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Dealership Franchise Rights – What Are They Worth?

Learn how valuing dealership franchise rights involves GAAP methods for accurate financial reporting.
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In determining the value of a dealership (including retail automotive, heavy truck, machinery and equipment, power sports, and motorsports), the most subjective asset is what is known as the blue sky. The blue sky is considered the entire bucket of intangibles in a dealership. For various purposes, but most frequently for generally accepted accounting principles (GAAP) financial reporting purposes related to the purchase of a store, the blue sky must be delineated between goodwill and identifiable intangible assets. The identifiable intangible assets, which frequently have the most value, are the franchise rights associated with the dealership. 

What Are Franchise Rights?

Franchise rights represent the dealership’s ability to sell and service vehicles in a certain area of responsibility (AOR) as outlined in the franchise agreement with the manufacturer. Franchise rights are initially granted to dealerships by the manufacturer through an “open point” application. The type of franchise(s) held by a dealership is a significant component of its value, and the franchise agreement is protected by strong franchise laws in each state. 

Valuation Approaches to Consider

In determining the appropriate approaches, it is important to consider the standard of value. For GAAP financial reporting purposes, the standard is fair value as defined below:

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.1

In general, there are three approaches to estimating fair value:

  • Asset Approach – Determining the value based on the value of the assets and net liabilities.
  • Market Approach – Determining the value by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.
  • Income Approach – Determining the value by using one or more methods that convert anticipated economic benefits into a present single amount.

The valuation process should involve one or more of the above approaches that are appropriate and provide a reasonable indication of value. When multiple franchises are acquired as part of a transaction, it also is important to note each franchise agreement typically must be valued separately for GAAP financial reporting purposes (as opposed to valuing them on a consolidated basis).

Asset Approach

This approach considers the costs that would be incurred in obtaining the initial franchise rights from a manufacturer as if the store acquired was an open point. These costs would primarily include the efforts required to prepare an open point application that would ultimately be selected by the manufacturer. Since the open point application process is often highly competitive, and these costs are not a true indication of the returns expected to be realized from the assets attached specifically to the franchise, the asset approach is not frequently utilized.

Market Approach

In dealership transactions, there is typically not a value ascribed specifically to the franchise rights alone, but instead a value is attributed to the total blue sky (as referenced earlier, this includes the entire bucket of intangibles). Since there is limited data available for transactions of franchise rights, this presents a challenge in using market data.

While there is limited market data available for franchise rights, market data is available for the blue sky. This market data is generally a range of reported market multiples that are applied to a normalized pre-tax, pre-LIFO earnings stream in determining the blue sky. In estimating the value of franchise rights, we have seen an approach we refer to as the modified market approach (MMA). Under the MMA, the normalized pre-tax, pre-LIFO earnings stream is adjusted to factor in only those earnings attributable to the franchise rights. These earnings typically include all new vehicles and a portion of used vehicles, service, parts, and finance and insurance income.

Income Approach

The income approach is frequently utilized to value franchise rights as it specifically considers the anticipated cash flows and returns required by a market participant for a particular franchise in a certain AOR; however, the approach is limited as it requires making many different subjective assumptions. We refer to the income approach utilized in estimating the value of the franchise rights as the franchise earnings approach (FEA). For those in the valuation community, the FEA is an application of the multi-period excess earnings method (MPEEM) that is often used to value customer relationships. Below are several key items to consider when using the FEA:

  • Selecting a revenue stream and operating margin related only to the franchise rights portion of the dealership.
    • As mentioned under the market approach, this typically includes all new vehicles and a portion of used vehicles, service, parts, and finance and insurance income.
  • Deducting the appropriate contributory charges in determining the excess cash flow attributable solely to the franchise rights.
    • These charges represent the other assets in place for the dealership to utilize the franchise rights.

As with any valuation project, understanding the facts and circumstances is essential in determining a reasonable value of dealership franchise rights. For more information on dealership valuation, reach out to your FORVIS professional or contact the author listed below.

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