If you own a car dealership, you may feel as if times are good right now. You may have been thinking of selling your business in recent years but have changed your mind now as you’re making more money than ever. Yet, while it may be tempting to sit on those profits and hang on to your valuable asset, storm clouds may be gathering on the horizon. You should think long and hard about your future and consider whether now is the perfect time to put your dealership on the market. What do you need to know about changes ahead and how inaction on your part could significantly affect your future plans?
Strong Market Conditions
Clearly, nobody would have predicted the events of the past year or so. The pandemic caused a nationwide slowdown and prompted the federal government to enable a raft of incentives to mitigate some damage. Dealerships around the country took advantage of the Paycheck Protection Program (PPP) designed to support and save jobs while vehicle sales were down. They used these loans to keep valuable employees on the payroll and, in some situations, to bring back terminated or furloughed staff. Some of these loans were “forgivable” if the dealer could meet certain conditions as well.
The PPP has undoubtedly been a significant source of revenue to dealers at the same time as they have managed to cut expenses. Yet, demand has also started to move back towards the pre-pandemic level, and U.S. auto sales surged in the first quarter of 2021. Indeed, April and May sales were the highest they have been for more than two decades as consumers opened their pocketbooks and dealers took advantage of pent-up demand following enforced lockdown.
When you take everything into account, profits are way up, and it’s not surprising that some dealers want to keep making hay while the sun shines. They may not be keen to sell their dealership while they appear to be making more money now than they may have done before the pandemic.
Changing Times
However, the Paycheck Protection Program “gravy train” has come to an end. Meanwhile, automobile manufacturers are doing their best to increase supply after being caught on the back foot when demand surged, and at the same time caught off guard by the microchip shortage. They are working hard to improve dealership inventory, and this will, in turn, damp down the seller’s market. While demand for new vehicles will probably remain high in the foreseeable future, supply will catch up. This change will eat into the profit levels currently being enjoyed at the dealership level.
Of course, these adjustments are not surprising. And if you have run a dealership for any length of time, you’ll know that profits can always fluctuate due to changes in demand and market forces. But other factors are at play that could significantly affect the real-world value of your dealership if you choose to delay your decision to move forward with a sale.
Capital Gains Tax Hikes
The new White House administration has released plans that detail sizeable changes to the capital gains tax structure. President Joe Biden has now proposed that long-term capital gains (for investors making more than $1 million) could almost double.
Biden wants to raise the highest capital gains tax threshold from 20% to 39.6%. This change means that long-term capital gains will be taxed as ordinary income and at the highest bracket level. He says that he wants to level the playing field: “We’re going to get rid of the loopholes that allow Americans making more than $1 million a year to pay a lower rate on (CGT) than working Americans pay on their work.
While the current top income tax bracket is 37%, bear in mind that the administration plans to increase this to 39.6%. Who knows what other tax hikes may be around the corner as the White House tries to balance its books following the pandemic?
Buyers Abound
Other factors are at play in the business buying marketplace. Large dealership groups recognize the buoyant market conditions and are, themselves, flush with cash as well. They're looking to snap up smaller dealerships, and other investors are attracted to the market, too. They are also seeking to buy, and here again, demand has started to outstrip supply.
Higher Valuations
Healthy market conditions have affected business valuation. With so many companies or individuals looking to buy, multiples are up – and outgoing owners can realize much more for their business than they might in leaner times.
All of these factors may put any decision to sell in a different light. In fact, you could say that storm clouds are beginning to gather on the horizon for those owners who may be in the market to sell but may have been lulled into a false sense of security.
On the Line
As a quick summary, here are some of the critical factors to consider.
- Expenses may have been low recently but may not remain so.
- PPP loans or grants have ended.
- OEMs are working hard to address low vehicle supply.
- High levels of profitability may soon come to an end.
- Sellers may have to pay a significant amount of additional tax when changes to CGT are confirmed.
Making Comparison
To make the picture a little clearer, let’s look at an example.
Consider a dealership that has an EBITDA (in today’s market) of $2 million. This particular dealership also has real estate valued at $10 million. Let’s have a look at how things could change soon and how the NET proceeds of the sale may change.
Here are some of the critical factors to consider:
- Long-term capital gains tax rate could increase from 20% to 39.6% under current White House proposals.
- Changing market conditions could reduce the current goodwill multiple from (for example) 5 to a factor of 4.
- These changing market conditions could also reduce profit levels, and the EBITDA in the future may only be $1.5 million.
Costs of Inaction?
Now, let’s do some calculations to compare the costs of inaction.
Today’s situation:
- Gross proceeds from the sale: $10 million (goodwill) (EBITDA x 5 multiple) and $10 million (real estate)
- Total proceeds from the sale: $20 million
- Net proceeds from the sale, assuming current CGT situation: (10-2) + (10-1) = $17 million
Tomorrow’s situation:
- Gross proceeds from the sale: $6 million (goodwill) (lower EBITDA x 4 multiple) and $10 million (real estate
- Total proceeds from the sale: $16 million
- Net proceeds from sale, assuming a revised CGT situation: (6-2.4) + (10-2) = $11.6 million.
So, as you can see, the net proceeds from the sale of this dealership have been reduced by $5.4 million, representing a 32% decline in the take-home situation.
Reviewing Your Options
If you are thinking about selling your dealership but have been sitting on the fence due to current, buoyant market conditions, perhaps it is time to think again.
You have a unique opportunity to maximize your proceeds right now. You can enter a strong seller’s market and put your dealership in front of the many aggressive buyers looking for an acquisition. You can use your current high profits and take full advantage of the high multiples in this market. If you act soon, you may be able to avoid those tax rate hikes as well, so you can keep as much of the proceeds as possible.
What to Do Next
Don’t forget – it may take between six months and one year to list, market, and close the sale of your dealership, so there’s no time like the present. Get in touch with the experts at National Business Brokers to discuss your situation and to get the ball rolling as soon as you can.
