Is it getting harder to buy a dealership in North America?

Article by Farid Ahmad, Founder and CEO

AS FEATURED IN AUTOMOTIVE NEWS

The market for dealership sales and acquisitions in Canada has been buffeted by strong headwinds in the form of high interest rates, inflation and the banking industry’s diminished confidence in the auto retail sector. But by following some basic best practices, both prospective sellers and buyers alike can more effectively navigate the complexities of complicated deals – and create mutually beneficial transactions. Farid Ahmad, Founder and Chief Executive Officer of DSMA, offers some insights and advice – and points out the most active regional markets that are primed for acquisitions.

Q: Has it become more difficult to acquire a dealership? And if so, why?

Farid Ahmad: Acquiring a dealership has indeed become more challenging, especially in the aftermath of the pandemic. Several factors contribute to this increased difficulty:

• Inflation and Interest Rates: Inflation led to higher interest rates, which increased the cost of financing for potential buyers.
• Inventory Issues: Ongoing supply-chain disruptions resulted in continued inventory shortages for some brands, while others were over-stocked, which complicated dealerships’ operations and hurt their profitability.
• Banking Confidence: All the major banks in Canada have shown reduced confidence in the retail automotive sector, which led to more-stringent lending criteria and increased caution in extending new business loans. This has additionally reduced their exposure when lending on such things as dealership goodwill.

Collectively, these factors resulted in a decline in the multiples applied to the net earnings of most automotive brands, further complicating the acquisition landscape.

Q: What can a dealership organization do to become a more attractive buyer to an owner looking to sell a dealership?

Ahmad: In today’s market, sellers recognize two critical factors that influence the successful sale and closure of their dealership: financing and manufacturer approval. Consequently, sellers are unlikely to engage in a formal buy-sell process unless the prospective buyer has thoroughly addressed and mitigated these challenges. To become a more attractive buyer, a dealership organization must demonstrate strong financial stability and secure the necessary manufacturer approvals, ensuring these aspects will not hinder the transaction.

“Acquiring a dealership has indeed become more challenging, especially in the aftermath of the pandemic.”

Q: What are the characteristics or best practices of a good dealership acquisition strategy?

Ahmad: I get asked this question frequently. A robust dealership-acquisition strategy requires understanding current market dynamics and implementing best practices tailored to both buyers and sellers. In today’s balanced market, buyers typically fall into three categories: Strategic purchasers, opportunistic buyers and “hometown dealer groups.” Sellers, on the other hand, are often motivated by various factors, including the potential for upside, high demand for their dealership’s brand or location or personal circumstances that prompt them to sell.

Here are some best practices for buyers:

• Simplified Offers: Keep letters of intent (LOIs) clear, fair and balanced, with minimal conditions.
• Experienced Advisors: Engage automotive accounting and legal firms with a proven track record and consult with companies such as DSMA.
• Focus on Key Issues: Prioritize significant deal aspects and avoid getting bogged down by minor details.
• Manufacturer Approval: Ensure you have, or can secure, the necessary approvals from the manufacturer.
• Pre-Arranged Financing: Secure financing beforehand to streamline the acquisition process for such things as goodwill, floor planning and working capital.

Sellers should consider these best practices:

• Accurate Valuation: Understand the true value of your business before listing it for sale (ask DSMA for a free quote).
• Identify Deal Breakers: Clearly define your non-negotiable terms when you are thinking about selling.
• Focus on Key Issues: Avoid getting sidetracked by minor details.
• Tax Implications: Be aware of the tax consequences of selling your dealership.
• Qualified Representation: Engage a reputable firm, like DSMA, to ensure your business is presented only to prequalified buyers.
• Experienced Advisors: Use experienced automotive accounting and legal firms to facilitate the deal.

By following these best practices, both buyers and sellers can navigate the complexities of dealership acquisitions more effectively, which leads to successful and mutually beneficial transactions.

Q: What can a prospective dealership buyer do to mitigate the impact of rising interest rates?

Ahmad: In the current environment of high interest rates and constrained lending, prospective buyers of dealerships have limited options to mitigate the impact. However, there is one effective strategy: Use of vendor take-back (VTB) deals. In a VTB arrangement, the seller agrees to hold a portion of the purchase price as a loan to the buyer. This loan typically can carry an interest rate lower than what banks offer and is structured for a specified period. This also can benefit the seller.

It’s important to note that in any VTB deal, the bank financing the transaction will retain first priority on the collateral. Thus, while VTB arrangements can provide some relief from high interest rates, they must be carefully negotiated to ensure both parties benefit and that the primary lender’s requirements are met.

Q: Are there regions of the country that offer more opportunities to a retailer that wants to acquire a dealership?

Ahmad: Several regions across the country present significant opportunities for retailers looking to acquire a dealership. The following regions are ranked in order of the most active markets: Quebec, Ontario, East Coast provinces, Prairie provinces, Alberta and British Columbia.

Each of these offers unique market dynamics and growth potential, making them attractive for dealership acquisitions.