Back in April and May of this year, the economy came to a grinding halt as many cities ordered businesses to close. Things looked pretty dismal, both for our dealer clients and Bass Sox Mercer. The phone stopped ringing and several buy-sells in our pipeline were terminated by buyers.
Come June and July, however, client activity began to pick up, and by August we had added 16 new, executed dealership buy-sell transactions to our deal pipeline. We have over 15 other client transactions in the pipe at varying stages of negotiation and document preparation. The dealership buy-sell business has certainly picked up and, seemingly, the effects of COVID-19 on dealership transactions are in the rear-view mirror. With this uptick in activity, due diligence dynamics in a dealership buy-sell, whether one is selling or buying, are all the more important to understand and consider as one undertakes the transaction process.
Sellers often in the past limited their due diligence to consideration of the relevant retail market experience of a prospective buyer (e.g., is my buyer able to be approved by the factory?). Occasionally, when a buyer consisted of several investors, a seller might ask if the investor group had legally solidified their deal among the group before executing a buy-sell agreement (I’ve seen a number of deals collapse when an investor or two drops out of a deal after the transaction is inked). Finally, a seller may consider the buyer’s financial wherewithal to close the deal. Those were the questions most often asked by a seller, and thereafter, its due diligence often ended.
In years past, buyers primarily concerned themselves with reviewing factory operating statements or accounting records of an acquisition target, examining its historical expense structure and analyzing its income potential. From this, buyers created profit and loss forecasts and pro-formas. Buyers unfamiliar with a particular geographic market might also analyze the market’s demographics and growth trends to determine whether they were consistent with the buyer’s forecasts and projections. Most of a buyer’s due diligence focused on the health of the dealership’s business and finances to confirm whether the price the buyer was paying was reasonable.
Those historic approaches to due diligence are still important today, and most every seller or buyer that Bass Sox Mercer represents still undertakes some level of similar scrutiny of a potential dealership buy-sell. However, a seller or buyer that limits its analysis of a prospective transaction to just those traditional areas of due diligence is ill-prepared to face the reality of today’s environment of factory facility and imaging initiatives. Today, substantially more preparation is necessary to sell or purchase a dealership.
In spite of 2020’s economic challenges, manufacturers remain focused on achieving their dealer network initiatives. For some dealers, a particular initiative may have redeeming qualities such that a dealer is willing to participate in the factory program and make the investment. Other programs, however, may require a dealer to make substantial financial commitments that are not in line with forecasted business levels for the dealer’s market, and so downward pressures on profitability become a potential problem.
Prospective buyers need to carefully research all initiatives that may arise in the approval process discussions with their future franchiser. In pricing a particular dealership, a buyer must take a close look at the applicable initiative. How much is it going to cost? What effect will it have on the buyer’s sales and service forecasts? What is the cost of full compliance? All of this information is important, not only with respect to the valuation and pricing of the deal, but also with respect to whether the buyer is able to meet such facility requirements while achieving expected income forecasts.
In the case of image upgrades, manufacturers at times have provided financial assistance to help underwrite the cost compliance. A buyer should never assume, without confirming, that such assistance remains available as the buyer negotiates the price for the dealership. In the past, factories have pulled their financial support to dealers.
As part of acquisition due diligence, a buyer should also consider the franchise laws in the state where the targeted dealership is located. Using an attorney that understands the interplay between the state’s dealership franchise law, factory programs, and dealership acquisition dynamics, a buyer gains important information that may assist in its acquisition negotiations. Some states impose a mere reasonableness standard to a factory’s evaluation of a proposed transaction. Other states specifically enumerate the standards by which a proposed buyer may be evaluated, and dealer network initiatives are not one of the acceptable criteria.
Whether embraced or reviled by dealers, it is clear that the continuing implementation of factory initiatives changes the due diligence landscape. Initiatives must be carefully examined by a buyer to determine the overall effect on a proposed transaction.
A careful evaluation of factory initiatives and state franchise law should also be an important component of a seller’s due diligence efforts as part of preparing to take a dealership to market to sell. Buyers traditionally have spent the most time on due diligence, but sellers must also expand their due diligence and preparation for sale of a dealership.
Like a buyer, a seller also should look carefully at the factory initiatives that impact the seller’s franchise and consult with its accountants and financial advisors in arriving at a proposed purchase price. Better to face the economic realities of a factory program before incurring transactional costs and later having a buyer run from the deal because the seller’s price did not take into account the cost of the buyer complying with the particular factory initiatives.
In this regard, sellers have an advantage over buyers. Sellers can begin their due diligence and prepare well in advance of taking the store to the buy-sell market. How many dealers routinely toss factory notices, memos, and form letters into the proverbial round file? Don’t do it, at least not before carefully reading these materials. These factory documents should be carefully reviewed with an eye toward how they might affect a future sale of the dealership. As such, dealers should maintain a file in which to collect these documents so they are prepared should a transaction opportunity arise.
Sellers must also look well beyond the mere approvability of a buyer. For example, some brands limit the number of franchises a dealer may own, or may prohibit the ownership of dealerships in contiguous markets. A seller should consider the brands owned by a buyer and the location of the buyer’s stores. Additionally, a seller should direct his attorney to consult state franchise law to determine the extent to which a factory may be prohibited from implementing its multiple-dealer owner policies.
In sum, as more dealers explore selling or buying opportunities, the expansion of due diligence investigations becomes critical. Traditional due diligence models fall well short of providing information necessary to craft a successful negotiation and transaction in light of the ever-growing list of factory initiatives. Thorough and relevant preparation, in advance, are critical components of due diligence in today’s buy-sell market. Be sure to employ professionals (accountants, lawyers, consultants) who are in the know, can help you with this preparation, and can fashion an effective buy-sell agreement. In the long run, this investment in due diligence will pay dividends. With such preparation, you will be ready when your buy-sell opportunity arises.