Preparing your Dealership for Financial & Tax Due Diligence

As dealer consolidation continues, chances are many dealers will become a buyer or seller in the near future. When purchasing a dealership, whether an asset or stock transaction, buyers will need to administer a thorough review of the company to ensure they know exactly what they are buying – this process is commonly referred to as “due diligence.” Likewise, many sellers of automotive assets are small owner-operators not typically experienced with a transaction process. So that buyers and sellers may navigate such complexities with ease, DHG offers financial and tax due diligence services to help clients overcome the common issues associated with any given transaction.

The multi-pronged process of acquiring another dealership involves due diligence on both sides of the purchase and will often result in a “quality of earnings” (Q of E) report. A quality of earnings analysis tells the narrative of the company’s business and its operations while highlighting certain factors that would be helpful in determining the buyer’s decision to move forward with the deal. A quality of earnings analysis involves a great deal of work and includes, but is not limited to, analyzing key reconciliations like bank reconciliations and floor plan reconciliations, analyzing trends throughout the balance sheet and income statement, analyzing detailed schedules, and thorough discussions with various parties. The quality of earnings should represent normalized historical earnings.

Preparation for Due Diligence

Conducting buy-side due diligence allows the buyer to assess the quality of the dealership’s earnings and cash flows, and to identify potential issues or risks associated with the seller’s business. Sellers should also conduct their own due diligence before they make their final decision to sell the company as this may greatly decrease the chances of a derailed transaction.

Dealership transactions are different than any other business transaction, and an automotive (or even dealer) business owner typically doesn’t sell their company very often, so due diligence is an unchartered process for many. The varying tax provisions, types of assets, relationships with manufacturers, and value determination specific to the industry are some of the peculiarities that make these transactions challenging to navigate.

In order to gain a better understanding of the target business, a buyer needs to receive comprehensive and factual financial information, including assets, liabilities, and future earning potential from the seller. Sellers are also better positioned to obtain maximum value and reduce the risk of unexpected purchase price adjustments or surprises by investing in sellside due diligence. Below are some items to consider as the potential seller:

  • It is common practice to inform a limited number of employees about the potential transaction, but it is essential to include the controller or person responsible for the accounting records, as he or she will likely be responsible for providing the necessary information for the due diligence and they will likely have the answers to many of the questions that will arise during the process.
  • Understanding your dealership’s financial statements will prove advantageous throughout the lifecycle of the transaction. Sellers should be prepared to discuss trends and variances such as: performance, inventory mix, gross profit margins, operating expenses, location by location analysis, and items hidden in other income and expenses.
  • Be sure to accumulate any non-recurring or unusual items that have occurred in the recent past which might skew your numbers, in a positive or negative manner. This is the sellers’ opportunity to identify all “management adjustments” that should be factored into the Q of E report. Some examples of management adjustments are certain expenses running through the company’s records that are unrelated to the business; professional fees incurred preparing for the transaction; and market adjustments such as compensation and rent.
  • Prepare to discuss any hidden liabilities. Think about any exposure that a future buyer would inherit from a transaction including, but not limited to, any for-life programs such as oil changes and tires for life which may not properly be recorded on the balance sheet. The buyer would have to honor the program’s future costs with the customer base it is inheriting or run the risk of immediately ostracizing customers. We see time and time again that this causes a transaction to be significantly delayed, or to ultimately fall through.
  • Identify any reinsurance or other income items that are not recorded in the company’s records by either being paid directly to the owners or other related companies.
  • Although financial due diligence is focused on the accounting records and numbers, sellers should still ensure the appearance of their dealership is acceptable. Perform a facilities walkthrough of your dealership, not only the show room, but the parts warehouse, service bays, accounting office, and exterior parts of the building.
Departmental Responsibilities
  • Human Resources – Gain a full understanding of your current benefits position including the related employer costs associated with the following: (i) medical, dental and vision insurance coverage, (ii) 401k plans, and (iii) vacation/paid time off. Also, from a personnel perspective, have a game plan in place to properly inform the company employees about the transaction after an agreement has been reached and discuss the changes that will be forthcoming. Lastly, it’s important to note that even if it’s an asset purchase transaction, the buyer is typically acquiring the current processes and people so it’s helpful to understand the talent pool and key employees as well as attempt to avoid having significant turnover immediately following the transaction.
  • Legal – Have a complete understanding of your legal situation including potential claims and where they stand.
DHG Tips for a Smooth Transaction
  • Be patient and prepared to dedicate time and effort before, during and after the transaction.
  • Understand and anticipate the detailed historical operating results and complexities in order to keep the transaction on the right course.
  • Sellers should perform sell-side due diligence to prevent surprises and provide opportunities for increased value.
  • Buyers should perform buy-side due diligence, especially if new to the industry, since significant adjustments to reported EBITDA often lead to important considerations for deal negotiations.

John Seymour
Senior Manager, DHG Dealerships