By Adriana Puente, The Rawls Group and Antonio “Tony” Argiz, MBAF
Business owners, especially owners of automotive retail enterprises, are motivated to build value. Discussions at the senior management level and Board meetings generally trickle down to how each decision could impact people, revenue and value. Return on investment is a key predictor looked at in determining if an initiative or purchase is a good decision, and if resources were managed effectively.
Focusing on building value also provides options for the future in terms of lending, buying and selling. Value can often be subjective, with differing definitions depending on who you are speaking to and the purpose of the discussion around “Value.”
One of the most significant components of business value is the predictability a dealership will continue to be successful. IRS Revenue Ruling 59-60 stipulates there are multiple facets to the definition of business value. For purposes of this article we define business value as the actual or perceived utility of cash, cash flow, tangible assets, and intangible assets to an owner, prospective owner, or creditor.
A comprehensive process addressing all issues impacting the continuation of success enhances its future sustainability, which builds business value. The perceived benefits or risks that each business represents can significantly impact the perspectives of business value.
The question looms: what does business value have to do with dealership succession? Business succession is driven by the goal to continue financial, social and cultural benefits the dealership’s success has provided owners, family, managers employees and vendors. A higher degree of success is required for dealership succession than the maintenance of a “cash cow” that fulfills all the current needs and desires of current owners.
Because dealership value and succession planning are so closely aligned, we wanted to get a perspective from a dealership CPA. Here, Tony Argiz, Chairman and CEO of national accounting firm MBAF, says, “An accurate and thorough business valuation is of course critical when preparing for a sale or merger. But to ensure maximum tax advantage and full compliance, it’s also essential when transferring assets to family members.
“For most dealerships, which are incorporated as pass-through entities (typically S corporations or LLCs), an ongoing challenge in these latter situations relates specifically to the often-contested matter of assessing the ‘tax effect’ on the organization’s earnings.”
Tony also shared that since pass-through entities are not subject to corporate income tax, but instead “pass through” the responsibility to owners and investors who report profit as income on their individual tax returns, evaluating the indirect tax impact on a dealership’s earnings, and ultimately its value, is obviously complex.
We asked Tony to walk us through the basics of valuing auto dealerships along with the implication of the tax effect:
To value auto dealerships, appraisers analyze several areas including the dealer’s historical performance and business expectations; type of brands sold; business location; competition; current management team; required dealership renovations and auto market environment. Valuations can be a combination of three standard approaches: an asset-based approach, and income approach, and a market approach.
The Implications of Tax Effect
The arguments for tax affecting the earning stream of a dealership include the fact that most of the market inputs for valuation engagements are derived on an after-tax basis. The pass-through entity valuation should follow this standard, since the dealership owners and investors will pay their share of taxes from the business profits at the individual level.
The IRS and the U.S. Tax Court have, however, consistently argued against the idea that individual taxes paid by interest holders affect a pass-through entity’s value. In the landmark cases of Gross v. Commissioner, Wall v. Commissioner, and Heck v Commissioner, the court has ultimately ruled against factoring tax effect. And there are two more cases pending that may provide further guidance, Cecil v. Commissioner and the Michael Jackson estate tax case.
Consider the potential problems presented by the court’s past positions for dealerships today. We need only look at a recent example from our own MBAF consulting experience: a large family-owned auto dealership whose main partner had passed after a prolonged illness. The Estate needed to file form 706, and it required an appraisal of its assets, including its stake in the family car business. In this example, if we were not to tax effect the income stream to estimate the value of the business, the dealership would be overvalued by up to 30%. The tax implications are clear.
A dealer has a unique perspective of the value of dealership resources and the predictability of earnings. Personal financial security, lifestyle, and pride in ownership can be dominating factors to the owner’s valuation perspective. It is the role of the dealer’s strategic advisors to help the dealer understand the various perspectives to business valuation and to promote the use of the appropriate perspective for the specific planning issue being addressed.
Adriana Puente is an Associate of The Rawls Group, a business succession planning firm. Adriana specializes in dealing with the issues that must be resolved by business owners to implement succession strategies geared towards building business value. For additional information, visit www.rawlsgroup.com or call 407-578-4455
Antonio “Tony” Argiz is Chairman and CEO of MBAF, one of the top 40 accounting firms in the nation. With more than three decades of experience, Tony has extensive, in-depth knowledge and experience in practices involving automotive dealerships, valuations, audits, business planning, economic damages, fraud examinations, and litigation cases. For additional information, visit www.mbafcpa.com or call 1 (800) 239-1474.