Investing in car dealerships – how to value them

Most business estimates are largely driven by a company’s historical financial statements, mitigated by other factors such as: location, brand, management, etc. In fact and in fact the balance of the dealership represents less than half of the information needed to properly evaluate a car dealership. The balance sheet is only the starting point from which to add up the true value of assets you need to add and subtract a number of factors.

Car dealership valuation is concerned with forecasting future profits and opportunities based on the “dynamics” of the particular car dealership being valued and the automotive business itself.

The Internal Revenue Service recognizes that valuations include more than just financial statements: “The valuer must exercise his judgment regarding the degree of risk associated with the business of the corporation that issued the shares, but that judgment must be related to all other factors affecting value.” Income Decree 59-60, Section 3.03.

DEFINITION OF MARKET SIGNIFICANCE

The determination of the market value, according to the American Institute of Real Estate Appraisers’ Real Estate Appraisal Dictionary, is as follows: a fair sale, with the buyer and seller acting prudently, knowingly and in the best interest, believing that neither is compelled. ” American Institute of Real Estate Appraisers, Dictionary of Real Estate Appraisers. (Chicago: American Institute of Real Estate Appraisers, 1984), 194 195.

У Decree on Income 59-60, The Internal Revenue Service defines “fair market value” as follows: “… the price at which a business changes owners between a willing buyer and a willing seller if the former is not required to buy and the latter is not under any coercion to sell by both parties who possess reasonable knowledge and relevant facts. “

The purpose of the Decree on Income 59-60 – to outline and generally get acquainted with the approach, methods and factors that must be taken into account when evaluating the shares of capital shares of joint stock companies that are in the public domain.

The methods discussed in the Income Ordinance are applied to the valuation of shares of corporations on which market quotations are either not available or have such a deficit that they do not reflect a fair market value.

The Decree further states that no established formula can be developed to determine the fair market value of publicly traded shares, and that the price will depend on considerations such as:

(a) The nature of the business and the history of the enterprise from the beginning.

(b) Economic prospects in general and the state and prospects of a particular industry in particular.

(c) The carrying amount of the shares and the financial condition of the enterprise.

(d) the company’s profit potential.

(e) Ability to pay dividends. The ability to pay dividends is often more important than the history of the distribution of funds to the company’s shareholders, especially when assessing controlling interests.

(e) Whether the entity has goodwill or other intangible assets.

(g) Sale of shares and size of block of shares to be valued.

(c) The market price of shares of corporations engaged in the same or similar activities, their shares are actively traded on the free and open market, either on the stock exchange or without a prescription. With regard to individual dealer sales, it is best to compare the amount paid or received by a state-owned company for the purchase or sale of such a dealership, rather than how much the value of the public company’s shares or profits are multiples per se displayed on the stock exchange.

In practice, several different formulas have been used to obtain the fair market value of a car dealership:

1. Return on investment formula (or profit estimate): The value of a business to a specific buyer based on an analysis of return on investment. This value depends on the buyer depending on the investment criterion of the buyer, and it may or may not reflect a fair market value. The National Association of Car Dealers (NADA) calls this value an “investment value”. Dealer’s guide to car dealership evaluation, NADA, June 1995, revised July 2000.

The capitalization rate is determined by the stability of the dealer’s profit and the risk associated with the automotive business at the time of sale, investment or valuation. This method is very subjective because the capitalization rate is based on the perception of a particular business risk assessor; thus, the lower the appraiser perceives the risk, the lower the level of capitalization and the higher will be the price he could expect from a potential buyer for the business.

In short, the capitalization rate is the appraiser’s opinion on the rate of return on investment, which would motivate a potential buyer to buy a dealership. The calculation includes those specified in the Decree on Income 59-60, as well as the available rate of return on alternative investments.

2. Adjusted net worth formulaA: The company’s net worth is adjusted for the appraised value of the assets used in the day-to-day operations of the business, based on the fact that the user or buyer will continue to use the assets. To this cost of “net worth” will add the blue sky or goodwill, if any. The “adjusted net worth formula” is the most common method used when buying and selling a car dealership.

3. An ordered liquidation formula. This method evaluates the assets as if they were all to be sold – not on a “fire sale” but orderly and without time constraints. Usually, if the dealership is profitable, some value will still be given to goodwill.

4. Compulsory liquidation. The lowest of all values, compulsory liquidation means that all assets must be sold by forced sale, such as at auction, sale of creditors or by a court decision. The bankruptcy process of a new car dealership almost never brings goodwill. This may be the most appropriate formula if the car dealership has no lease (or remains only for a short time) and cannot, as a practical matter, relocate.

5. Income formula. The income formula basically takes the store’s revenue and multiplies it by the appropriate capitalization rate. The trick here is to define “earnings”. In determining “profit,” a prospective purchase may use any combination of the following:

(a) current income

(b) average salary – add the last five years together and divide by 5

(c) weighted average salary – usually inverted weight with the current year multiplied by five, last year by four, the year before last by three, four years ago by two, five years ago by one, then adding them and dividing by 15

(d) cash flow – net income plus agreed allowances such as depreciation, LIFO, personal expenses, excess bonuses, etc.

(e) projected profit – the future projected profit reset to date.

6. Fair value. NADA also refers to the third value in addition to the “Market Value” “Investment Value”, which it calls the “Fair Price”. NADA describes “Fair Value” as “… primarily used when a minority shareholder opposes a proposed sale of a company when assessing damages.” and defines it as: “The value of the minority’s share immediately before the transaction which it disagrees with, except for any valuations or impairments pending the transaction and without reference to either the minority or the trade discount.”

The NADA guide states that car dealers often encounter this valuation standard. This author has never used, and never seen this value in relation to the evaluation of car dealerships.

As can be seen from this report, this author in discussing the valuation excludes what NADA describes as a “fair value”.

7. The great theory of the fool. The publication of the National Association of Automobile Dealers (Dealer’s Guide to Car Dealer Evaluation, NADA, June 1995) is somewhat confusing: “The rule of thumb is more properly called ‘big fool theory.’ dealer: 2004 update “NADA dropped the reference to ‘fool’ and simply claims that the theory ‘… is rarely based on sound economic theory or valuation’, but advises sellers’ to go for it, and maybe someone will be stupid enough. to pay [it]. “

Opinions on the evaluation of car dealerships are more complex than when evaluating most other companies. Dynamics such as the unique requirements of car manufacturers and distributors can limit the amount of money you can pay for dealer sales, no matter what prospective buyers may offer pay for the store.

Thus, the cost of a new dealership varies depending on the needs and capabilities of the buyer, and thus the same dealership may have two different values ​​for two different buyers, and both values ​​would be correct.

Therefore, our assessment of the subject of the dealer should be considered in the context and limitations of the facts and history of car dealership sales, as set out in this document.