If I had a winning scratch ticket that paid $100,000 per year, every year, forever, not just for my life but forever, what would you pay for that ticket?
Probably a lot.
Now what would happen if you could collect the $100,000 a year, but only if you visited a certain place every day all day? If you were not there, then you might receive less than $100,000. The scenario would reduce what you would pay for the scratch ticket, right?
What if the ticket paid $100,000 every year except during certain times, such as when bad weather arose or a pandemic struck? The scenario would again change what you would pay for the scratch ticket, right?
As the riskiness of receiving cash flow increases, we will pay less to collect the cash flow. The more we have to do or relinquish to get the money, the less we will pay for it.
Determining what a knowledgeable investor will pay for a given cash flow is the essence of estimating a business’s value.
Valuation Breakdown
Before any valuation is performed, knowing the valuation’s purpose and what is included in the valuation is essential.
In a divorce or succession scenario, business valuation usually involves the whole organism: cash, receivables, payables, loans, furniture, fixtures, equipment, goodwill and future cash flow.
However, if the business will be shuttered, the valuation does not include goodwill and future cash flow. The valuator’s task is to estimate the proceeds earned from selling off the pieces.
If you are selling your dealership to an outsider, the business valuation typically includes the goodwill, fixed assets and inventory only. The seller usually keeps the current assets (other than inventory), pays the current liabilities and pays off his debt.
In most situations, other than liquidation, the fair market value standard is applied. A good fair market value definition might be the amount at which ownership would change hands between a hypothetical willing buyer and willing seller, with both fully aware or knowing the relevant facts and neither under compulsion to buy or sell the subject property.
Anyone can look around their business and estimate the market value of products such as computers, desks and shelving. They can research vehicle values through public resources such as the NADA guide. The challenge is determining a “going concern” business’s goodwill value.
Goodwill, the secret sauce keeping people coming back to your dealership, is represented by the cash flow received each year.
As with the lottery ticket, what would a willing buyer pay for the income streams your business generates annually? The valuator is trying to estimate the rate of return an investor requires to buy the cash flow stream.
If a buyer is willing to pay $200,000 for a $100,000 yearly cash flow, that equates to a 50% rate of return. The rate, also known as a multiple of 2, is a two-year payback to recover the purchase price.
If the buyer pays $400,000 for the $100,000 cash flow, the rate of return is 25%, or a 4 times multiple, the equivalent of a four-year payback.
Investors’ Options
What are the main factors influencing the rate of return a buyer will need to invest in your dealership?
First, what other options does the buyer have? What else can a buyer do with their money?
The buyer could put the funds in a savings account, where they would be safe but pays about a .25% return. The buyer could invest in fairly safe mutual funds at 5% to 7% return or riskier stocks at 8% to 20% or more.
In each option, the investor can be hands-off. Every business, even with a manager in place, needs some tending.
Most important, in any publicly traded investment, investors can cash out their investment and have money in the bank in about three business days. Ownership in private businesses, though, is much more difficult to sell. Some are not saleable, and selling these investments takes an undetermined time. One dealer I met had his dealership on the market for five years.
Because of the monitoring required and lack of liquidity, investors need significantly higher rates of return. Often you will see rates of return on private businesses anywhere from 25% to 75% or more. Rates of returns such as those are multiples of 4 to 1.3, or payback periods of four years to 1.3 years.
Factors Increasing Value
Numerous factors can increase a dealership’s value to investors. Here are a few.
Designated territories: All dealerships selling new unit inventory are assigned specific territories. Many states even have legislation preventing manufacturers from locating another dealership within a specified distance. In other industries, a new competitor could choose to locate next door.
Limited and known competition: Each year, models change to some degree, but overall, competitors are known and limited.
Profitability and growth: Successful RV dealerships generate net income or cash flow often totaling 5% to 15% of revenue. The levels are at or above many other industries. Additionally, once dealers have proven their abilities to the floorplan company, those dealers can realize growth by acquiring other dealerships.
Wealth: The wealth needed to acquire an RV dealership means dealers typically are business savvy. This translates to a sophisticated industry. Owners understand margins needed to stay in business.
Associations providing training, education and support: The industry is characterized by associations that provide members training, education and support. This is not necessarily the case in other industries.
Factors Decreasing Value
Various factors can decrease a dealership’s value to investors. Here are a few.
Floorplan lenders: If I buy a golf course generating $300,000 of cash flow per year, I give my down payment to my local Small Business Administration lender. If my credit is good and the business passes the bankers’ test, I walk out owning a golf course. If I want to buy an RV dealership generating the same annual cash flow, I might need the same type of financing, and the floorplan company requires much more than the down payment. As a result, a smaller buyer pool qualifies for an RV dealership than other similarly sized businesses.
Personal guarantees: Floorplan companies typically require owners to provide personal guarantees, often forever. Other businesses require such guarantees to last only the length of the acquisition financing.
Complexity and expertise required: RV dealerships are complicated. In other industries, senior management sets prices/margins, and line staff have no knowledge of or authority to adjust them. In dealerships, front-line workers negotiate each sale and hold the margins that can make or break the business. Service and parts departments require technically skilled staff. Dealerships’ interdepartmental transactions usually are found only in much larger, often publicly traded, enterprises. Understanding and managing these complex organizations profitably requires sophisticated business skills.
Other Factors to Consider
Your RV dealership may have other factors affecting its value, beginning with historical financial results.
Cash flow is king—and is what you are selling (or valuing). The goal is to create cash flow at or above industry benchmarks, as a percentage of revenue, over time. Start generating cash flow now; otherwise, your dealership has no value.
Cash flow is evaluated after normalizing. Dealers must remove one-time items, such as software installation fees or gains/losses on equipment disposals. Additionally, they must remove unrelated revenue/expense, such as a vacation rental revenue/expenses in the same legal entity.
Finally, the dealer adjusts expenses to market rates. This is important. The most common adjustments are owner and family member wages and rent when the property has the same owners.
One tip is to pay yourself market wages and market rent when you own the property. Doing so forces you to make better decisions in your business and increases the value and the selling price.
Remember, cash flow is evaluated over years. You would not buy stock to hold long term without looking at the last few years’ performances. The same applies to businesses. A single great year might help but will not erase historically poor results. Start today to prepare for the day you will leave your dealership.
Ideally, investors are looking for smooth upward trending revenue and net cash flow.
Declining results can be a concern. Often, I meet tired owners. They have hit the wall and have no more energy. Revenue has tipped down, as has cash flow, and they have decided to sell.
A revenue/cash flow downturn is values’ and selling prices’ kryptonite. Investors cannot tell whether the dip is due to an unenthusiastic owner or whether a permanent force is at work. As a result, they will pay less, so the value is less.
Having management in place can be a valuation factor. Investors pay more for a business not needing daily oversight. Skilled long-term staff in key roles increases your business’s value. With a general manager running the daily business, your dealership is much more appealing to a much larger buyer pool.
Location can be a factor. Small towns are wonderful places to live and raise a family, and these days the whole country seems to be moving to small towns. When a business needs to find an investor/buyer who is willing to relocate, though, the prospect pool is much smaller, which decreases the value.
In conclusion, no specific formula exists to estimate any business’s value. Valuators and investors look at each business and the factors and influences affecting that business to estimate the cash flow stream’s worth.
A Note on Multiples
You often will hear people say the multiple for dealerships is X – Y times cash flow. Do not fall for this trap.
First, the formula depends on what you are including in the sale.
Second, valuators use commercially available databases of other businesses’ sales to estimate the rate/multiple for the subject business. The transactions within those databases are inconsistent. Some add in parts and RV inventory, some have no inventory at all and some include real estate.
So, a 10 times multiple including real estate might be a 1 times multiple without the real estate. The average of all the inconsistent submissions applies to no one.
As a result, an average is just an average, like the average home price. Your situation and fact pattern will be unique to your dealership. So will the multiple/rate of return.
Carrie Stacey is the owner of Stacey & Associates, a company specializing in business valuations, mergers and acquisitions, consulting, coaching and benchmarking geared at dealerships. She is a certified valuation analyst and a licensed CPA in the U.S. and Canada. She spent a decade as the owner and general manager at powersports dealerships in Idaho and Canada. She also worked as general manager at both marine and RV dealerships. Additionally, early in her career, Carrie spent a number of years in professional sales. To reach her contact (208) 290-2289 or go to Staceyandassoc.com.
