Capitalizing on Growth Opportunities

If you are considering expanding your dealership holdings through acquisition, now is the time to sharpen your pencil. The industry generated an estimated $278 billion in pretax earnings since the pandemic, which is three times the level achieved from 2016 to 2019, according to the third-quarter Blue Sky Report by Kerrigan Advisors.

Since much of that capital has yet to be allocated, Kerrigan estimates the acceleration in consolidation, fueled by pandemic-induced earnings, to continue in 2025.

Exciting as this opportunity might be for growth-minded owner-operators, the “What next?” proposition can often inhibit the ability to seize the moment. This article demonstrates how a smart capital strategy can put you in the driver’s seat to achieve your goals. 

What You Are Buying and Why it Matters

Because the “basic” uses of funds can vary depending on several factors, using terminology common among buyers and sellers is helpful:

• Current assets include short-term assets intended to be used or sold within a year, e.g., vehicle inventory, receivables, parts and accessories.
• Fixed assets are long-term assets, such as machinery, furniture, fixtures and equipment.
• Working capital and current ratio help assess a company’s ability to support business operations. While closely related, they differ in definition and how they impact the borrowing power of a given company.

Working capital is a measure of the liquidity available to operate the company effectively. The minimum amount, or working capital guideline, is generally set by the manufacturer. Derived by subtracting current liabilities from current assets, the figure is represented as an absolute dollar amount. Working capital measures typically defined in a lender’s financial covenants are generally referred to as net working capital and exclude certain short-term assets, such as prepaid expenses and “friendly” receivables.

Current ratio, on the other hand, is derived by dividing total current assets by current liabilities. Also a key measure of liquidity, current ratio measures a company’s ability to cover its short-term obligations with its short-term assets. As a ratio, it fluctuates with the expansion and contraction of the balance sheet. A higher current ratio reflects a stronger liquidity position, whereas a lower ratio may indicate potential liquidity challenges.

• Blue sky (or goodwill) is the intangible market value of the franchise, or the premium paid that exceeds the net of assets and liabilities. The value of the company’s historical earnings performance is also a key consideration of blue-sky valuation.  
• Real estate transactions for dealership property acquisitions typically require minimum buyer’s equity of 20% of the appraised value. However, a buyer may reduce the equity needed at closing by negotiating a lease with the seller that includes a future option to purchase.

As part of the approval process for a change-in-ownership transaction, manufacturers often require a buyer’s commitment to make substantial facilities improvements. Some lenders provide construction finance options to help your organization facilitate improvements to fulfill that requirement.

Capital Components

Equal to the importance of defining your assets, or uses, is understanding the options available to pay for them, or sources. Because dealership acquisitions require a substantial upfront investment, it’s often necessary to use more than one capital source. It’s important to know the breadth of available resources and how they can be leveraged to support your overall strategy.

• Buyer’s equity is simply capital, or cash, the buyer puts toward a purchase. Business owners often prefer not to use 100% personal equity; however, a certain amount is generally required by the manufacturer and the lender for any acquisition.
• Lender financing is a blanket term for credit facilities provided by a financial institution. In the context of car dealerships, lender financing types and terms include new- and used-vehicle floorplans, commercial real estate mortgages, working capital term loans and lines of credit.
• Service contract advances can be an instrumental source of alternative funding for new business ventures. In this relationship, a service contract provider advances funds to the buyer based on the anticipated future sale of service contracts, for example, an extended warranty. The advanced funds are then repaid over time as the buyer sells the service contracts over the term of the contract.
• Seller financing is just that: financing arrangements made directly between the seller and the buyer. It can be a favorable way for the seller to generate a stream of future income and possibly defer taxes.
• SBA 7(a) is the U.S. Small Business Administration’s primary loan program. It provides financial assistance to small businesses that can be used for a broad range of purposes, including:
  • Acquiring, refinancing or improving real estate and buildings
  • Short- and long-term working capital
  • Refinancing current business debt
  • Purchasing and installing machinery and equipment
  • Purchasing furniture, fixtures and supplies
  • Changes of ownership (complete or partial)
  • Revolving funds
  • Construction
  • Business establishment

Often government-guaranteed and arranged through an SBA-approved financial institution, the SBA 7(a) loan has generous borrowing limits of $500,000 to $5 million and can include longer-than-average amortization terms at a fixed rate. 

Lender Financing 

Being familiar with the terms and metrics commonly used in dealership purchase transactions is important, and being aware of your dealership’s liquidity markers and how they are perceived or used by a lender can affect the outcome of a purchase. But remember that scrutiny can and should go both ways — not all lenders are equal, and the value of various lending products often depends on how the deal is structured.

Flexibility is also valuable in any market and with nearly every deal type. Here are some considerations and questions to keep in mind when looking for a capital provider that can address current and future needs for a range of buy-sell opportunities:

• What loan amortization and term options are available? Are there interest-only alternatives?
• Are you confident that the lender will be able to deliver and meet closing-date requirements?
• Does the lender have access to unique lending alternatives, such as the SBA 7(a) loan?
• Is it committed to the automotive industry?
• Can it assist with personal needs in addition to commercial services and solutions?

Finally, look for a banking partner that is willing to create a strong, trusted relationship with you and to be a good sounding board.

Scott C. Young has worked in the commercial auto dealer finance industry for 30 years. He currently leads KeyBank Dealer Finance.

Author’s Disclosure: This article is for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual person or entity. KeyBank does not provide legal, accounting or tax advice. Banking products and services are offered by KeyBank National Association. All credit, loan, leasing, lines of credit and merchant services products are subject to collateral and/or credit approval, terms, conditions, and availability and subject to change.

EDITOR’S NOTE: This article was authored and edited according to Auto Dealer Today editorial standards and style. Opinions expressed may not reflect that of the publication.