Getting under the hood: Understanding the value & “value drivers” of your dealership

By Francis P. Brown, J.D., MIM, LL.M., CM&AA®, director of Key Family Wealth &
Joan B. Kaye, senior vice president and relationship manager, Key Private Bank

It is fairly common for a dealership owner preparing to retire to discover that not everyone views or values his or her business in the same positive light. The reason? Many auto dealers have become desensitized to the amount of risk that exists in their business.

Francis P. Brown

Auto dealers, like most entrepreneurs, are a unique breed and have an appetite for risk that allows them to succeed where most would fail. After all, taking risks is part of owning a dealership. However, this personality trait— while certainly a strength in growing a business — may lead dealership owners to underestimate the amount of risk that exists and to assume that anyone with a similar appetite for risk should be able to generate the same level of profits. What this way of thinking fails to consider is whether another auto dealer would be satisfied with the rate of return a dealership is earning given the amount of risk being assumed.

One of the most common approaches to valuing companies in M&A transactions is to rely on comparable multiples. Embedded within this figure is the buyer’s assessment of how likely he thinks he can generate an adequate rate of return given a dealership’s strengths and weaknesses. While sellers think their auto dealership should receive a multiple higher than the industry average, buyers, on the other hand, weigh whether they can justify paying the industry average, much less a premium.

For example, there may be aspects of your business you might structure differently today if you were starting over from scratch. In fact, we suspect you’ve learned to live with certain “inefficiencies” or “sub-optimal” aspects of your business despite the little voice inside warning you that these inefficiencies may have a negative impact.

So, what is an auto dealer to do? There’s an easy answer, but it takes time. Invest in working on your business instead of just in the business by focusing on and strengthening your dealership’s “value drivers.”

Focus on Value Drivers

Have you ever wondered why two dealerships that appear similar were valued differently? Looking under the hood, it’s often clear that the businesses are not very similar. Typically, one is a lot riskier (and worth less) than the other. The differences can probably be attributed to quality and state of each business’ “value drivers.” Value drivers are characteristics of a dealership that either reduce the risk associated with owning the business or enhance the prospect that the business will grow significantly in the future.

Joan B. Kaye, Key Private Bank

In the auto dealership business, there are several key value drivers: These include franchise, real estate, quality of facilities, quality of the management team and employees, and recent economic performance.[1] When valuing your dealership, a certified appraiser will look at these key value drivers. To the extent they are present, your business will receive a higher valuation than it would otherwise receive.

It’s important to note that there are two categories of value drivers: internal and external:

External value drivers create opportunity for a dealership to grow. Generically speaking, they include industry, products and services offered, distribution channels, branding, strategic relationships, and competition.
Internal value drivers, which are equally important, include management, systems processes, strategy, structure, organization, mission, vision planning and leadership. Internal value drivers are critical to a dealership’s success because they create the capacity for it to grow.

Go for the Premium (Pricing, that is)

The reason a buyer is willing to pay a premium price centers on his or her perception of risk and return. If the characteristics that buyers find valuable — characteristics that both reduce risk and improve return — are present, a buyer will pay top dollar or a higher “blue sky” value versus what he or she would pay if those value drivers were not present. Buyers are inherently comparing both the risk and return of buying your business to alternative investment opportunities.

The most common mistake auto dealers make is choosing to pursue a growth opportunity without any thought to whether their business is prepared to scale, or if they have created the capacity for growth. Without proper preparation, the odds of success are harder to achieve.

As an example, a manufacturing company hired a new sales team to double sales without any forethought of how the operations and service delivery department could fulfill the increase in orders. The company almost went under after the huge volume increase because the rest of the company failed to keep up with sales.

Here are a few questions dealership owners should ask before considering a sale:

Inventory: What type of franchise do you have? A luxury brand is more sought after than a non-luxury brand.
Real Estate: Where is your real estate located? Is it in the nicer part of town? Do you have all the necessary acreage to account for future growth?
Facilities: What are the conditions of your facilities? Are they old and outdated?
Performance: What’s the recent economic performance of your dealership? Do you have positive year over year growth vs. volatile and /or downward trending growth patterns?
Talent: Finally, are your employees highly trained, competent, and stable? Or are they unmotivated, untrained, and lacking initiative?

Take a moment to think about your business and the direction it is headed. According to Warren Buffett, risk comes from not knowing what you’re doing. You know what you should be doing. The question is whether you are acting to implement the changes necessary, or simply comfortable with the status quo.

This material is presented for informational purposes only and should not be construed as individual tax or financial advice. KeyBank does not provide legal advice. KeyBank is Member FDIC. KeyCorp. © 2018. CFMA #180220-361076

Joan B. Kaye is senior vice president and relationship manager with Key Private Bank. She can be reached at Joan_B_Kaye@KeyBank.com or 1-516-660-9851.

[1] “What It’s Worth: Automobile Dealership Value,” Business Valuation Resources, March 2016, p. 11