Buying a dealership requires much more capital than many dealers have access to through traditional channels. A growing number are partnering with investment firms that provide that capital to grow. Those firms often take an equity stake in the growing dealership group.
“We have seen a surge of interest in an equity investor,” says Stuart McCallum, Partner and Dealership Services Practice Leader.
Such arrangements can be beneficial to both parties if the partnership is correctly structured. The right structure ensures even a dealer with one or two franchises can expand without taking on an unreasonable amount of risk.
Many of those interested in equity investment partners are first-time dealers looking to grow, McCallum says. The problem? Even the smallest dealership acquisition is going to require at least $7 million to get off the ground, McCallum says. “There are very few first-time buyers who have access to that.”
For a first-time buyer, coming up with that kind of capital to acquire another store represents an “existential risk,” he says. But not with an equity investor, who can allow a dealer to take a “reasonable” risk.
An equity investor could shoulder $2 million of that $7 million, he explains. Now, the dealer only needs to contribute $2 million. “I may have that in used car inventory,” McCallum says. “Now, if I am successful, I still get the fruits, but if I fail it doesn’t kill me.”
Stuart McCallum, Partner and Dealership Services and Practice Leader
Taking the Open Road
Dealers often bring Withum in to review the terms of the offered structure. Without a properly structured agreement, bringing on an equity partner might not kill a dealer, but it could weaken them financially. A well-structured agreement makes the arrangement a great way to grow stronger, however.
In a poorly structured agreement, a dealer could get hit with a huge tax bill even though they didn’t pocket the cash, McCallum says. Withum can show the dealer the true value of the offer with a “waterfall analysis” that shows the waterfall of the profits based on who gets paid when in the capital structure.
Equity investment can take different forms depending on the client’s needs, says Tim Batchelor, co-founder and managing director of Open Road Capital. Open Road takes minority and majority stakes in dealerships.
Open Road’s partnership with Rinaldi Halim is a good example of how these kinds of partnerships can help a small dealer grow. Halim owned several Chrysler Dodge Jeep Ram stores in California and wanted to acquire the Sierra Auto Group, which included a Honda, a Chevrolet, and a Subaru dealership in Monrovia, east of Los Angeles.
With just two CDJR stores, Halim was “maybe on his way to buying a third store but probably not,” says Batchelor. Certainly not the Sierra Auto Group.
So, Rinaldi contacted Open Road, which contributed cash to buy the three stores, taking a majority stake. It also took a majority stake in Rinaldi’s two CDJR stores.
Today, Sierra Auto Group has 11 rooftops including 14 franchises and a commercial truck center. Rinaldi used his own cash flow to buy more stores after he doubled the cash flow of the original three stores in a few months. “He has doubled his net worth as a result,” Batchelor says.
Crafting an “Eject Button”
For Open Road, there is a “big disparity” between good dealers and not good dealers, and before it partners with a dealer it does extensive due diligence to ensure that dealer is a good one. “Assets are important, but the partner is more important,” says Batchelor.
Before it invests in a dealership, Open Road assesses the potential partner to ensure he or she will fit well into Open Road’s collaborative company culture. A good partner has ethics and fairness in their perspective, says Batchelor.
Open Road spends a “good deal” of time with a potential partner before making an investment. And it asks questions in the industry. “There is almost nobody we can’t find out about by asking around,” says Batchelor.
That kind of carefulness is crucial because the major downside risk to the equity investment model is a mismatch between the two partners. Dealers like to be their own bosses, McCallum says. But once you invite an equity investor in, “you went from being single and now you are married and have a roommate,” he says.
No longer can a dealer have a good month and decide to buy a corporate jet. “You will get questions from your financial overlord,” McCallum says.
That is why including an “eject button” in an agreement is crucial. Withum has had to play marriage counselor more than once. McCallum recommends both parties agree to a mechanism that allows them to split up if absolutely necessary.
But the “eject button” must be designed so that one partner doesn’t unfairly benefit. For example, one partner could get bought out and the computation has that partner getting paid a “ton of cash” while the other is now an operator with no money and a store that is a poor performer, McCallum says.
Family Dynamics
Open Road also works with family-owned dealerships where one or more family members want to exit the business, and the other stakeholders need money to buy out the existing shareholders. Open Road provides that capital. Then, another capital need arises – capital to buy more stores. “Whoever is running the business now wants to put their own stamp on it and grow,” says Batchelor.
While a few of the deals Withum works on involve family buy-outs, says McCallum, “It’s a growth story no matter how you slice it.”
The family members looking to buy out another family member usually want to do so because that family member isn’t on-board with acquiring more stores at the pace the remaining stakeholders would like, he says.
Given the rise in the amount of capital needed to buy the most desirable stores, bringing in outside capital will only become more attractive, McCallum predicts. And it makes sense. Even for dealerships with a lot of cash flow, expansion can be difficult considering the rising cost of real estate.
Bringing in an equity investor can help make owning that desirable store a reality.
Some dealers settle for less because they believe it’s their only option for growth. However, partnering with an equity investor increases their options. For example, a dealer looking to expand could either purchase a lower-performing store to sell inexpensive cars or partner with an equity investor to own a stake in a high-performing store selling luxury models. Equity investors offer dealers various choices, and we provide the necessary analysis to help them make the most profitable decision, says McCallum.
Author: Alysha Webb, MA
Contact Us
For more information on this topic, please contact a member of Withum’s Dealership Services Team.
