Investing in car dealerships: how to value them
Most business valuations are based substantially on the company’s historical financial statements, tempered by other factors such as: location, brand name, management, etc. In fact and in fact, the dealership’s balance sheet represents less than half of the information needed to properly value a car dealership. The balance sheet is nothing more than a starting point from which a series of factors must be added and subtracted to determine the true value of the assets.
Valuing new car dealerships is all about projecting future earnings and opportunities based on the “dynamics” of the particular dealership being valued and the auto business itself.
The Internal Revenue Service recognizes that valuations include more than financial statements: “The appraiser must exercise his judgment as to 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 the value. ” Revenue Resolution 59-60, Section 3.03.
DEFINITION OF MARKET VALUE
The definition of market value according to the American Institute of Real Estate Appraisers Dictionary of Real Estate Appraisal is: “The most probable price in cash, cash equivalent terms or other precisely disclosed terms, for which the appraised property is sell in a competitive market under all conditions necessary for a fair sale, with the buyer and seller each acting prudently, knowingly and in their own interest, and assuming that neither is under duress. ” American Institute of Real Estate Appraisers, Real Estate Appraisal Dictionary. (Chicago: American Institute of Real Estate Appraisers, 1984), 194-195.
On Resolution of Income 59-60, the Internal Revenue Service defines “fair market value” as follows: “… the price at which the company would change hands between a willing buyer and a seller when the former is under no obligation to buy and the second not under any obligation to sell, both parties with reasonable knowledge and relevant facts. “
The purpose of Revenue Resolution 59-60 is to outline and generally review the approach, methods, and factors that should be considered when valuing the equity shares of closed corporations.
The methods discussed in the Revenue Resolution apply to the valuation of corporate stocks in which market quotes are not available or are so rare that they do not reflect fair market value.
The Resolution goes on to state that no fixed formula can be devised to determine the fair market value of closely held shares and that the value will depend on considerations such as:
(a) The nature of the business and the history of the company since its inception.
(b) The economic prospects in general and the conditions and prospects of the specific industry in particular.
(c) The book value of the shares and the financial situation of the business.
(d) The ability to generate profit of the company.
(e) The ability to pay dividends. The ability to pay dividends is often more important than a company’s history of distributing cash to shareholders, especially when controlling interests are valued.
(f) Whether or not the company has goodwill or other intangible value.
(g) Sales of shares and size of the block of shares to be valued.
(h) The market price of the shares of corporations engaged in the same or similar line of business whose shares are actively traded in a free and open market, either on a stock exchange or on the over-the-counter market. With respect to the sale of an individual dealer, the best comparison is the amount that the public company paid or received for buying or selling a similar dealer, not the value of the shares of the public company or the earnings multiple, per se. which is reflected in the stock market.
In practice, to arrive at the fair market value of a new car dealer, several different formulas have been used:
1. Formula for return on investment (or profit valuation): The value of a business to a particular buyer based on a return on investment analysis. This value varies from buyer to buyer, according to the buyer’s investment criteria, and may or may not reflect fair market value. The National Association of Automobile Dealers (NADA) refers to this value as “Investment Value.” A dealer’s guide to valuing a car dealership, NADA June 1995, revised July 2000.
The capitalization rate is determined by the stability of the dealer’s earnings and the risk involved in the automobile business at the time of sale, investment, or valuation. This method is highly subjective as the capitalization rate is based on the individual appraiser’s perception of the business risk; Consequently, the lower the appraiser perceives the risk, the lower the capitalization rate and the higher the price that a potential buyer would expect to pay for the business.
In short, the capitalization rate is the appraiser’s opinion of the rate of return on the investment that would motivate a prospective buyer to buy from the dealership. Considerations include those specified in Income Resolution 59-60, as well as the rate of return available on alternative investments.
2.Adjusted net worth formula: Net value of the company, adjusted to reflect the appraised value of the assets used in the daily operations of a business, assuming that the user or buyer will continue to use the assets. To this value of “net worth” will be added the blue sky or the goodwill, if any. The “Adjusted Net Worth Formula” is the most common method used to buy and sell a new car dealer.
3. Orderly settlement formula. This method values assets as if they all had to be sold, not in an “immediate sale”, but in an orderly manner and without time constraints. Typically, if the dealership is profitable, some value will still be placed on the goodwill.
4. Forced liquidation. The lowest value of all, forced liquidation means that all assets must be sold in a forced sale, such as an auction, creditors sale, or by order of a bankruptcy court. A bankruptcy proceeding with respect to a new car dealer almost never generates goodwill. This might be the most appropriate formula if the dealer does not have a lease (or there is only a short term left in their lease) and cannot, in practice, relocate.
5. Income formula. The income formula basically consists of taking the profit of the store and multiplying it by an appropriate capitalization rate. The trick here is the definition of “profit.” To determine “earnings,” a prospect purchase could use any combination of the following:
(a) current earnings
(b) average earnings: add the last five years and divide by 5
(c) Weighted Average Earnings – usually an inverted weight with current year multiplied by five, last year by four, year before last by three, four years ago by two, five years ago by one, then adding and dividing by fifteen
(d) cash flow: net income plus agreed upon supplements such as depreciation, LIFO, personal expenses, excess bonuses and such
(e) projected earnings – future projected earnings discounted to present value.
6. Fair value. NADA also refers to a third security in addition to the “Market Value” “Investment Value”, which it calls “Fair Value”. NADA describes “fair value” as “… used primarily when a minority shareholder objects to a proposed sale of the business in assessing the settlement of damages.” and defines it as: “The value of the minority interest immediately before the transaction to which the dissident opposes, excluding any appreciation or depreciation in anticipation of the transaction and without reference to a minority or non-negotiable discount.”
The NADA guide states: It is not common for car dealers to come across this particular standard of valuation. This author has Never used, nor has this value ever been used with respect to the valuation of car dealers.
As can be seen from this report, this author in discussing valuations excludes what NADA describes as “Fair Value.”
7. The Big Fool Theory. The publication of the National Association of Automobile Dealers (Dealers’ Guide to Valuing an Automobile Dealer, NADA June 1995), puzzles, in part: “A rule of thumb is more appropriately referred to as a ‘dumbest theory.’ , this is not a “valuation theory.” (In their “Car Dealer Appraisal: 2004 Update”, NOTHING removed the reference to “dumb” and simply states that the theory is “… Rarely is based on sound economic or valuation theory “but advises sellers” Go for it, and maybe someone is stupid enough to pay [it]. “
The considerations for valuing new car dealerships are more complex than those for valuing most other businesses. Dynamics like the unique requirements of car manufacturers and dealers can limit the amount of money that can be paid by a dealer, regardless of the perspective buyers may offer to pay for the store.
Therefore, the value of a new car dealer varies based on the buyer’s needs and ability, and consequently the same dealer could have two different values for two different buyers and both values would be correct.
Therefore, our assessment of the dealer in question must be viewed in the context and limitations of the facts and history of new car dealer sales as described in this document.