Capitalizing on growth opportunities: A strategic approach to dealership acquisitions
If you are considering expanding your dealership holdings through acquisition, now is the time to sharpen your pencil. Dealership franchise sales were up 38% over the same period last year,1 according to the First Quarter 2024 Blue Sky Report® by Kerrigan Advisors. Driven by an increase in the number of sellers coming to the market (without a related rise in buyers), Kerrigan expects 2024 to be a franchise buyer’s market for the first time since the COVID-19 pandemic.
Exciting as this opportunity might be for growth-minded owner-operators, the “What next?” question can inhibit your ability to seize the moment. But it doesn’t have to. In this article, we demonstrate how a smart capital strategy can put you in the driver’s seat to achieve your goals.
What are you buying and why does it matter?
Because the “basic” uses of funds can vary depending on several factors, using terminology common among buyers and sellers is helpful.
- Current assets include short-term assets intended to be used or sold within a year, e.g., vehicle inventory, receivables, parts, and accessories.
- Fixed assets are long-term assets such as machinery, furniture, fixtures, and equipment.
- Working capital and current ratio both help assess a company’s ability to support business operations. While closely related, they differ in definition and how they impact the borrowing power of a given company.
Working capital is a measure of the liquidity available to operate the company effectively. The minimum amount, or working capital guideline, is generally set by the manufacturer. Derived by subtracting current liabilities from current assets, this figure is represented as an absolute dollar amount. Working capital measures typically defined in a lender’s financial covenants are generally referred to as net working capital and exclude certain short-term assets such as prepaid expenses and “friendly” receivables.
Current ratio, on the other hand, is derived by dividing total current assets by current liabilities. Also a key measure of liquidity, current ratio measures a company’s ability to cover its short-term obligations with its short-term assets. As a ratio, it fluctuates with the expansion and contraction of the balance sheet. A higher current ratio reflects a stronger liquidity position, whereas a lower ratio may indicate potential liquidity challenges.
- Blue sky (or goodwill) is the intangible market value of the franchise, or the premium paid that exceeds the net of assets and liabilities. The value of the company’s historical earnings performance is also a key consideration of blue-sky valuation.
- Real estate transactions for dealership property acquisitions typically require minimum buyer’s equity of 20% of the appraised value. However, a buyer may reduce the equity needed at closing by negotiating a lease with the seller that includes a future option to purchase.
As part of the approval process for a change-in-ownership transaction, manufacturers often require a buyer’s commitment to make substantial facilities improvements. Some lenders, including KeyBank, provide construction finance options to help your organization facilitate improvements to fulfill this requirement.
Components of the capital landscape
Equal to the importance of defining your assets (“uses”) is understanding what options are available to pay for them (“sources”). Because dealership acquisitions require a substantial upfront investment, it’s often necessary to use more than one source of capital. It’s important to know the breadth of resources available and how they can be leveraged to support your overall strategy.
- Buyer’s equity is simply capital (or cash) the buyer puts toward a purchase. Business owners often prefer not using 100% personal equity; however, a certain amount is generally required by the manufacturer and the lender for any acquisition.
- Lender financing is a blanket term for credit facilities provided by a financial institution. In the context of car dealerships, lender financing types and terms include new- and used-vehicle floorplans, commercial real estate mortgages, working capital term loans and lines of credit.
- Service contract advances can be an instrumental source of alternative funding for new business ventures. In this relationship, a service contract provider advances funds to the buyer based on the anticipated future sale of service contracts (e.g., an extended warranty). The advanced funds are then repaid over time as the buyer sells the service contracts over the term of the contract.
- Seller financing is just that: financing arrangements made directly between the seller and the buyer. This can be a favorable way for the seller to generate a stream of future income and possibly defer taxes.
- SBA 7(a) is the U.S. Small Business Administration’s primary loan program. It provides financial assistance to small businesses, which can be used for a broad range of purposes, including:
- Acquiring, refinancing, or improving real estate and buildings
- Short- and long-term working capital
- Refinancing current business debt
- Purchasing and installing machinery and equipment
- Purchasing furniture, fixtures, and supplies
- Changes of ownership (complete or partial)
- Revolving funds
- Construction
- Business establishment
Often government-guaranteed and arranged through an SBA-approved financial institution (KeyBank is among the top 10), the SBA 7(a) loan has generous borrowing limits ($500,000–$5 million) and can include longer-than-average amortization terms at a fixed rate.
The KeyBank team understands how we can be successful using different capital alternatives. They were quite knowledgeable about SBA 7(a) and could move rapidly to close, which is important.
Ray Sminchak, Partner, Mentor Nissan
Lender financing considerations
Being familiar with the terms and metrics commonly used in dealership purchase transactions is important, and being aware of your dealership’s liquidity markers and how they are perceived or used by a lender can affect the outcome of a purchase. But remember, scrutiny can and should go both ways — not all lenders are equal, and the value of various lending products often depends on how the deal is structured.
Trusted relationships also play a crucial role in the success of a deal, as one seasoned capital broker points out. “The difference is in the relationship,” acknowledges John Mecham, a 20-year client of KeyBank with 20-plus years of experience negotiating acquisitions for car dealers. “When you establish relationships with people you trust and like,” he says, “it will get you through the deal, including the serious business decisions.”
The KeyBank team is so valuable to me — with both sellers and buyers — because a small change isn’t going to jeopardize a deal.
John Mecham, Senior Partner, Performance Brokerage Services
Flexibility is also valuable in any market and with nearly every deal type. Here are some considerations and questions to keep in mind when looking for a capital provider who can address current and future needs for a range of buy/sell opportunities:
- What loan amortization and term options are available? Are there interest-only alternatives?
- Are you confident that the lender will be able to deliver and meet closing date requirements?
- Do they have access to unique lending alternatives such as the SBA 7(a) loan?
- Are they committed to the automotive industry?
- Can they assist with personal needs in addition to commercial services and solutions?
Creating a skillful road map
Welcome to the foundation of a solid acquisition strategy: You’ve inventoried your assets and numerous means to account for them. To access the right capital in a strategic way, however, it requires a bit more homework and industry expertise. As a leader in dealer finance solutions, your KeyBank relationship manager is poised to help you:
- Evaluate needs: Once we identify the specific funding requirements for each asset category, we can help create strategies using as our compass the highest potential return and operational efficiencies.
- Compare options: Our breadth of lending relationships and experience enables us to optimize interest rates, repayment terms, and eligibility criteria.
- Plan for the future: Building trusted relationships over time is at the heart of our brand, which allows us to develop a long-term financial strategy and leverage a mix of funding sources within and beyond KeyBank products and services. This approach can help mitigate risks and ensure you have timely access to critical capital.
Our bankers are a good sounding board; not many finance institutions understand our business. With Key, they can grasp a concept we present and share ideas on how to pay for it.
Jamie Pilla, Principal, Mentor Nissan
Realizing growth and/or acquisition opportunities is possible when you have access to reliable, creative resources. KeyBank has provided commercial lending to auto dealers for more than 80 years and continues to build long-standing industry relationships. Whether it's managing inventory, investing in equipment, ensuring sufficient working capital, or acquiring a franchise or other real estate, we’re here to help you make strategic financial decisions that support the growth and sustainability of your dealership.
This article is for general information purposes only and does not consider the specific investment objectives, financial situation, and particular needs of any individual person or entity. KeyBank does not provide legal, accounting or tax advice.
Banking products and services are offered by KeyBank National Association. All credit, loan, leasing, lines of credit and merchant services products are subject to collateral and/or credit approval, terms, conditions, and availability and subject to change.