Having spent 35 years in the automotive industry, it is my experience dealer principals are generally concerned about “being in debt,” though debt, when managed properly, can be a powerful tool for dealership principals to enhance liquidity and profitability. Leveraging debt allows dealerships to access capital needed for growth, manage cash flow effectively, and take advantage of investment opportunities without diluting ownership.

Let’s look at which types of dealership assets are relevant and how to effectively leverage them:

Inventory

Inventory is one of the most significant assets for automotive dealerships. It includes both new and used vehicles held for sale. Leveraging inventory often involves utilizing a floor plan line of credit. Dealerships can obtain floor plan financing, where lenders provide funds based on the value of the inventory held. Typically, new vehicles are financed at 100% of value and used vehicles are financed at 80% of NADA value. This helps manage cash flow and ensures the availability of vehicles for sale without tying up too much capital. Standard repayment is interest only and principal is repaid as vehicles are sold. Principal curtailments come into play as vehicles age.

Accounts receivable

Accounts receivable, or outstanding invoices for vehicle sales and service, represent funds owed to the dealership. These can be leveraged through accounts receivable financing, also known as factoring. Factoring involves selling invoices to a third-party finance company at a discount in exchange for immediate cash. This improves cash flow and reduces the risk associated with late payments or bad debts.

I asked Matt Fahey, senior vice president at M&T Bank, to provide some context around leveraging a dealership’s accounts receivables.

“Financial institutions sometimes offer revolving credit facilities for large syndicated facilities that are governed by a borrowing base whereby a dealership can borrow based on a percentage of accounts receivable and other eligible assets (inventory, FF&E, etc.). A borrowing base, which is a summary of the dealership’s eligible assets, is required to be submitted to the financial institution monthly, and sometimes more frequently,” Fahey said.

Real estate

Real estate owned by the dealership, such as the dealership lot, showroom, or service center, can be leveraged through mortgage loans or commercial real estate loans. This allows dealerships to unlock equity in their properties to finance expansion, renovations, or other business initiatives. Real estate can also serve as collateral for larger loans at favorable interest rates due to its tangible value.

When asked what banks need when real estate is put up as collateral, Matt Fahey responded: “Most financial institutions require an appraisal that is no older than six months and generally do not provide loans greater than [80-85%] LTV. Environmental reports are also required. Repayment terms can vary, but typically feature 5-year terms with a 15–20-year amortization”.

Equipment and machinery

Equipment and machinery used in the dealership’s service department, such as diagnostic tools, lifts, and specialized equipment, can be leveraged through equipment financing. Lenders provide funds to purchase or lease equipment, with the equipment itself serving as collateral. This financing option helps dealerships upgrade equipment, improve operational efficiency, and manage cash flow effectively.

Strategies for effective asset leveraging

Let’s discuss the importance of debt in improving liquidity and profitability, and 10 factors that should be considered to assess how to leverage the dealership’s debt.

  1. Conduct a comprehensive asset assessment

Begin by conducting a thorough assessment of all dealership assets, including inventory, accounts receivable, real estate, and equipment. Understand the current market value, depreciation rates, and potential for generating cash flow or collateral value.

  1. Develop a strategic debt management plan

Debt provides immediate funds that can be used for expansion, introduction of new technology introductions, and other strategic initiatives. Unlike equity financing, debt does not dilute ownership, allowing original owners to retain control over the company. Based on the asset assessment, develop a strategic plan for leveraging assets to optimize debt management. Determine which assets can be used as collateral for loans or lines of credit, considering interest rates, repayment terms, and risk management strategies.

  1. Negotiate favorable financing terms

When leveraging assets for financing, negotiate with lenders to secure favorable terms and conditions. Compare offers from multiple lenders to ensure competitive interest rates, flexible repayment schedules, and minimal fees.

  1. Monitor and manage cash flow

Regularly monitor cash flow projections and financial statements to ensure that leveraging assets does not strain liquidity. Maintain adequate reserves to cover operational expenses, debt obligations, and unexpected costs. Debt can smooth out cash flow fluctuations, ensuring that dealerships have the necessary working capital to cover operational expenses. Short-term debt instruments like lines of credit can help manage day-to-day expenses and handle seasonal variations in cash flow.

I asked Matt Fahey about what requirements banks have relative to short-term instruments; Matt offered this response: “Financial institutions commonly include financial covenants associated with certain types of debt. A common financial covenant is debt service coverage which is calculated by dividing annual free cash flow by annual debt service payments. Financial institutions typically require a 1.00:1 – 1.25:1 ratio.”

  1. Utilize asset-based financing wisely

Use asset-based financing as a strategic tool to support growth initiatives, such as expanding inventory, upgrading facilities, investing in marketing campaigns, or enhancing customer service offerings, or even to expand the dealership through acquisition. Align financing decisions with long-term business objectives and market opportunities. Dealerships can take advantage of blue-sky term loan financing when making an acquisition. Standard terms include a shorter term / amortization when compared to a mortgage and are often limited to 50% of the purchase price.

  1. Tax considerations and advantages

Interest payments on debt are often tax-deductible, reducing the overall tax burden on the company. This tax shield can make debt a more attractive financing option compared to equity.

  1. Leverage

Properly leveraged debt can amplify returns on investment by using borrowed funds to generate higher profits. However, it’s crucial to maintain a balance to avoid over-leveraging, which can lead to financial distress. In the dealership world, leverage is measured by taking total debt (less floor plan) divided by free cash flow or EBITDA.

  1. Cost of capital

Debt can be cheaper than equity in terms of cost, especially if the company’s credit rating is good, resulting in lower interest rates.

The lower cost of capital enhances profitability by reducing the overall expense of funding.

  1. Strategic flexibility

Debt can provide strategic flexibility by enabling dealers to act quickly on opportunities such as mergers and acquisitions. Having access to debt allows a company to be agile and competitive in the marketplace.

  1. Partner with a financial advisory firm

While your accountant may be qualified and a great resource to help manage your books and operational P&L, it is advisable to seek counsel from financial experts, such as M&T Bank, whose services include asset and debt management.

Effectively leveraging automotive dealerships and financial assets is a fundamental aspect of successful debt management and business growth. It is an aspect that is generally underutilized by most dealer Principals. Rather than thriving to operate “debt free”, dealers typically miss out on maximizing profitability or expansion through leveraging existing debt.

Using inventory, accounts receivable, real estate, and equipment as collateral for financing, dealerships can optimize cash flow, reduce debt burdens, and capitalize on growth opportunities. It’s essential to conduct thorough assessments, develop strategic plans, negotiate favorable terms, and monitor cash flow diligently to ensure sustainable financial health and operational success.

By leveraging assets wisely, automotive dealerships can navigate challenges, seize opportunities, including expansion, and smartly use “other people’s money” to thrive in a continuously evolving market landscape.

George Pero is an accomplished leader in the automotive industry. George began his career in the automotive retail sector, where he held various management positions. George’s career achievements include successfully launching, operating, and selling Auctions In Motion (AIM), a regional mobile auction company that brings the auction to the dealer. George has extensive knowledge and expertise in mergers and acquisitions in the automotive sector, having overseen more than $1 billion in transactions. His sales and general management experience coupled with his success in M&A activities led George to establish Mach10 Automotive, a dealer advisory firm offering a suite of services to include dealer performance improvement, succession planning, and M&A.