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 Aquisitions - August 2008  |
Thinking of Buying a Car Wash? Used-car buyers will usually judge the quality of their purchase based on the performance of the vehicle and the car dealer after the sale. Most buyers will be satisfied if the vehicle starts and runs smoothly, gets good fuel economy, and doesn’t break down. Customer satisfaction can also be measured by how well the car dealer responds if something does go wrong. Unfortunately, there is no “lemon law” in the car wash industry, and most existing washes are sold “as is.” However, there are a number of things investors can do to avoid buying a pig in a poke. EXPECTATIONS Buyers will naturally want to pay as little as possible for a car wash business and sellers will naturally want as much as possible. If both parties have an unreasonable expectation of how much the wash is really worth, it doesn’t matter what the business is worth on the books or what it has been appraised for if the buyer and seller can’t come to terms. As such, buyers should evaluate their decision to purchase an existing wash based on the answers to these questions: • Can I make a decent salary? EVALUATION When evaluating an existing wash, the buyer should begin by seeking answers to the following questions: Are the books clean? What is included in the sale? Is there a potential upside to the market? Can the business be improved upon? Is the price fair? How long will it take to recover the initial investment? Can I qualify for financing? Can I live with the conditions and terms of the agreement? What are the liabilities? If the answers are favorable, the acquisition may make sense. OPERATING RECORDS The number one red flag in buying an existing wash is considering one without adequate operating records. By adequate records, I mean at least two to three years of monthly car counts, income/ expense and balance sheet statements, and/or several years of income tax statements. If the seller is unable or unwilling to provide a financial history of the wash, the lack of information will greatly increase the buyer’s risk. If a buyer is entertaining the idea of purchasing a wash from an owner who is running the business out of a cigar box, all bets are off when it comes to negotiating price and terms. Conversely, if the seller is offering a wash that is supported by healthy financial statements and real estate market conditions, the buyer should expect the seller to command a premium price and be less willing to negotiate price and terms. WHAT ARE YOU BUYING? If the buyer is purchasing land, buildings, and equipment, the key elements involved with due diligence will include a title review to ensure that the property is unencumbered; a property survey to verify the legal boundaries of land ownership; an environmental audit to ensure that the property is not contaminated by hazardous substances; an inspection of the facility to determine the working condition of the assets as well as repair and replacement requirements; an analysis of the retail trade area to determine market potential ; and a financial review to confirm gross sales, operating expenses, and net operating income. FAIR PRICE The worth or value of an existing wash can be determined on the basis of future expectations of profits and return on investment or an appraisal of the assets at the time of negotiation. The latter method is most commonly used when real estate is included in the sale. If conventional financing is involved, the bank will require a summary appraisal of the wash where the worth of the business is determined by a certified appraiser. The appraiser will develop an opinion of the fair market value of the wash by using the cost, sales comparison, and income approach to value as it relates to the present. If seller financing is involved, the value of land can be determined by bargaining between the parties on the basis of comparable land values. Inventory and supplies can be valued on the basis of the seller’s replacement cost. The value of buildings, equipment, and fixtures should reflect the cost of the assets subject to accumulated depreciation. The value of goodwill — the ability of a business to realize above-normal profits which arises from good name, financial performance, etc. — can be estimated by capitalizing net earnings at a rate that represents the buyer’s required return on investment. The difference between this amount and the appraised value of the physical assets is considered the value of goodwill, which is often subject to a considerable amount of bargaining between the buyer and seller. When real estate is not included in the buy/sell transaction, the preferred method of determining the worth of an existing car wash business involves trends in sales and profits, the capitalized value of the business, and the buyer’s expected return on investment. DETERMINING PRICE The car wash industry is replete with suggested guidance and standards for determining the price for an existing wash. This includes “rules of thumb” for the use of net income multipliers, gross income multipliers, overall capitalization rates, etc. However, prospective buyers who want to invest money in an existing car wash business should be most concerned about receiving a good return on investment. From the buyer’s perspective, the rate of return is usually related to the risk; the higher the risk, the higher the return should be. Consequently, this renders “rules of thumb” guidance rather useless; the aversion to risk varies considerably by individual. As such, the price to be paid by the buyer should be based on the capitalized value of anticipated future earnings. Common experience shows that the capitalized value is the value that would bring the stated earnings (usually stabilized earnings) at a specific rate of interest. This rate is usually the current rate of return for investments with a similar amount of risk. The capitalized value is determined by dividing the annual profit by the investor’s desired return on investment. Let’s consider a buy/sell transaction involving an existing self-service wash with projected stabilized earnings of $75,000. If the desired return is 15 percent to 20 percent, the buyer should pay from $375,000 to $500,000 for this business. If the business earns the projected $75,000, the buyer should recover the initial investment in five to seven years. Consequently, the terms of the agreement must be long enough to achieve this. Furthermore, new investors should consider ratcheting the rate up by a few percentage points to compensate for their lack of experience. MARKET POTENTIAL Market data measure the potential demand for products and services in a defined retail trade area. These data can provide car wash investors with insight on the market and growth potential of an existing wash and make informed decisions based on trends and consumer demand. Estimating the market potential for an existing car wash is critical in determining the economic feasibility of acquiring it. Predicting this potential will determine if the market is large or strong enough to support the asking price. This means answering questions like what type of customers will use the wash; where are they located; how many are there; how much do they consume; who and where are the competitors; what prices are being charged; and what is the potential for growth and market share? The key steps in estimating the market potential for a retail outlet like a car wash are to define the target market and segments, define the trade area boundaries, derive average expenditures for the category of wash, determine average household income for the area and state, and estimate market share. After this information has been collected, estimated sales can be expressed as a function of market area population, average expenditures for the category of wash, the ratio of area to state average household disposable income, and estimated market share. The outcome of this approach provides an upper boundary on the market size, which can be expressed in terms of units and/or sales dollars. There are a number of methods to derive these variables and most require the services of a qualified professional. LIABILITIES In addition to determining the purchase price and returns, key lease issues are often the subject of negotiation between the buyer and seller and their attorneys. This includes things like base rent and additional rent, security deposit, options to renew, use restrictions, and assignment and subletting issues. Another area that should not be overlooked is the outstanding warrants that remain in circulation that the buyer will need to honor. This can include things like discount coupons, pre-paid vouchers, club plan benefits, gift certificates, etc. The buyer should try to determine the amount of outstanding warrants and work out a redemption agreement with the seller or make an adjustment to the purchase price. If the buyer doesn’t establish such an agreement, redeeming the warrants may create an unexpected drain on working capital. AFTER THE SELL Another area that new buyers should not overlook is training after the sell and, more importantly, what is the fall-back position if the seller doesn’t honor the agreement or if the quality of the hands-on information transfer is inadequate? For example, I purchased an existing full-service wash about 12 years ago, and the seller didn’t even show up the next day to show me how to turn on the car wash equipment. The seller thought this was rather humorous but I wasn’t laughing, and neither were my customers. Even if there are no qualms about the seller honoring certain provisions of the purchase agreement, the buyer should develop a relationship — well in advance of signing an agreement — with a qualified equipment distributor that is capable of serving the chemical, equipment, and maintenance requirements of the wash. RISK ASSESSMENT Buying an existing wash has the risk of capital loss, which is a function of investment ownership risks as well as business operating risks faced by an owner (or tenant, which translates into leasing risk). The principal business operating risks that the owner or operator-lessee faces are competitive risk (will the site produce adequate gross sales?) and operations risk (can adequate management be provided to ensure an effective economic and customer-centric operation?). If the buyer is financially qualified to purchase an existing wash and the wash has a proven financial history, the risks associated with investment ownership would be much less than with a typical start-up venture. If the buyer has experience in the car wash industry or a proven track record of management success in a closely related industry, the risks associated with operating the business would be much less than with a typical start-up venture. EXIT STRATEGY If the wash is performing at less than 100 percent of projected sales volumes, the owner/operator may choose to discontinue operations or an operator/lessee may not exercise future lease options. In this case, the owner or lessee would move to sell the underperforming assets to a third party buyer. Sales volume levels needed for loan payoff and recovery of investor’s equity will be a function of a multiple of net operating income; the lower the sales volumes, the lower the net operating income, and thus, the lower the price. As such, the owner or lessee would need to sell the wash to a third party buyer priced to yield a positive return on the buyer’s equity (new buyer) after all operating costs and overhead. FINAL ANALYSIS Buying an existing wash can be a rewarding experience and a practical way for new investors to get into the car wash business without spending a small fortune or several years planning for a new wash. However, buyers need to temper their enthusiasm with a fair dose of common sense. This means disengaging one’s emotions and taking a couple of big steps backward to observe the business in an objective manner with a very critical eye. If the wash is the proverbial fixer-upper (AKA, “needs a good manager and TLC”), there are valid reasons why the wash is in this condition and the buyer needs to ferret these out. Otherwise, would-be owners may face the prospect of purchasing an expensive job or, worse, being left holding a bag, which contains no bacon. Robert Roman is president of RJR Enterprises — Consulting Services, Clearwater, Florida (www.carwashplan.com) and vice president of Bubble Wash Buildings, LLC. Bob can be reached via e-mail at rjrcarwashplan@yahoo.com.
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