By Richard H. Kotzen, CPA
Of the various factors fueling today’s vigorous merger and acquisition (M&A) activity among auto dealerships, one of the most interesting – and often one of the most challenging – is the growing role of nontraditional buyers.
These new buyers’ business approaches, concerns, and strategies can differ significantly from those involved in a traditional dealer-to-dealer sale. A prospective seller who understands these differences will be better positioned to see the transaction through to a successful conclusion.
The Manufacturers’ Perspective
These new types of nontraditional buyers sometimes are referred to as the “Wall Street class” of buyers. They often apply different valuation methods and metrics from those of traditional buyers and might use both traditional and nontraditional methods to finance their deals. These different approaches and perspectives can affect how a transaction proceeds.
Both the manufacturer and the dealer selling his or her business sometimes find the methods and approaches of these nontraditional buyers to be unfamiliar. Since the manufacturer controls the approval process, a manufacturer’s lack of experience with these types of buyers may result in a much more detailed analysis of the transaction and could cause delays in obtaining approval. However, manufacturers and nontraditional buyers are having more positive experiences with one another as more nontraditional deal transactions are occurring in the marketplace.
Every transaction presents its own particular opportunities and challenges, so generalizing about this subject can be misleading. With that caveat in mind, some of the characteristics of these various categories of investors are common, as are the reactions they might trigger from the manufacturers.
Private Equity Groups
PEGs typically are formed to invest in entrepreneurial companies and often seek large, mature operating businesses with long-term track records of generating net income and above-market returns on invested capital. Successful auto dealerships often fit this profile well.
PEGs’ funding can be derived from multiple sources, including private investors, public pension funds, universities, and other endowment funds. This can be a concern to manufacturers, who generally want to be able to clearly understand the ultimate source of all the funds that will finance the transaction.
To improve investors’ return on investment (ROI), most (but not all) PEG transactions involve a significant component of debt to fund the purchase price. Manufacturers typically are concerned that dealership transactions comply with their preferred debt-to-equity ratios, and it can be difficult to identify what portion of a PEG transaction is funded by equity and what portion is funded by debt.
Therefore, everyone should be prepared for a longer due diligence process as the manufacturer analyzes the financing structure of a PEG transaction. Moreover, unlike a traditional dealer-to-dealer transaction, there are no personal guarantees from the prospective buyers – a contract provision often required by financial institutions.
The expected duration of the new ownership also is of interest to manufacturers, who generally are looking to establish long-term dealer relationships. PEGs, on the other hand, often focus on somewhat shorter time frames, with the goal of producing a significant gain in value within a predetermined strategic period – typically 7 to 12 years.
Although the transactions can be more complicated, PEGs have shown that they can be successful in making retail dealership acquisitions. In addition, PEGs often adjust their financing structures and investment holding periods to be more compliant with manufacturers’ approval requirements, thus reducing the approval process risks that have been experienced in the past with PEG retail dealership transactions.
Family Office Funds
FO diversification funds are established to professionally manage the investments of individuals or families of high net worth – typically in excess of $100 million. Wealthy entrepreneurs in manufacturing, retail, and technology establish FOs to seek out opportunities to diversify their families’ portfolios – and successful auto dealerships can be attractive targets.
One important difference between FO funds and PEGs is that FO investments are more likely to be generational investments with time frames longer than 7 to 12 years. This can make them particularly attractive to manufacturers who are interested in building long-term, well-established dealership relationships.
In addition, it generally is easier to trace the sources of capital in an FO purchase. Typically there is one source of funds, which makes an FO purchase relatively simple for a manufacturer to analyze. Moreover, although FOs sometimes choose to use some borrowed funds to help improve the potential ROI, they generally fund transactions with a high percentage of equity, which makes their investment model attractive to manufacturers.
One potential hurdle both PEGs and FOs may face is a lack of retail dealership management experience. The automobile dealership business model is unlike most other businesses, and manufacturers typically prefer that the acquiring owner’s management team has direct experience running a successful dealership.
In some instances, the solution might be for the selling dealer to agree to stay involved for a specified period while a new management team is put in position to meet the manufacturer’s retail dealership management expectations. Such arrangements can present challenges of their own as the decision-making authority is shifted during the transition.
Other Nontraditional Buyers
The Wall Street class of investors includes two other categories of buyers: foundations – such as those established to manage investments for universities, pension funds, and other long-term endowments – and wealthy individual entrepreneurs who are seeking to diversify into industry segments that are unrelated to their existing businesses.
Both of these groups share some of the characteristics found in PEGs and FOs. Like FOs, foundations generally are not heavily reliant on debt financing – a plus from the manufacturers’ perspective. Wealthy entrepreneurs generally have long-term investment horizons and offer relatively transparent, traceable funding sources.
Wealthy entrepreneurs, moreover, bring considerable business acumen from outside the retail automotive industry. They still might face some hurdles in gaining manufacturer acceptance, but their successful track records in other businesses are a significant benefit, even while manufacturers focus on entrepreneurs who have retail automotive experience.
Know What to Expect
While traditional dealer-to-dealer sales will continue to dominate M&A activity for the foreseeable future, any dealer who is contemplating a sale should not overlook the potential opportunities these new, nontraditional buyers represent. At the same time, a selling dealer should recognize the possible challenges such a transaction might encounter and should seek out experienced advisers who can guide them around the obstacles that might arise.
Rick Kotzen, a partner with Crowe Horwath LLP in the retail dealership services group, is based in the Fort Lauderdale, Fla., office. He can be reached at 954.489.7430 or richard.kotzen@crowehorwath.com.
