Dealer Looking at Tachometer with Steps of Aquisition

Review this checklist of items to help you achieve a successful dealership acquisition.

Preparing for transition

Keys to a Successful Dealership Acquisition

  • 5/28/2014

As the dealership industry continues to expand and mergers and acquisition activity accelerates, we have prepared a checklist of key items to consider in achieving a successful dealership acquisition. A dealership acquisition is a complicated process with typically a lot of emotions on both sides of the transaction; however, it can be greatly simplified if you focus on a few important items in the initial stages of the process.

Develop a comprehensive financial forecast for the targeted dealership

One of the keys for buyers is to develop a conservative financial forecast for the targeted dealership that provides a clear understanding of the projected rate of return on invested capital. The financial forecast should include three items:

  • Proforma balance sheet
  • Proforma income statement
  • Cash flow forecast

The development of the financial forecast model and the calculation of the projected rate of return on the acquisition are critical for the buyers to understand their potential yield on the deal along with the downside risks.

Proforma balance sheet

The proforma balance sheet includes a summary of the assets acquired and invested capital. The invested capital includes debt financing and capital invested by the buyer as part of the acquisition. The capital investment in cash required of the buyer typically includes the costs related to the purchase of fixed assets, parts and accessory inventories, goodwill, and working capital. The working capital amount is based on required minimum standards developed independently by each of the manufacturers. Vehicle inventories are normally financed as part of any acquisition through the buyer’s floorplan financing source, so the buyer does not have to invest cash in the deal to finance vehicle inventories.

Proforma income statement

Buyers need to develop a conservative income statement forecast based on current sales volumes from the seller, along with planned changes based on the buyer’s sales process and team. One of the most important valuation elements of a dealership is the level of gross profit being generated by the targeted store and the stability of historical gross profit levels. Buyers will take the gross profit level and layer in their expense structure focusing on personnel costs, advertising and interest expense, and rent structure for the acquired facility. Many dealers are able to generate acquisition savings through lower personnel costs, reduced interest costs, and lower rent expense from economies of scale and lower cost of capital.

Cash flow forecast

A cash flow forecast provides the acquirer with a good visual of the projected net cash flows that can be expected from an acquisition. The forecast will show cash flows from the deal after debt service and taxes have been paid and should align with the buyer's expected return on invested capital.

Determine goodwill value of the targeted dealership

Determining the goodwill (or “blue sky”) value of a dealership is the most important aspect of an acquisition. The top franchises in major markets can command a goodwill multiple in the range of six to eight times adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), while lower tier franchises in smaller markets will generally sell for two to three times EBITDA.

Make sure to consider these operational characteristics when evaluating goodwill:

  • The number of competing franchises in a market and their location
  • Current units in operation for the targeted dealership
  • Projected earnings based on the buyer’s financial forecast

Structure the acquisition in a tax-efficient manner

There are essentially two methods of acquiring a dealership, either through a stock purchase or an asset purchase. Most dealerships are acquired through an asset purchase because the buyer does not want to assume any of the underlying liabilities of the existing dealership, and because there are tax benefits for the buyer. An asset purchase allows the buyer to allocate a portion of the purchase price to fixed assets and goodwill. Fixed assets are eligible to be depreciated for tax purposes using accelerated depreciation methods and goodwill is written off by the buyer over a fifteen year period. In a stock purchase, the buyer has only limited ability to write-off a portion of the purchase price for tax purposes and also assumes the liabilities of the existing dealership.

Assess the dealership's real estate value

As factory requirements for dealership facilities have expanded, this has become an extremely important element of evaluating any dealership acquisition. One of the primary reasons that dealership acquisitions fail is the cash flow drag from expanding manufacturer facility requirements that cannot be offset by higher gross profit levels. The combination of higher rent and significantly greater real estate taxes and operating costs must be considered in the due diligence process of every acquisition.

Acquisition factors on the horizon

As the dealership industry continues to consolidate over the next decade, capital requirements will increase for new facilities and factory working capital standards. Larger dealership groups will continue to increase their economies of scale in the major metro markets and grow through acquisitions. These industry dynamics will require single point stores to grow through new add-points or acquisitions to stay competitive in the dealership market. There are always risks to completing a dealership acquisition, but if you focus on a few key areas, you can create significant value for you and your dealership.