8 Adjustments to consider when buying or selling a car dealership.
As North America’s leading automotive M&A firm, DSMA has worked on hundreds of transactions totaling Billions in transaction value, providing our team with a superior understanding of how dealership acquisitions are structured. Over the last decade, we have completed over 1,000 detailed dealership valuations. We rely on our proprietary data analytics platform to support our work and on average we can establish the value of a dealership within 5% to 10% of the actual selling price. The automotive industry has adopted a standard approach to valuing a dealership’s goodwill by using a multiple-based approach. By calculating the “true” profitability of a business and multiplying that number by a “multiplier,” goodwill value of the business is calculated. The proper multiplier is determined based on several factors, including the brand and the quality of the dealership, the historical performance, and the future potential.
What do we mean by “true” profitability? In simple terms it’s the unaltered income a business would generate regardless of who the owner is. In most instances to save on corporate taxes, certain owners may run personal expenses through the business to lower their taxable income, however when a new owner takes over, these personal expenses would stop and need to be removed. This adjusted income is what we refer to as the “true” profitability and is the closest measure to a cash flow of the business and is the benchmark used for the multiplier. Unsurprisingly, all DSMA’s transactions has some level of adjustment to profit and in most cases Dealer Principals are shocked to learn about where profit is hidden or lost. The following sections highlight the common adjustment areas for dealers.
A common area which significantly impacts adjusted profitability is the rent factor normalization. Regardless of whether the property is bought or leased by a purchaser, at the dealership level, the seller will need to account for the market rent of that property to accurately account for the “true” unaltered cash flow of the business. In most instances, due to the strong increase in property values and rents in the past decade, Dealer Principals are not paying market level rents which ends up negatively hurting the earnings of their business. For dealers considering selling in a few years, our recommendation is to make sure you check what market rents are in your local area and start paying yourself for that market rent today.
As mentioned above, personal expenses like golf memberships, life insurance premiums, cars/boats, and other non-business costs need to be added back as the new buyer will not be incurring these costs. A clean set of books is recommended and reducing as many personal transactions as possible from the dealerships operation prior to a sale is ideal. There are still ways to address theses expenses in a normalization process, but it must be done with diligence and a good understanding.
The other area that results in some surprise is owner salaries. The key question is are you paying yourself enough? A new buyer will need to account for a market-level salary for the key positions that need to be filled or replaced due to a change in ownership. For example, assume a husband-and-wife duo fill the GM and Controller positions and they decide to sell, a new buyer will need to replace them, so we must normalize earnings to account for the cost of these replacements. As a reference, depending on location and dealership size (which influences the cost of labor), normalizing market salaries for GM positions range from a low of $100k to as much as $500k, for a Controller position its typically in the $75-110K range. All too often we see sellers of small rural stores pay themselves below or above market or take their salary through dividends resulting in a painful downwards adjustment once they are ready to sell. Always make sure to pay yourself what you are worth to avoid any unhappy surprises when selling.
For non-automotive buyers, this is an important distinction. Unlike other industries where the full amortization expense is added back (in establishing an EBITDA calculation), in the dealership world, buyers only add back the amortization in specific circumstances. The logic is simple, because the industry is capital intensive, a buyer would need to account for the future expense of replacing the equipment acquired (herein referred to as maintenance CAPEX). So instead of adding back the full amortization and deducting CAPEX, automotive buyers simply do not add back the amortization on the equipment and use it as a proxy for the annual maintenance cost of replacing the equipment. Unfortunately, general business brokers and accounting firms fail to consistently apply this rule when they get involved in a dealership sale which results in a lot of buyer confusion and debate. Therefore, we reiterate the importance of dealing with an automotive-focused M&A advisor rather than your local accountant or real estate agent, that may not understand these industry-specific changes.
Interest on Debt
Another major area of confusion is the add back related to interest on debt. In simple terms, interest charged to long-term debt (equipment, real estate, acquisition loans) or shareholder loans is added back whereas interest related to the floorplan is not added back. The logic is simple, long-term debt and shareholder loans will not continue for the new buyer and are seller-specific items that need to be normalized as these loans will be paid out. However, floor plan financing is broadly used by the industry and will be used by the new buyer as well to support their inventory needs, so the cost will continue post transaction and is therefore considered an operating cost.
Considering specific dealership related issues, a more frequent add back is the non-recurring revenues and expenses seen in the dealership industry. One-time benefits awarded by government agencies or OEMs that are not performance-related are deemed non-recurring and would need to be removed. Conversely, inventory write offs, large bad debt expenses, and donations among others would be considered non-recurring expenses which are added back. The litmus test in simple terms is under a new owner looking into the future, are these revenues or expenses going to happen again? If not, then they are considered non-recurring and need to be normalized.
A more unique adjustment relevant for larger dealer groups is shared corporate-level expenses. For example, BDC and accounting costs are usually spread across multiple rooftops as they are the easiest synergies to achieve when consolidating the dealership sector. However, in a scenario where a large group were to sell a single store, your advisor would need to isolate and determine what the individual cost of these services provided are and then account for this cost on the P&L of the store that is being sold. Pricing this cost correctly requires relevant industry expertise from your advisor and the ability to complete proper carve out financial statements.
A smaller change that we sometimes come across is the interest income generated from the excess cash a dealer has on their balance sheet. Buyers do not buy the seller’s cash so any income generated from this excess in cash (invested in GICs, stocks, bonds or applied against bulk interest) will need to be removed from adjusted profit.
As is evident by the multiple sections described and the other add back categories not covered in this article, normalizing profitability for dealerships is both an art and science, requiring the consideration of multiple variables and in-depth knowledge of the mergers and acquisitions process. Our recommendation follows a time-tested lesson that we share with our clients, “Don’t step over the dollar to pick up the nickel,” which means, do not try to cut on cost when hiring your investment banker or M&A professional. The amount you save in advisory fees is usually much less than the amount of money you leave on the table when dealing with a non-automotive specialist. DSMA leverages its proprietary data mining platform to support every valuation and provide our clients with the TRUE VALUE OF YOUR DEALERSHIP.
Our job at DSMA is simple, to maximize the value of your business assets during a sale process. To do so, we need to find and understand specific areas where we can add back expenses to ensure that the true cash flow of your business is maximized resulting in the highest goodwill to you.