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There is never a wrong time to buy a car dealership, only a wrong way to buy one.

In 2009 there have been dealerships (both domestic and import) that have made over half a million dollars in one month, yet the majority of the pundits said that 2009 was not the time to buy a dealership.

Remember “If you wait for perfect conditions, you will never get anything done.” Ecclesiastes 11:4. It is not the “conditions” that count; it is your “analysis.” The fact is that most car dealerships that closed in 2009 were bought or established during what the pundits now describe as “the good times.” The times when owners and the experts lamented were “the right times” to buy and build.

Case in point: In 2008 Automotive News ran a front page story on a fellow that was building a Toyota dealership on the freeway, across from the Oakland Coliseum — a $35 million store, with five floors and a four-story glass showroom. The experts proclaimed about the dealer “… has a broader vision about the relationship between real estate and car dealers than you would ordinarily find.”

On February 24, 2009 The Oakland Tribune reported: “New Toyota dealership in Oakland closes”. In that article the dealership's customer relations manager lamented: “I'm kind of in a state of shock because we thought we had such a bright and opportunistic future here, and with this, it just leaves an empty taste… “

When one analyzes that situation, the dealership was supposed to fail.

For a plethora of reasons, not the least of which was the store's rent factor, the dealership's success would have been contrary to the laws of nature. Analyzing that situation, however, is left for another article. For this article, the object lesson learned is: Even though the factory approves a transaction, the lenders finance it and the trade publications applaud it, those endorsements provide no guarantee a dealership is going to succeed. Having said that, there are many buyers who will still believe those endorsements mean success.

With the epidemic of lawsuits today, factories and lenders cannot give business advice because if the dealership did not succeed, it is the factories and lenders that will get sued. Consequently, one must rely on oneself and advisers that are not afraid to contradict the boss.

As an aside, be careful not to associate with habitual “deal-breakers.” Some advisers are perpetual naysayers because advisers do not get sued for telling a client not to do a deal. They only get sued when a client gets into a deal that goes sour because it is never the client's fault. It is the bank, the factory, the accountant, the lawyer, the business advisor (anyone other than the client) that is to blame.

The bottom-line is that there are two critical factors in buying an automobile dealership that will help ensure success for the long term: (1) How it is bought; and (2) How it is managed.

Each factor has a story, but those are the two keys. How the dealership is bought and how it is run will determine its long-term success or failure. We say “long-term” because car dealerships provide enough cash-flow that some deals could take five years to fold.

Buying a Car Dealership

What is the right way to buy a car dealership in bad economic times?

In the “good times,” buyers were paying premiums for dealerships, based upon brand names, pretty buildings, nice locations, and so forth. The fact is, in good times or bad, dealerships should be valued in the same manner: by how much the buyer expects to earn after the purchase. In other words, upon expected ROI (return on investment) — not the brand, or the building, or the location.

Determining what a store can earn after its purchase encompasses more than math. Regardless of how often the “multiple of earnings theory” has been proved wrong, members and associates of the trade still perpetuate the myth that the purchase of a car dealership can be that effortless.

As a natural consequence of the ROI method, purchase prices will fluctuate because one would tend to expect to make more during “good” times, versus “bad.” Therefore, when one states that the values for blue sky or goodwill are dropping, their statement has nothing to do with the “value” of the dealership. Furthermore, there is no information in the foregoing statement to help one decide a reasonable value to pay for a dealership. Rules of thumb are only guides. Guides are good servants, but bad masters.

If a dealer is going under and throws a prospective purchaser the keys to the building and says: “It's yours. I just want out.” That act does not make the dealership worth more or less. The questions a buyer must ask are– (a)” what is it going to cost me to open the doors?” and (b) “what do I think I will earn after I own the store?” In other words: “What is my expected return on the investment?”

At one time there was a dealer group in Colorado that presented an offer for the existing dealer to pay them (the buyer) $2,000,000 for them to take-over the stores. The offer was based upon projections of what the stores would lose while buyer tried to turn them around. The seller refused and ended-up losing several million more before the stores closed. The dealerships properties were eventually sold to a church.

A good checklist for valuing car dealerships can be found in IRS Revenue Ruling 59-60, published by the Internal Revenue Service in 1959. While the ruling (59-60) was intended to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes, the methods discussed are applicable to valuing an automobile dealership and valuing blue sky in an asset sale simply by backing-out the amount of the stock valuation attributable to goodwill/blue sky.

The Five Biggest Mistakes Buyers of Automobile Dealerships Make:

1. Thinking that when they verify earnings they have completed a major task. The truth is, what the seller made or lost does not matter. A plethora of details and formulas need to be applied to determine what the new owner can net. What rent factor PNUR can the store afford? Do those numbers correlate to the percentage of gross requirements?

2. Overestimating vehicle sales projections. The first question is: “What can the new owner realistically retail?” We have seen too many dealerships that went under because the buyer could not accurately predict potential sales. On more than one occasion we have seen factories and lenders approve dealerships where the prospective purchasers projected sales volumes that exceeded the volume of the area's historical sales leaders.

3. Famous buyers thinking their names alone can turn-around dealerships or sell cars. We can name more unsuccessful, former car dealers that are famous, than successful car dealers that are famous. We have one photo that depicts a famous athlete getting a business award from the President of the United States. He went to the White House and received the award the year before the factory closed his stores. Either nobody saw it coming, or nobody cared.

4. Thinking that buying a store at a low or zero multiple of earnings means they got a bargain. The biggest misconception of a bargain is when the factory awards a new point. Most people think they got something for nothing. They really did not. The ones that do succeed, however, usually succeed because of the timing and the location — not because of the dealer.

The fact is, it takes about a year to build the service department of a new point, yet the dealer must capitalize the store as though it were already operating on 8-cylinders. In many instances, a new point suffers through months of losses until, if ever, it finally becomes a successful store. Those losses are “blue sky.” In other instances, it is the second owner that makes a go of it and in some instances, such as the Englewood store mentioned above, the point goes away.

The savvy purchaser understands there is a value to buying a dealership that has its number is in the phone book, a loyal service base and repeat customers. The main value is that the day after the store is sold there are people lined-up for service, people buying parts and customers coming back to the store. That is worth a bonus (blue sky) to the owner even if the store has been losing money.

5. Thinking there is some “magic” formula that will make a store successful. The only formula that will work most of the time is a mixture of hard work and knowledge of the retail automotive business. Each of those words is an operative word: “retail” and “automotive.” Knowledge of another business is not enough.

One last bit of advice to rookies. When making changes in the retail automotive business act swiftly. Erasers are made because people make mistakes. We have yet to meet the person who has never used one, although in today's world one might substitute the word “eraser” with “backspace” or “delete. When a mistake is made, the trick is to analyze, decide and act quickly. Do not hesitate to correct errors and bad decisions.

That advice has been around for thousands of years, both in the proverbs one learns as a child (such as “A stitch in time, saves nine” and “He who hesitates is lost,” and so forth), and in Ecclesiastes 12:12 “But, my son, be warned — there is no end of opinions ready to be expressed. Studying them can go on forever and become very exhausting!”

In summation, do not hesitate to buy a car dealership in a bad economy, just buy it correctly. Read the articles referred to above and act upon them.

“A dealership should be bought for one reason and one reason only — to make money. It should not be bought because it is close to home, because the buyer likes the franchise, because a partner wants to provide a job for a relative or, because the building is attractive. A dealership is purchased to make money and, in order to make money, it has to be “bought right”. A Practical Guide to Buying and Selling Automobile Dealerships, National Legal Publishing Co. (1989), at page 2-4.

That was written twenty years ago. It was true then and it is true today.

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Source by John Pico J.D.