This week’s post is a part of a periodic series called “Family Business Industry Spotlights.”  In these posts, we will share conversations with our family business advisory professionals who have deep experience working with family businesses in a particular industry.  We think the conversations promise to be of interest to family business directors regardless of their industry.  This week, we talk with Scott A. Womack about the challenges and industry trends facing families in the Auto Dealer Industry.

1. How have auto dealers performed over the past decade?

As with most questions, this isn’t a quick and easy answer. Generally, I would say that the auto dealer industry has rebounded from two very poor years during the recession (2009 and 2010) and performed favorably since 2011. A seasonally adjusted annual rate (SAAR) for new lightweight vehicle sales is a leading indicator for the health of this industry. Since June 2011, the SAAR has been generally climbing and has maintained a figure above 14 million units since January 2012.

The longer answer is more complicated. In addition to the national economic trends, the success of an auto dealer can be sensitive to more local economic conditions. Further, the auto dealer industry tends to be somewhat cyclical. For instance, it is very common for an auto dealer to have several good years, followed by a down year or two.

Brands or manufacturers also have a big impact on the profitability and success of a particular auto dealer. Some brands have historically been more desirable than others, and the perceived values of other brands have fluctuated over the past decade for a variety of reasons.

2. In your experience, how do families in the auto dealer industry deal with ownership and management transition?

Like many other industries, many auto dealers are in to the second and third generation of family ownership at this point. We see many current owners facing the potential decision to sell because the next generation either doesn’t have the desire or ability to continue running the business. Another unique element of this industry is that each dealership has to have a factory-approved dealer principal. Approval of proposed new principals is not always a given, and we have seen many hiccups in this process at death of an owner, transition to other family members, or proposed sale to a third party.

The other trend that we are seeing occurs when a family has several children and some are active in the business and some are not. Some families are choosing to transfer interests in the business only to those children that are active in the management/operations. For the non-active children, retaining an interest in the real estate may be an option to reach an equitable outcome. Most auto dealers are set up with the operations as an entity and the real estate held in a separate holding-company entity. It can become quite important to have both properly valued for any tax implications with these gifts/transfers, but also for the transparency to the children that the different gifts/transfers have been equitable.

3. What are some important trends in this industry that families should be thinking about?

As the SAAR begins to flatten out and show small signs of decline in the first two quarters of 2019, auto dealers are probably also experiencing similar trends with their new vehicle sales. Opportunities exist for auto dealers to capitalize on used vehicle sales during these times. Also, auto dealers should be able to focus on their Fixed Operations (parts & service). As the average age of vehicles in service continues to rise, more consumers are spending money to repair existing vehicles rather than purchase new vehicles. Finally, we are seeing more auto dealers practice expense controls to mitigate the current revenue trends.

4. If you could add one agenda item to the next auto dealer’s board or management meeting what would it be?

In the last few weeks, we have bid on two large projects in this space: one involving an IRS-challenged valuation impacting a taxable estate and another involving a family transition and buy-sell agreement stemming from the last family transition dispute. In both cases, a proper valuation from an industry-qualified appraiser would have greatly remedied the situation. The auto dealer industry is very specialized, from the way dealers report their financial statements (factory dealer statements) to the terminology used (Blue Sky value). Don’t be afraid to ask an appraiser for their specific industry experience and what specialized methodologies should be used for this industry. Be wary of general valuation appraisers that are not alert to factors such as LIFO adjustments and potential normalization adjustments for real estate, leasehold improvements and rent.

5. If a family is considering or has made the decision that they want to sell their dealership, what things should they be thinking about?

Even before a family reaches this point in the decision process, I would recommend having the business valued. While certain obvious events dictate the need for a formal valuation (death of owner, divorce, litigation, transaction), sometimes it can be too late. Not only would a valuation provide a current indication of value, but it can also manage expectations around what the family thinks the value should be. Additionally, the valuation should help identify many of the value drivers in this industry which would allow for the family to assess and monitor over time if they wished to try to increase the current value to be more in line with their expectations.

Another item a family should consider is the potential timing of a sale during the calendar year, as the timing may impact the tax consequences. An earlier sale in the calendar year could limit the wages for that year’s tax return that could offset a large ordinary income event from LIFO and depreciation recapture and other ordinary income. Whenever possible, contact your accountant or tax planning consultants to discuss the timing of a proposed sale.