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Seller Question #2: How is My Equipment Handled in a Business Sale?

Seller Question #2: How is My Equipment Handled in a Business Sale?

When you sell your company, the equipment used in the operation is included in that sale. Any asset that helps you generate revenue is part of your overall enterprise value, and those assets (in almost every case) need to be conveyed to the buyer free-and-clear of all debt as part of an asset sale, which most transactions are. While this sounds simple enough, many business owners have circumstances surrounding their equipment that they’ve never really thought through or aren’t sure how to handle. Here are some general guidelines for you to consider when it comes to your equipment when you sell your company.

Equipment and Business Value

Every business in every industry has some sort of equipment required to keep the business running.  Your company may only require a desk, a computer, and a phone to operate, you may have tens-of-thousands of square feet filled with manufacturing equipment, or maybe your business maintains a fleet of 50 service vehicles – whatever the case, all of the equipment your company uses to operate and produce revenue is included in the sale of your business.

In the vast majority of industries, a business’ value is determined primarily by a multiple of its EBITDA or seller’s discretionary earnings (SDE), and the value of the equipment is included in that calculation. The underlying thought in these scenarios is that the assets are what ultimately produce revenue and EBITDA, so the multiple applied to that EBITDA takes into account the value of the equipment.

There are some industries where the valuation standard calls for the value of the equipment to be added on top of the business value, but in those instances, the EBITDA multiple is lower to account for this.

Now that you understand how and why equipment is included in your business sale, there are some other important factors you need to be conscious of as you prepare to take your company to market.

Financed Equipment

Most businesses have debt on equipment, or at least have debt that collateralizes the assets of the company even if that equipment is paid for. The essence of an asset sale, when it comes to debt, is that all equipment and assets must be transferred free-and-clear of any encumbrance. Simply put – you’ll need to pay off the business debt at or prior to closing.

Most business owners address this by obtaining payoff statements from their creditors and providing those to the closing attorney or escrow agent. When closing occurs and the proceeds of the sale are deposited into escrow, the funds needed to pay off the debt will be distributed to the creditors directly, with the balance of the funds going to the seller. So it’s all handled at closing through escrow.

In some cases, business owners don’t consider the impact that clearing debt will have on the final proceeds of the transaction, and that can be a major wake-up call. So it’s critical when you are considering the financial benefits of selling your company to factor in the cost of clearing the business debt.

It might even make sense to delay the sale of your business in order to pay down the debt to a more acceptable level. If time is something you have the benefit of and you aren’t in a situation where you absolutely want to sell and need to sell, paying down the debt can be a good option.

Let’s say you owe $150,000 with five years remaining on your debt, and you currently have a business generating $250,000 in EBITDA that’s valued at $750,000. After the sale, you would net $600,000. But if you kept the business for two years and reduced the debt to $90,000, not only would your net proceeds from the sale increase to $660,000, but you would have also earned another $500,000 in cash flow from the business – so your true comparative benefit for waiting two years to sell would be $1.16M vs. $600,000, assuming the business stayed the same size.

New Equipment

Whether or not you finance the addition of new equipment or you pay for it outright out of the business profit, the idea of including relatively brand new equipment in the sale of a business doesn’t sit well with many owners.

Consider this, two HVAC companies could have the same total revenue, the same EBITDA, the same number of employees and the same number of trucks that are well maintained and in good working order with plenty of useful life left. However, one of them has trucks that are six months old and valued at $300,000, while the other has trucks that are 36 months old and valued at $150,000.  These businesses are going to ultimately sell for basically the same price because the business value is primarily based on a multiple of EBITDA, not the value of the assets that produce that EBITDA.

As described above, with large amounts of debt on assets sometimes the best course of action might be to delay the sale of a business if the assets are so new that the owner hasn’t had the chance to realize any benefit from them. By waiting to sell you can depreciate the asset, which provides immediate financial benefit to the business, while you generate profit utilizing that asset. Then sell the business when the value of the equipment has reached a more reasonable level and you’ve been able to more adequately benefit from owning it.

Old Equipment

While a business owner might shy away from selling a company with brand new equipment, the other side of that coin is the buyer who is going to shy away from acquiring a company with equipment that needs to be replaced.

As a general rule, if you look at your equipment and think it needs to be replaced soon, then a buyer is going to think the same thing, and then some.

This is not to say that your equipment needs to new by any means, nor will you be required to represent and warrant that the equipment will remain operational beyond closing for the new owner. You just need to be conscious of the age and condition of what you are including in the sale.

A lot of this is common sense. If your business’ equipment is in good working order and you have a fairly consistent amount of sustained capex (not taking into account growth), then a buyer has a pretty good idea what to expect in terms of future capex and the production your assets generate. However, if your equipment costs tend to fluctuate cyclically, you are nearing the end of that cycle and it’s getting to be time to replace some equipment, a buyer is going to want to try and account for that by possibly reducing the price of the business.

Leased Equipment

Most equipment leases are expensed through the business, whereas financed equipment is capitalized and only the interest is expensed. What that means is that businesses that lease equipment and expense that lease has that cost baked into the EBITDA and ultimately the value.

Theoretically, when a buyer acquires the business the cost of the lease is just another expense line on the P&L, and the lease agreement is just assumed by the buyer.

Not so fast. Most leasing companies don’t allow a transfer of the lease to another party, so you’ll need to read your lease agreement to see what the specific term are and also talk to your leasing company about your plans to sell your business and how to handle the leases. In some cases, they’ll allow a transfer but in others, they will require you to pay off the lease in order to convey the equipment to the new owner.

Personal Assets and Your Business

Many business owners have another equipment conundrum – either the business owns an asset that the owner uses personally, or the owner personally owns an asset that the business uses.

Just because your Corvette and your Malibu speedboat are on the company’s balance sheet and paid for by the business doesn’t mean they go with the business when you sell it. Assets like these that are purely personal and have no use in the operation of the company simply need to be disclosed in the beginning stages of the sale process and excluded from the deal.

While that’s simple enough, it gets a little trickier when you personally own an asset that is clearly important to the business – these assets need to be included in the sale, regardless of if you would prefer to keep them or not. Ultimately, if the business uses it to produce revenue, then it comes in the sale. You may need to transfer the asset into the company’s name prior to closing, or you could do a separate sale agreement with the buyer for those personally owned pieces.

The Bottom Line is Timing

When it comes to the subject of equipment relating to the same of your business, the most important thing to keep in mind is timing. Be mindful of your equipment situation and don’t plan the sale of your business without considering the financial impact it will have on the net proceeds from your transaction.

Does it make sense to pay down some debt before I sell the company? Should I add those new assets to my business right now? Do I need to sell my business now before I need to replace some equipment in three years? Do my leases transfer? Is there anything I need to move in to, or out of, my company’s name before selling it?

If you have questions like these and what to discuss how the different answers impact the value of your business, please reach out to us and we’ll be happy to help. As always, one of the first steps in this process is to have us provide you with a no cost, no obligation business valuation.

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