BEYOND THE LOT (NOV. 2021 EDITION): SELLING A FRANCHISED AUTOMOTIVE DEALERSHIP IN 2021

I often get asked “is this the right time to sell a franchised dealership?” As I help clients buy and sell franchised dealerships, I know that I am not being asked this question because of my legal expertise, but because I often meet with brokers and accountants involved with auto dealers and dealer principals.

THE ANSWER INEVITABLY IS “IT DEPENDS”

With everything that has happened this year and last year with COVID-19, this is especially true now. You could claim that now is a good time to sell because OEM’s and dealers have had higher earnings related to new and used vehicle shortages, more consumers are moving to the suburbs, capital gains taxes are going up, and dealerships have shown better-than-expected resilience when faced with COVID related closures and disruptions.

On the contrary, now might not be a good time to sell. Buyers may disregard earnings results from the past year as short-term occurrences subject to correction when chip production resumes and pent-up vehicle demand is satisfied. Some critics are also highlighting how inventory shortages are actually a negative factor that will pull earnings down over the next year due to lost sales from buyers whose needs cannot be met.

WHAT TO KNOW

For dealership sellers, part of the uncertainty is driven by this debate going on at the national level. However, most dealers that I have spoken with are more focused on some of the fundamental issues occurring, regardless of industry trends, that drive their decision to sell. Two major issues to consider are the following:

1. Brand – Most dealers know that different brands bring different valuations. A luxury brand may bring in a higher price based upon an earnings multiple that is greater than a non-luxury brand. However, the decision to sell is not just about earnings multiples. How easy it is to get an OEM to approve a buyer is just as important. Some brands are notoriously stringent in their criteria when accepting a buyer as a new franchisee. They may not even look at a prospective franchisee unless its ownership and/or proposed management team have particular experience with the given brand. As a result, the pool of potential buyers may become more limited, reducing the likelihood that a seller will get a competitive offer for a given rooftop. OEM’s may further frustrate the buyer approval process by exercising their right of first refusal (“ROFR”) for any offer made and assigning that right to a preferred franchisee. This has happened enough that buyers have become more careful in making offers, particularly if they know that a local dealership group friendly with the OEM may get a “last look” through a ROFR. A seller can develop workarounds like having buyers take a minority equity stake first in the business and then get the experience needed to be approved by the OEM. However, this requires careful planning and consideration before exercising these alternatives.

2. Facility Investment – For the past two years, factories have been demanding that dealers fulfill two seemingly inconsistent goals: increase their remote sales capabilities and improve and enlarge their facilities. COVID-19 provided a significant rationale for remote selling, as government-mandated lockdowns went into effect last year. Remote test drives and deliveries and increasing use of the web-based tools for consumers to identify vehicles, make trade-ins, get financing and negotiate price have become more desirable options to consumers. This practice is not likely to go away when there are Internet-based competitors whose remote sales business model has gained ground over the standard “on-the-lot” model used by traditional dealerships.

Yet, despite the push to sell and market vehicles away from the lot, OEM demand to replace showrooms with larger, more extravagant “jewel box” alternatives has continued unabated. The question I have often heard from dealers is “why should I replace my showroom with a bigger, fancier alternative if the future of my business is tied more to remote selling?” Even more concerning is that the shift to selling more electric vehicles will require dealers to invest further in charging stations, repair equipment and other items related to these vehicles. Even if a dealer is doing well financially, the need to invest significant capital in facility improvements may change the financial viability of the dealership over the long term. Beyond the EV and chip shortage headlines of Automotive News, a dealer’s position on facility investment is often a more critical factor in deciding to sell a dealership.

While chip shortages and electric vehicles may be the hot topics right now in trade publications, sellers should instead focus on issues, like the ones above, that have always driven their decision-making. Similarly, buyers looking to negotiate with sellers should recognize that addressing these fundamental seller issues is paramount for any offer that they make.

At Schwartz Ettenger, we are well versed in helping dealers to better understand buy-sell considerations and put these considerations into customized terms in their next buy-sell agreement. We are also experienced in developing alternative solutions for dealers looking to sell their dealerships. For questions and additional information on our automotive dealership practice, please contact me by phone at 631-777-2401 ext. 32 or via email at ket@selawny.com.

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