Buying or selling a dealership business is unlike any other business transaction—and that isn’t just rhetoric.
When you combine the different ways in which a dealership’s departments operate, its relationships with manufacturers, dealer-specific tax provisions, the types of assets dealerships hold, and how dealership values are determined, the result is a complex process that can surprise buyers and sellers alike—and not always pleasantly.
Transactions among auto dealers are picking up pace across the nation, a product of the industry’s perceived strength among traditional buyers, Wall Street, and private equity investors alike. During the recession, when consumers put new vehicle purchases on hold, auto dealers demonstrated sustainability by putting more emphasis on used vehicles, parts, and service. The investor community took note of the elasticity of the franchised dealer.
With this as the backdrop, many dealers are poised to take advantage of their strength and attractiveness to investors. But before diving in, let’s look at a few of the most common pain points you’ll want to be aware of and prepared to tackle.
A number of factors impact a dealership’s value. In addition to a franchise’s historic performance, potential buyers, brokers, and valuations experts examine the dealership’s geographic market (metropolitan versus rural), competition, and stability as well as whether the brand is desirable and how it treats its dealers.
To accurately determine value, each of a dealership’s departments needs to be examined. A parts department sells high-volume, low-cost items; the new and used vehicle sales departments sell lower-volume, higher-cost units. Then there’s the service department and body shop, which sell labor, and the financing department, which brokers loans and other products. Each department has different operations, profit drivers, and potential landmines. What this means in a transaction is that looking at a dealership’s performance as one unit isn’t a great measure of its value or its earning potential.
Further, the sale of a dealership involves a wide range of assets, including real estate, fixed assets, inventory, corporate goodwill, and personal goodwill. Each of these has its own value to both buyer and seller, who ultimately need to come to an agreement for a sale to be successful. How pricing is allocated between these asset types can also have a substantial tax impact. Note that a valuation calculated for purposes of generally accepted accounting principles, or GAAP, may differ from the valuation calculated for tax purposes.
Manufacturer’s Right of Refusal
Auto manufacturers can intervene in a potential transaction involving the franchise. A manufacturer might do so, for example, if it isn’t happy with a potential buyer, has a different buyer in mind, or is concerned with concentrations of ownership in a geographic market. In these cases, the manufacturer may elect to exercise its first right of refusal and buy back the franchise.
Buyers are typically looking for multiple franchises, and some brands are more desirable than others. Having the desirable brand pulled by the manufacturer often makes the transaction unviable for the buyer. Proper planning around these scenarios is important.
Costs, Timing, and Taxes
The costs of a transaction are significant once you add in brokerage fees, accounting services, and legal fees—not to mention tax on the transaction.
Further, transactions often trigger tax liabilities many dealerships don’t realize they’re carrying. Accounting methods specific to the dealership inventory, including last in, first out (LIFO) inventory management and the lower-of-cost-or-market method for used vehicle inventory, are some examples of great tax planning that can complicate the financial picture during a transaction.
Timing too is often a sore spot for dealers: Given the level of complexity involved in a dealership transaction, deals typically take around six months from start to finish. The longer the transaction takes, the more opportunities there are for a decline in dealership performance, brand-related events—such as the Volkswagen diesel scandal—and employee fallout. Timing is more important than ever with the changes under tax reform. A transaction that closes just a few days later could mean a difference of thousands of dollars of additional taxes.
Last, confidentiality is a significant factor in any deal, and sellers are often surprised by how quickly it can be lost, despite their best efforts to keep a deal private. The dealership business is, after all, a fairly close-knit community, and once the manufacturer, broker, and potential buyers learn a dealership may be for sale, information tends to spread quickly to the marketplace.
This can result in a workforce issue as the dealership’s employees scramble to plan for the situation. As a result, it’s critical that a dealership has all its contingency plans in place and is well prepared for the sale leaking to the marketplace.
Tips for a Smooth Transaction
Knowing what surprises and complications you may encounter is a large part of making any potential transaction go smoothly. To get ahead, perform sell-side due diligence early—even before you’re ready to initiate a transaction. This not only helps you anticipate questions but also illuminates opportunities for your dealership to increase its potential value.
Further, make sure you work with professionals who know the automotive industry. From your tax accountant to your legal advisor to your valuations expert, each one needs to understand the nuances of the accounting methods, tax provisions (especially deferrals), and entity structuring arrangements that are relevant to your business.
We’re Here to Help
To learn more about any of these topics or how you can prepare your dealership for a transaction, contact your Moss Adams professional. You can also visit our dedicated tax reform page to learn more.
This updated article was originally published in May 2016.