I am not naturally strong in math, so I have to break it down to understand. Just in case you are like me, I will approach this from a mathematical perspective, then transition to dealership operations.
The bottom part in a division formula is called “the denominator” because it is the strongest number. In other words, it packs the most punch when it comes to changing present value. The denominator for calculating the value of your dealership is the Discount Rate less the Growth Rate. The formula is: Discount Rate – Growth Rate = Capitalization Rate. The Capitalization Rate is a “shortcut” to converting future earnings to present value (I know—more math—but it becomes important in just a minute).
If you put money in a savings account, money market, or stock market, you expect a return. The interest rate is the percentage you expect to earn on your investment. Working backwards, if you have an amount of money in the future and you want to know what it is worth today, you apply a discount rate. An interest rate is used to calculate the future value of an amount today. A discount rate is used to calculate present value from some future amount of money—in this case, your dealership’s expected earnings or benefit stream.
You have heard the saying “Higher Risk = Higher Return.” That “return” refers to the interest rate. The same is true for the discount rate. The discount rate is a way of quantifying expected risk. The higher the risk, the higher the discount rate—but the effect is different: the higher the discount rate (or risk), the lower the value. If you can lower risk, you decrease the discount rate and increase value. Growth is subtracted from the discount rate because expected growth (based on historical trends plus economic and market forecasts) means sales and earnings are trending up, thereby decreasing risk.
Now let’s look at the top part of the formula: normalized (historical) earnings, which is a reliable way to determine an expected benefit stream. The most common earnings used in powersports is EBITDA—Earnings Before Interest, Taxes, Depreciation, and Amortization. Increasing earnings is the most common way we think about increasing value, as the popular method is a multiple of earnings. The amount of increase, however, is dependent on the multiple.
Here is the “big reveal”: a multiple is the inverse of a discount rate. A multiple of 3 converts to 1/3 = 33% discount rate. A multiple of 4 = 25% discount rate. A seller would make more with 4 X earnings than 3 X by lowering risk from 33% to 25%. (If you are familiar with the investment world, you may be thinking that is close to venture capital returns—and you would be right. Powersports is a risky business, and the market requires a higher rate of return for that risk.)
Lowering the risks to your earnings can have a greater impact on your dealership’s value than simply increasing earnings. Volatility is a sign of risk, so a short-term bump in earnings is not as impactful as a slow and steady increase. Best case, of course, is to decrease risk and sustainably increase earnings.
So what does this mean for your dealership today?
- Implement proven systems and processes. The latest-and-greatest idea, product, or service will not be as impactful as procedures that you and your team can and will use day in and day out to make incremental changes that decrease risk (volatility) and sustainably increase revenues.
- Focus on fixed operations—especially steady maintenance work. There is a reason independent service shops and retailers sell after-market parts, accessories, and clothing to your customers: they are meeting customer needs. Fixed operations provide a steady income stream, but we tend to focus on major unit sales. Yes, “the money is in the metal,” but in today’s competitive market, we have to increase every source of income we can and stabilize our earnings. Strong fixed operations will do this, but it takes focus on long-term goals and consistent effort every day.
- Invest in your team. You cannot be at your dealership 24/7, and you cannot see everything even when you are there. If you treat your team like a means to an end, they may do what you require—but nothing more. Go beyond for them if you expect them to go beyond for you.
Every single one of us will transition out of our business someday. If you want that transition to be through a successful sale, remember this: your business is an investment that a prospective purchaser is comparing to other investments. Risk is inherent in the powersports industry. To compete in the market against other opportunities, be aware of how the market penalizes risk. Sustainable increases in earnings lower the volatility of earnings, thereby decreasing risk and creating a multiplier effect on the value of your dealership.
Laura Lemco, AM, MBA - Dealership Valuation Services, LLC
Laura Lemco grew up in her parents’ Honda, Suzuki, and Harley-Davidson dealership. When her father started a consulting firm for motorcycle dealerships across the globe, Laura worked in varying consulting and sales roles including F&I sales and building membership in professional peer groups. Eventually, Laura took over the consulting business. Laura’s consulting focuses on analyzing financials and operations to drive improvements. Laura builds on that expertise to develop appraisals to assist dealerships in transitions, succession planning, tax matters, dispute resolution, and litigation matters. Laura’s ability to work with Courts, attorneys, accountants, manufacturers, employees, shareholders, and finance companies led to engagements as an Interim Operator to stabilize dealerships in litigation or distress.
