Before You Seal the Deal
March 20, 20237 minute Read
By Tom Gresham
In recent years, the mergers and acquisitions (M&A) landscape has been marked by feverish activity and robust growth. Owners who were looking to sell typically found themselves with a variety of suitors to consider.
Recent changes in the broader economy, however, have brought a sudden shift in that market, according to experts. Sellers will need to adapt to the new climate.
“There's definitely a complete change in where car wash M&A is today – it’s dramatically different from where it was two months ago,” said ICA member Jeff Pavone, owner of Commercial Plus Group and a founding partner of Amplify Car Wash Advisors. “We are now in car wash M&A 2.0. We peaked, and we’re going in the other direction — the snowball is going downhill, not uphill.”
The challenge starts with rising interest rates, which is making life harder on buyers.
“Because capital is more expensive, buyers cannot pay as much as they could before,” said George Odden, partner at Ardent Advisory Group. “Almost overnight, the ability to pay a higher price has been hindered.”
In addition, Pavone said, many buyers have been selling off the real estate of the washes that they purchase to REITs and then paying rent tied to interest rates.
“Now they're getting hit with higher rent costs, higher interest costs, and generally speaking with higher costs from operating when you look at labor, utilities, chemicals and other stuff. So the cost side of the equation is going up,” Pavone said.
Car washes have grown increasingly attractive to private equity, and Odden said there’s a double-edged sword to their high activity levels. Valuations have climbed, and private equity’s access to financing has led to larger transactions. However, private equity firms have a hurdle rate that they need to clear – with interest rates up, accomplishing that requires lower purchase prices.
Still, interest in car washes remains high, and sellers should find buyers if they have something attractive to offer.
“It's still a very good business,” Pavone said. “There’s a large consumer demand for car washing, and we’re not anywhere near saturated — there is room for lots more car washes to serve all that pent-up demand for the kinds of car washes that are being built today.”
Odden said premium sites, particularly express sites, continue to attract fulsome numbers, fulsome multiples and a significant amount of interest. Transactions for sites that are more mixed in terms of location, offerings or financial results, on the other hand, are becoming more challenged, he said.
“There is an expectation on the part of the seller that's based on the last three or four years of frothy valuations for what those businesses are worth, and then there's an expectation on the part of the buyer of the return that they have to get,” Odden said. “And we're seeing that that Venn diagram overlaps less right now.”
“You’ve got to be realistic with your expectation of valuation,” Pavone said.
Doing everything possible to present a strong offering to the market can help. Highly attractive characteristics to buyers include defendable real estate, high membership numbers, a scalable management team and excellent recordkeeping, Pavone said.
“There are still ways to win, but you’ve got to execute in operations and get your numbers up,” Pavone said. “I’m preaching to our clients that you’ve got to deliver a car wash that’s performing.”
In general, Colin May, managing director of Car Wash Advisory, said large- and medium-sized car wash buyers prize turnkey locations.
“They want modern, updated sites that require as little work and renovation as possible after purchasing,” May said. “This includes proper signage and street visibility, functional layouts with an adequate number of central vacuums, paystations, membership programs in place, and more. Time and resources are limited for most buyers, so many of them prefer modern, upgraded sites that don’t require large and lengthy refurbishment projects.”
Variety of deal types
The shift in the M&A climate means that buyers and sellers will need to get a little more creative about the types of transactions that they do, Odden said.
“You're seeing more minority deals as an example, where somebody comes in and buys not control of the business, but a smaller piece,” he said. “And that allows the seller of that minority stake to have some money either to take a little off the table, which is great, but also to fuel their growth.”
In addition to minority sales, Odden said sale-leasebacks offer a popular alternative to a full sale for owners who are thinking about raising money, but are struggling with selling their business as a whole or don't want to in a market that isn't necessarily going to evaluate it the way that they'd be comfortable with.
For that reason, sellers can undermine their offering if the buyer does not have the sale-leaseback option, May said.
“A car wash’s real estate being included in a sale transaction has become especially important throughout 2022 for most buyers,” he said. “The sale-leaseback market has been very robust, allowing buyers to spin off and sell the land at very attractive amounts. If a car wash seller wants to keep their land, or they currently lease it from a landlord, this can significantly affect the value of the site and reduce the number of potential buyers.”
Because of the challenges in the M&A market, Odden and Pavone believe there will be a shift toward operators who might have preferred to buy existing washes before now opting to build new ones from scratch. Odden said building a new site has grown more expensive. “But it's still cheaper and can still offer a substantially better return on investment in the long term than paying an inflated price for an asset in the M&A market.”
“You're going to see an onslaught of new development coming in,” Pavone said.
Weighing the terms of a deal
In M&A negotiations, Odden said fundamental disagreements center on price and the allocation of risk. The buyer wants to pay less and assume less liability while the seller has the opposite goals.
“The more generous buyers are in terms of valuation and price, and the happier sellers are with the number, the more risk sellers are likely to take on,” Odden said.
The terms of noncompete clauses frequently are contentious topics in negotiations, particularly sellers agreeing not to open a competing car wash within a certain mileage. As buyers gain more leverage, they seek more wide-reaching noncompetes — sometimes even encompassing the entire country, Pavone said.
Valuation of development sites also is a common sticking point, Odden said. In those instances, the owner of a chain of car washes is selling not just locations that are open but locations that are in some phase of development.
“There is meaningful negotiation over how those sites are treated,” Odden said.
Negotiations also can get hung up on a potential ongoing development role for the owners, Odden said.
“I've seen in a number of transactions where the owner knows the market that they're in very well, and the buyer would love to have that person continue to develop sites,” Odden said. “Determining under what construct they're willing to do that, what fee is paid, when it is paid, who takes the financial risk of building the site — those details can be very thorny.”
May said the sellers should consider a variety of details about the dynamics of an offer.
“How long does the buyer need for due diligence and to close the deal?” May said. “Is the purchase price paid all on closing or is part of it kept in escrow as a holdback for a year or more? Is the buyer putting down an upfront deposit and at what point does it become non-refundable? These are all key components of an offer that a seller needs to consider.”
In addition, May said, “All buyers are not created equal.”
“A very high purchase price is great but how confident are you that the buyer is going to be able to follow through and close the deal?” he said. “It is not uncommon for us at Car Wash Advisory to advise a seller that receives multiple offers to accept one with a lower price because the buyer has a good reputation and there is more certainty of actually getting to the finish line and completing the transaction.”
A competitive process
Ultimately, it is critical for sellers to have options, Odden said.
“Being able to have different parties compete for the same asset typically is necessary to get the best possible results,” he said.
Odden noted that owners get cold-called frequently by buyers in the car wash market, but they should be wary of approaching sales that way. For the highest price and the best overall deal, a competitive process inevitably is more effective, Odden said. Advisors can help navigate the complex wording and scope of deals, ensure contracts say what sellers intend for them to say, and negotiate the terms.
“The most effective approach is to bite the bullet and do a disciplined, competitive process,” Odden said. “That's going to end up getting you more optionality and more competition — which is going to yield a better price.”
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