March is one of the best months on the sports calendar for avid and casual sports fans. Last week, the NCAA College basketball tournament began. Most of us have been checking our brackets to see which games we picked correctly and which upsets have destroyed our brackets. There’s a reason they call it March Madness. Who would have predicted that St. Peter’s would beat Kentucky? The tournament and the bracket challenges are an opportunity to unite friends, co-workers, and family members in a spirited competition. But, they can also be a source of frustration with stumbling blocks at unexpected terms. In many ways, succession planning can leave auto dealers with the same fears and confusion over the process and some of the decisions made along the way.

What is succession planning? Succession planning is the transfer of value or leadership in a company or organization. For auto dealers, the dealership can represent a lifetime of efforts and relationships with key employees and customers. Hopefully, the dealership has also provided the owner with wealth and income over the years. These factors make the discussion of succession more complicated for auto dealers because of the deep emotions tied to the legacy that they have created.

This post discusses some of the key factors involved in the succession planning process and why they are so critical.

Cost of a Business Valuation

One of the first steps in the succession planning process is to determine the value of the auto dealership. Often there can be a difference in the expectation of value. In other words, there may be a perceived difference in value when assessed by a third party versus the owning dealer. The cost of obtaining a business valuation can also be a stumbling block to the succession planning process. Most valuation professionals will offer different levels of service based upon the strength of the conclusion, the level of procedures performed and the information analyzed, and the style of the report. While it may be more cost-beneficial to engage a business valuation professional to perform limited procedures, a formal valuation is the better course of action. If decisions are ultimately made to transfer the auto dealership in some estate planning tool, a formal valuation will help protect the integrity of that transaction or transfer. In other words, if the transfer was ever to be audited or challenged by the IRS, a formal business valuation serves to justify the indication of value used in the estate planning process.

Besides the formal event requiring the valuation, a business valuation can also benefit auto dealers for other reasons. A formal business valuation can be useful to an auto dealer when examining internal operations. While the business valuation represents an estimate of value at a certain point in time, the value can also be examined relative to the business over time. An auto dealer may use additional valuations to evaluate the performance of the dealership over time to assess its performance relative to a budget or long-term plan. Valuations can also give auto dealers insight into the value drivers of their dealership. Auto dealers can continue focus on areas of strength that contribute to value, while also addressing other areas of weakness that may be detracting from value. Finally, a business valuation could serve to evaluate the dealership relative to its peers and competition.

Who Should Perform the Business Valuation?

The selection of the business appraiser is critical to the succession planning process. A quality business valuation will not only determine the value of the dealership, but also provide a well-reasoned report to explain the basis of value and the underlying assumptions. Further, the valuation assists the auto dealer and their advisors in an understanding of how the dealership is valued. As we’ve written in this space before, dealers and their advisors should select a business appraiser that is properly qualified and credentialed. Additionally, the auto dealer industry is unique from other industries due to its unique financial statements, terminology, and specific valuation methods. When selecting a business appraiser, you should also seek a firm or individual that has experience in the auto dealer industry.

Timing of Decision-Making

Auto dealers have to face many daily challenges and operational decisions. Chief among them in the current environment, what is my new vehicle inventory and where am I going to obtain additional new and used inventory? Decisions that can be made tomorrow, such as succession planning, may be shifted to the back burner. However, these decisions should be made sooner rather than later. First, unexpected events can impact the value of your auto dealership or the succession planning process. We have focused more on the value of the dealership in this blog post, but succession planning also refers to the transfer of leadership with key employees. A life-changing event to the owner or the departure or thinning of key leadership over time can also impact the value of the dealership.

In the current environment, the profitability and implied values of auto dealerships are at record highs.

In the current environment, the profitability and implied values of auto dealerships are at record highs. Most prognosticators believe those trends will continue in the short-term due to inventory constraints. For auto dealers that have seen the value of their dealership climb in recent years and the expectation that those values could climb even further, why not consider transferring some of that value to your family? With annual gifting amounts being fixed, auto dealers could transfer more ownership at lower values today than retaining those shares in an appreciating climate. While there has been a lot of talk about estate planning and tax law changes since the change in administration, no material changes have been enacted as of yet. Changes could still be on the horizon.

In addition to annual gifting, the lifetime estate and gift tax exclusion is set to sunset in 2026. The current exclusion allows for individuals to transfer $12.06 million ($24.12 million for a married couple) without being subject to estate taxes. These levels are set to drop by almost 50% in 2026. Auto dealers can transfer considerably more value under the current exemption levels today, than if those levels are reduced in 2026.

Ultimate Decision

The current environment in the auto industry has placed many auto dealers at a crossroads in terms of their ultimate decision:  should they consider transferring the dealership to the next generation or should they sell? High profitability and high blue sky multiples for most franchises translate to heightened valuations. The evolution and adoption of electric vehicles forces many dealers to contemplate the additional expenses and challenges that will come with retailing and servicing these vehicles. Further, consolidation in the industry by the public companies and larger private auto dealership groups forces the smaller auto dealer families to compete with companies that have much larger resources and economies of scale. What decision should auto dealers make?

Some of the decision revolves around the expectation of value discussed previously in this Blog. Does the dealer’s perception of value equal reality? If the dealership is worth less than what a dealer expected, perhaps it makes sense to retain the dealership and improve operations and improve certain value drivers to eventually increase the value of the dealership. If the dealership is worth more than the dealer expected, perhaps it makes sense to consider selling the dealership at a time of heightened value.

High profitability and high blue sky multiples for most franchises translate to heightened valuations.

The other critical factor to succession planning, and in this case, transferring the ownership of the dealership to the next generation or key employee, is to assess the existing leadership talent in the business. Is there a second generation of the family that is currently involved in the dealership and familiar with the operating environment? If not, is there a key employee that could step in and continue the legacy of the dealership? In either case, an auto dealer must consider whether either of these individuals would be approved by the OEM. The OEM has to approve the dealer principal of an auto dealership. This consent is not always guaranteed and presents another unique element to the succession planning process for auto dealers.

Conclusion

At Mercer Capital, we perform valuations of auto dealerships for owners and advisors all around the country for a variety of purposes. Additionally, we follow the auto industry closely in order to stay current with trends in the marketplace. These give insight into the market that may exist for a private dealership which informs our valuation engagements. If you are contemplating succession planning with your dealership, contact a professional at Mercer Capital to discuss your valuation needs in confidence.