Leonard A. Bellavia, senior partner at Bellavia Blatt & Crossett P.C.
If it were happening during the Prohibition era, they would be called “rum-runners. But because the selling or leasing of cars is not so nefarious, a less disparaging name applies – “auto broker.”
An auto broker or auto buying service is a person or entity that engages in the business of brokering where there is an arrangement under which such broker, for a fee, provides (usually to an individual consumer) the service of arranging, negotiating, assisting or effectuating the purchase or lease of a new or used motor vehicle not owned by such broker.
What does this mean in plain English? An auto broker helps retail customers find cars from dealerships and acts as the agent for such customer for the purpose of negotiating and purchasing or leasing of the vehicle for a fee or commission.
Although the advent of broker/leasing companies as a business is not a recent phenomenon, there have been a proliferation of store-front style broker/leasing companies that are delivering new vehicles in the very back yards of franchised dealers—frequently at locations literally right next door to them.
Furthermore, while there is a prevalence of broker/leasing companies in Metro New York and New Jersey, the successes realized by these brokers/leasing companies has resulted in the expansion of their footprint to other regions, including California, Florida and New England. The activity of brokers in a particular market may have profound impacts on a dealer’s performance, and, more importantly, may create pitfalls and headaches for would-be buyers of dealerships.
Why are brokers so bad for dealers? In short, they distort the performance of one dealer to the disadvantage of another. Suppose a buyer is looking to purchase a suburban dealership that has significant volume. Unbeknownst to the prospective buyer, the seller has an existing relationship with a broker in a distant market, and supplies vehicles to the broker.
In turn, when the broker sells the vehicle, the sale occurs using the dealer’s paperwork and the dealer receives credit for the sale. In this circumstance, the sales facilitated by the broker artificially inflate the selling dealership’s sales. Conversely, the dealer assigned the market in which this broker operates appears to have significant pump-ins and may appear to underperform. This dealer’s sales, and the corresponding valuation to the dealership is artificially depressed.
Here is an example of how a broker may affect a dealership’s valuation. Assuming $2,500 gross profit per vehicle, a dealer losing 100 sales each month to brokers could mean the gross loss of $3,000,000 annually. Utilizing a multiple of five to calculate blue sky value, a dealer that is negatively impacted by this broker/leasing company conduct could face a $15,000,000 diminution of the blue sky value of his or her dealership. The dealership working with the broker, in turn, has a corresponding inflation of its valuation.
The reality of brokering creates another step of due diligence buyers must perform on potential acquisitions. If the dealership has an unusual amount of pump-outs, you should investigate these causes further. If the seller is pumping out to local markets, this may simply indicate the dealer is effectively covering his market and capturing sales in other markets.
However, if the seller seems to pump vehicles into distant markets, this could be a sign that the dealer is working with a broker. If you are purchasing a dealership that appears to be performing below its potential, this deficiency may be caused by an active broker in the dealership’s market. These dealerships may not be as easy to turn around as an under-performing dealership in a market with no brokers.
Even if your state permits brokered sales, the dealerships that work with brokers may expose themselves to significant liability. For example, many states prohibit off-site sales without proper permission from the motor vehicle commission of the state. A broker selling vehicles through his business on behalf of the dealer could be interpreted as an off-site sale for purposes of the law.
Also, turning the sales over to the broker, and allowing the broker to consummate the transaction at his office instead of the dealership, exposes the dealership to potential liability under the Safeguards Rule and the Red Flags Rule. The last thing a potential buyer wants is the bad will associated with consumers’ claims that the previous dealer engaged in conduct that put their privacy and personal information at risk.
When evaluating a potential acquisition, it is important to appreciate the prevalence of brokering and to look for its signs. Take the necessary steps to quantify this impact and adjust your valuation models accordingly. If you do not, you may find that you paid too much for your latest acquisition.