio; a review report by a CPA firm is likely to be sufficient for a company that does not have a portfolio. The CPA firm does not need to be a large national one, but it should have an established reputation in your local area, and the CPA responsible for your relationship should understand accounting and tax rules applicable to equipment leasing businesses. • Develop good systems for financial statement preparation and management reporting, consistent with the size and needs of your company. Prospective acquirers expect to receive timely interim financial statements and management reports. Since much of the buyer’s due diligence efforts will be directed to financial analysis, the seller’s credibility can be heavily influenced by the quality of the accounting personnel and financial reporting systems. • Use the preferred accounting methods, and err on the side of conservatism. Most prospective buyers will do enough due diligence work to uncover aggressive accounting practices for such items as bad debt reserves and residual valuations, so don’t be embarrassed by insupportable accounting assumptions. • Prepare detailed annual budgets and long-range projections. It is difficult to get where one is going without a road map. Every equipment leasing company, even one-person firms, should develop the discipline of preparing business and financial plans. The long-term strategic plan should be tied into the owner’s exit strategy. • Have an attorney experienced in equipment leasing review your lease documentation and internal procedures to make sure they adequately protect the 5 company’s interests. More than one leasing company acquisition has fallen through because the buyer was uncomfortable with the lease documentation. • As the time to sell the business approaches, retain a professional merger and acquisition advisor who understands the equipment leasing business and who has sold other equipment leasing companies. The experienced advisor can provide an indication of the company’s probable market value, recommend a deal structure that will best fit the owner’s needs, introduce prospective acquirers who are interested in acquiring equipment leasing companies, market the company’s strengths and growth potential and guide the owner through the selling and negotiation process. Most prospective acquirers have experience in acquiring other companies, whereas most sellers sell only once. Thus, sellers that do not have an experienced merger and acquisition advisor guiding them can be at a distinct disadvantage in the selling process. Getting your equipment leasing business in the best position for a possible sale is not an easy task. However, following the recommendations outlined above will not only make your business more valuable to a buyer but should also improve your business’s long- term prospects. You can be sure that competition for business will become even more intense in the coming years, and small companies that do not have the capital availability or borrowing costs of the major companies will be at a competitive disadvantage. However, the highly focused small leasing company that is always striving for improvement can continue to be successful. So, regardless of the timing of your exit strategy, as the owner of a small leasing business, you should always be looking for ways to make your leasing company more valuable. * * * * * * * * Bruce Kropschot is President of Kropschot Financial Services of Vero Beach, Florida, a merger and acquisition advisory firm for the equipment leasing and financing industry, which he founded in 1986. Mr. Kropschot has been active in the equipment leasing industry for 30 years and has served as a senior executive of 3 large leasing companies. Kropschot Financial Services has arranged the sale of over 130 equipment leasing and specialty finance businesses and numerous portfolios. The firm also arranges lease funding, subordinated debt and equity for leasing companies and performs business valuations. Mr. Kropschot is a CPA and holds BBA and MBA degrees in accounting and finance from the University of Michigan. He has served on the Board of Directors of ELA, EAEL and UAEL and is also a member of NAELB.
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