A few times each year, I ask one of my law partners to prepare a guest article for this column. BSM partner, Robert Bass, has graciously provided an article addressing an important but often forgotten aspect of any franchise sale transaction – valuing fixed assets. Robert heads up BSM’s transactional practice for our dealer clients, which includes assisting with both buying and selling franchises, corporate, partnership and shareholder documents as well as real estate issues.
We have seen a steady increase in the number of dealership buy-sells since 2009. And while goodwill values for many dealership brands are similarly increasing, it is all the more important for a seller to capture as much value as possible in all the dealership’s assets, so as to maximize the economics of the transaction. This is even more important for those dealership brands that have lagging or declining goodwill values.
Most dealership transfers of ownership are structured as a sale and purchase of operating assets and inventories (as opposed to an agreement for the sale and purchase of the dealership’s common stock). Asset purchase agreements (which are often referred to as an “APA”) describe the assets to be sold and purchased, contain a variety of warranties/representations and covenants (promises to do something) that are exchanged between the seller and buyer. At the heart of any APA is an outline of the economics and valuation or pricing method for each of the assets to be sold.
Many sellers narrow their focus on the pricing of the goodwill or bluesky of the dealership. This is not surprising inasmuch as goodwill often constitutes the most valuable asset being transferred. But, it perhaps is also a lingering inclination from the days when goodwill values were reaching irrational levels. As a result of this attention to goodwill value, however sellers often fail to adequately capture the value of their fixed assets (i.e., furniture, fixtures, equipment, special tools, computers, etc.). A seller should be careful to avoid such shortsightedness, because a dealership’s fixed assets may contribute materially to the overall economics of a dealership transaction.
In dealership asset transactions, fixed assets are commonly valued in one of three ways: by an appraisal method that is based off the seller’s dealership balance sheet or the seller and buyer review a list of the dealership assets and come to an agreed value on an individual basis (what I refer to as the walk-around valuation method). Each of these valuation methods may result in different fixed asset valuations, and thus different purchase prices.
The result of valuing a dealership’s fixed assets based on appraisal is generally considered friendlier to a seller than to a buyer. That is because assets that are often excluded (inadvertently or intentionally) from the other valuation methods’ calculation are captured by the appraisal method, thus maximizing value of the dealership’s fixed assets and providing for a higher purchase price. In selecting an appraiser, the parties should look for a person who knows their way around motor vehicle dealerships and is familiar with dealership operating assets. The parties should emphasize to the appraiser that the value of the fixed assets should be based on fair market value (“FMV”) and not liquidation value. Liquidation value presupposes a narrower class of potential buyers and compressed time frame for taking the fixed asset to market. Viewed in essence as a distressed sale, a liquidation value appraisal approach generally results in a lower purchase price or value for the assets. In contrast, the FMV method seeks to arrive at a market price/value for the assets that would likely arise out of a transaction in an unpressured setting between a knowledgeable, willing seller and knowledgeable, willing buyer. Since a dealership would continue to utilize its assets as part of an on going concern after a closing of an APA transaction, use of the liquidation method is not a fair and reasonable approach. The value of a dealership’s assets should be based on FMV.
In advance of an appraiser’s visit to the dealership, a seller should gather documentation on its assets to present to the appraiser to aid in its determination of FMV. While appraisers often make information requests prior to a site visit, a seller may need to take the initiative to educate the appraiser about the dealership and its assets. Preparing and providing to the appraiser a comprehensive list (not a mere depreciation schedule – more on that later) of the dealership’s fixed assets is ideal. Original invoice or cost information for the dealership’s assets showing the original date of purchase is important information for the appraiser. Maintenance and repair records on assets that are subject to routine upkeep are relevant to the asset’s value. Also, whether an asset has general or special purpose use in the dealership business is information that an appraiser may find useful in his analysis. A failure on the part of the appraiser to review or otherwise take into account this asset information may call into question the thoroughness of his investigations and the seller and buyer may want to seek out another appraiser.
Another basis for valuing a dealership’s fixed assets is net book value (“NBV”) as reflected in the dealership’s financial records. The common definition for NBV is original of an asset cost minus depreciation of the asset. This method is often selected because of its simplicity and the avoidance of the added expense of an appraiser. Generally speaking, pricing a dealership’s fixed assets based on NBV is considered friendlier to a buyer than a seller. That is because any assets that are fully depreciated, but nevertheless remain in-service at the dealership continue to have value. But this value is not realized in the overall pricing of the dealership’s fixed assets because the NBV of these fully depreciated assets is zero. Also, a seller may fail to realize the value of certain assets that the dealership purchased and expensed at the time of acquisition, because these expensed assets will not be a part of the dealership’s depreciation schedules.
Before agreeing to a fixed asset purchase price based on FMV, a seller should carefully review its depreciation schedules to make sure the assets listed are still in service at the dealership and to make sure that any newly purchased assets have been added to the schedule. It is not unusual for depreciation schedules to be incomplete at any given time. This is often due to an asset having been replaced or retired from service and the particular dealership department head failing to notify the dealership’s comptroller so that the asset can be removed from the depreciation schedule.
If the depreciation schedules are not updated, a seller may reach its decision to agree to a purchase price for the fixed assets on a NBV basis on flawed information, only later to learn after signing the APA that the NBV of the fixed assets was overstated and the resulting purchase price is less than expected. This unpleasant surprise may affect the seller’s overall view of the fairness and value of the transaction, particularly if the seller’s decision on the fixed asset valuation method and expected price had any influence on the seller’s decision to agree to a certain value for the dealership’s goodwill. Therefore, a seller should, in advance of any negotiations with a buyer, carefully scrutinize its depreciation schedules to ensure they accurately reflect the NBV of the assets so that the seller’s view of the overall value the dealership’s assets, both tangible and intangible, is not skewed.
A couple of other important points not to be overlooked if the parties are going to use a NBV for arriving at a purchase price for the fixed assets, are capturing the value of special tools and fixed assets that have been subject to accelerated depreciation. Many dealers expense their special tools in the year of acquisition and do not subject them to depreciation. As a result, they are not on a depreciation schedule and ownership of the tools may transfer under the radar to a buyer free of charge. A seller should insist on a special carve out in the pricing provision of the APA that captures the value of the special tools, as the parties may agree. A similar loss of value to the seller may occur as a result of the seller taking advantage of recent provisions in the U.S. tax code allowing for accelerated depreciation of certain assets.
A simple way to address such assets is to, for purpose of the dealership transaction, back them out of the dealership’s depreciation schedules and recast their depreciation on a special schedule calculating a straight line of depreciation assuming an agreed useful economic life as to those assets. The resulting value on this special schedule would then be added to the NVB of the assets on the dealership’s depreciation schedules (revised to remove the assets listed on the special schedule). If a seller agrees to a purchase price for its fixed assets based on NBV, it would be well advised to carefully prepare in advance (using some of the suggestions above and others that may be suggested by its CPA) to ensure maximizing the value of its assets.
Finally, the purchase price for the dealership’s fixed assets may be arrived at by a seller and buyer by conducting a “walk-around” of the dealership. The walk-around method is not particularly scientific, but may be appealing to the parties. It is a process that requires the parties to engage each other in asset-by-asset (or room-by-room full of assets) negotiations of the purchase price. To some, it is the art of the deal in its purist sense, which lends to its appeal for some sellers and buyers. What is important is if the parties undertake this approach, each needs to educate themselves on the replacement value of assets commonly used in the dealership. As should also be done as part of the other valuation methods described above, the parties should carefully create during the walk-around a list of all assets negotiated to ensure that they are present at the dealership on the day of closing.
It has been said that if one watches their pennies the dollars take care of themselves. The message here is to pay attention to details. This is solid advice when it comes to valuing assets for a dealership asset transfer of ownership. A seller who carefully considers and administers the variety of ways in which fixed assets can be valued is more likely to be satisfied with the economic results on the day of closing. As with any transaction, both seller and buyer should consult with their experienced motor vehicle franchise attorney and CPA prior to beginning negotiations and signing definitive agreements.