Newsletter - Fall 2003
Valuing an Automobile Dealership for Sale
by Edward J. Castellani
There are three basic approaches that are used in the valuation of an automobile dealership for sale of the dealership:
1. Asset Approach. Asset approach value has the advantage of being determined easily because the value of assets can be determined by an independent appraisal or by agreement of the parties. This approach is applied to operating businesses when there are no existing or potential earnings, and thus no value over and above the value of the assets that could be attributable to the earnings power of the business.
2. Earnings Approach. A buyer of a dealership is not interested in the value of the assets, but in the ability of those assets to generate earnings. If no earnings have been demonstrated, a purchaser must forecast what potential earnings might be generated in order to justify a particular purchase price. To calculate an earnings value, a buyer must do two things: determine actual or potential earnings value, and arrive at a proper capitalization rate to apply to those earnings.
3. Blue Sky Approach. “Blue sky” is defined as that value of the dealership over and above the value of the hard assets. It is also commonly referred to as “goodwill”. In the automobile dealership business, it is common to value blue sky (basically the value of the “franchise”) separately and then add that amount to the value of the hard assets that are included in the sale. The formula for valuing blue sky is a multiple of pretax earnings:
Pretax Earnings x Multiple = Value of Blue Sky
The pretax earnings are adjusted for excessive owner’s salary and certain fringe benefits that might accrue to the owner. The multiple that is chosen is subjective and depends upon such things as type of franchise(s), location, population, median income, competition, market share, condition of facilities, status of the economy, number of units allocated, etc.
The formula for valuing a dealership using the blue sky approach is as follows:
Value of Dealership = Blue Sky + Tangible Asset Value
In effect, this method combines the earnings approach and the asset approach to arrive at a value. It should be noted that this is a fairly unconventional approach to valuing a business, except in the retail automobile business.
Mr. Castellani is a member of our Business Department. He practices in the Lansing office and may be contacted at 517.377.0845 or toll free at 800.748.0436. You can also contact him via e-mail at ecastellani@fraserlawfirm.com.