Investing in Car Dealerships – Doing Your Homework

This article attempts to help give the investor a broader basis upon deciding whether a dealership merits their time, money, and attention.

Interviewing Factories and Financial Institutions

Lenders have an affirmative duty not to disclose the financial condition of their debtors promiscuously. In addition, most Sales and Service Agreements contain confidentiality agreements concerning the unauthorized disclosure of a dealer’s business. Consequently, questions directed to factories and finance companies should be limited to pertinent, non-confidential questions.


The Buyer’s Responsibilities

230 Kan. 684, 640 P2d 1235 held that not only was a bank under no duty to disclose information to a borrower intending to purchase a dealership but that the investor could not avoid the responsibility of exercising reasonable diligence for his own protection. See too: 387 NW2d 373 (Iowa) and 773 F2d 771 (7th Cir.) A buyer may not abandon all caution and responsibility for his own protection and unilaterally impose a fiduciary relationship on another without a conscious assumption of such duties by the one sought to be held liable as a fiduciary. 724 SW2d 343

Courts had even held that a seller’s accountants, upon discovery its client’s financial statements were misleading when they were given out, had no duty to correct them, even though they were included in a prospectus. See 513 FSupp 608 N.D. Ga.

The Physical Inspection of the Dealership

Due diligence requires more from a physical inspection of the dealership than searching for defects in the facility or potential EPA or OSHA problems. A skilled advisor can surmise how well a potential seller is operating by a visit to the facility. Whether the salespeople are energetic or lethargic, the amount of time it takes sales personnel to greet customers, whether the store is clean and well maintained, whether awards plaques are kept up to date all indicate the financial condition of the dealership.

Public Information

Data can be obtained from public information to determine the dealership’s financial strength and suggest how to structure an offer more attractive to a seller. Sometimes a seller will accept less money because of how the offer was structured. Determine what a seller needs, then find a way to enable him or her to get it.

UCC-1, title, and mechanic’s lien searches all supply information without seeking permission to obtain credit reports without violating contractual relationships with lenders.

The Fallibility of Dealership Financial Statements

Dealers are required to file financial statements each month. These statements, however, should not be materially relied upon in making projections.

A profitable parts department and a losing service department may mean the service department is doing poorly or that a strong parts manager is intimidating the service manager into paying too much for the part.

Industry Guides are available for each area of a dealership’s operations. Guides, however, are good servants but bad masters. They are prepared by many different groups, using a variety of sources. A prospective purchaser should:

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(1) Compare the selling dealer’s actual performance figures to the guides and obtain explanations for any variances; and

(2) Prepare a pro forma statement based upon expected sales and forecast gross profits and expenses, based upon personal experience rather than the selling dealer’s experience.

(3) Recognize inconsistencies and irregularities in the statements and pursue a more thorough investigation of those items.

Financial statements do not provide answers about a dealership; they present a method to formulate intelligent questions to pursue answers.Car

Keys to Analyzing Dealership Financial Statements

Consistency should exist from month to month in each account. All inventory and expense accounts should be compared. Note and receive an explanation concerning major fluctuations.

Buying Without Relying

One buys a dealership without relying solely upon a seller’s financial statements in the same way in which a manufacturer opens a new point. Major differences in these approaches generally inure to the buyer’s benefit. For example, there will be no existing wholesale parts business, retail sales base; yellow page advertising; or vehicles lined up for service the day after the escrow closes when opening a brand new store.

On the other hand, buying an existing business provides all that, as well as “historical” versus “projected” data to use with forecasts.

In addition to reviewing the financial statement, three additional questions should be answered before making projections for a new dealership:

(a) the current retail sales volume;
(b) the planning potential, at closing; and
(c) the new rent factor.

With those three figures, one may guesstimate the dealership’s earnings under proper management; and, the answers to those questions may be obtained from the factory and a reading of the lease.

Officer, Director, and Shareholder Approval

Most dealerships are incorporated, or LLCs and a check with the Secretary of State or Corporations Commissioner will reveal the shareholders, directors, and officers of the corporation and the LLC members. A check of local records will generally reveal a d.b.a., or general partnership, whether or not a partnership agreement or stock has been pledged or encumbered, and, if so, to whom.

Information regarding shareholders and officers should be acquired from sources and the factory, as the factory may not have all the information needed to assure the buyer he or she is actually negotiating with the person who possesses the authority to make a contract. Dealers sometimes have silent partners or sell an interest in the business without informing the factory. In either instance, a potential purchaser could be misled into negotiating with the wrong party.

You need that information to be sure you are negotiating with the right party. In 796 F2d 345 (10th Cir), Michael Gage, president of Michael Gage Chevrolet, signed a “Memorandum of Agreement” to sell his store. He had no approval from either the Board of Directors or the shareholders of the corporation. Subsequently, the Board and the shareholders rejected Gage’s agreement and entered into and approved a Buy-Sell Agreement with another party that was consummated.

Gage sued the Board and the shareholders. The state court dismissed, and Gage re-filed in federal court. The federal court held that when Gage (the dealer) signed a “Memorandum of Agreement” to sell, he had no approval from either the Board or the shareholders and “without such authority (he) could not validly contract to sell the corporation’s assets.”


Be aware, too: states vary concerning the number of shareholder votes required. Some require 100%, some a two-thirds vote, and some a simple majority.

Attorneys, Accountants, Brokers and other Automotive Advisors

Attempt to determine the other party’s advisors and whether they possess talent; are knowledgeable concerning the automobile business; and their reputations for veracity and keeping their word. After an investigation is completed, a decision should be made whether or not to proceed. Some purchases are better avoided, regardless of the attraction.

Questions to Ask about the Business

Why did the Dealership Fail or Succeed?

As in “Valuation of Dealerships” (a topic for another article), the critical question is not whether a selling dealership’s financial statements reflect a profit or a loss, but rather why?

A financial statement shows a large net operating profit, and a large number of vehicles sold is not enough answer to answer why it is profitable. Other questions must be answered before projecting whether new management will make a profit before deciding upon a reasonable offer for the dealership.

Actual Sales vs. Planning Potential

Planning potential is important for several reasons, such as vehicle allotment, build-out allotments, capitalization requirements, and reasonable expectations. A low planning potential and high volume sales may mean the working capital requirements are unrealistic. It is almost impossible to be profitable when a dealership is capitalized too high or too low.

When questioning the factory about planning potential, not only inquire as to the number but also as to how the planning was derived, the date it was determined, when it is expected to be updated, whether it reflects actual sales in the market area, and if not, why not.

Area of Sales and Service Responsibility

The dealership’s area of geographic sales and service responsibility is important both concerning surrounding dealers and concerning whether or not the factory intends to close an open store or open a new store. Past service and sales numbers will be less valuable to future projections if the factory intends to add or delete points.

Inquire of the factory, as to what the planning potential requirements would be, considering the newly closed or opened point.

Significant Document Checklist

Although some of the items are more important when dealing with a stock sale versus an assets sale, the prospective purchaser should have their advisors prepare a “significant document checklist collect them all.

In addition, the advisors should be certain to verify addresses on insurance policies, as we have encountered instances where the address being insured was not the address where the dealership was located.

Finally, the appropriate advisors should have an understanding of past, pending, and potential litigation, DMV, factory, and finance company problems, along with any settlements, payment of sales taxes, and whether or not favorable state unemployment insurance rates may be transferred.

Mr. Pico served as a court-appointed “Consultant to Debtor” in bankruptcy cases, a “Court Appointed Mediator” in automotive disputes, the “Court Appointed Arbitrator / Appraiser” in partnership disputes, a “Court Approved Consultant to Receiver” in a check-kiting case, as a “Superior Court Mediator” in dealership/lender litigation and has been recognized as an expert witness on both State and Federal levels.

He has consulted on upside-down positions of over $50 Million, of trust position of over $4 Million, and a bank overdraft of $30 Million. Since 1972, Mr. Pico has completed over 1,000 automobile dealership transactions, whose combined values exceed One Billion Dollars.