By Christian J. Scali, Halbert Rasmussen, and Gus Paras
This article seeks to explore some of the legal and deal considerations that buyers and sellers face in dealing with various types of acquisition financing. Commercial financing options and related loan agreements are, of course, issues that should be discussed early on with experienced counsel. Acquisition financing can come in many forms, including:
- Bank Loans
Many banks and other commercial lenders offer working capital or similar loans that can be used for acquisition financing. However, these often provide limited leverage, allowing only a fraction of the acquisition cost to be financed. In addition, these loans can include terms that are not keyed into the business realities of the vehicle dealer business, but at the same time are not very negotiable. Even though many terms are “take it or leave it,” buyer’s counsel should review these agreements, especially where automotive-specific provisions are, or should be, involved. Such areas include default terms, audit and inspection rights, and what financial statements a dealership is required to provide.
- Special Purpose Lenders or Funds
Although private equity groups have not historically been major players in dealership acquisitions, recent transactions such as Berkshire Hathaway’s acquisition of the Van Tuyl Group for over $1 Billion in 2015 and Mark Wahlberg’s July 2018 purchase of an Ohio Chevrolet dealership illustrate private equity’s increasing willingness to enter the automotive space. These groups are involved in lending as well as equity ownership, but, in either case, dealers can expect a very robust set of legal documents, replete with requirements for legal opinions, detailed management of cash flow (i.e., waterfall provisions), and other elements that some dealers might think should be reserved for Wall Street mega mergers. Even so, a good number of dealer groups, both large and small, have relied on these arrangements to grow their businesses.
- Buyer’s Flooring Lender
Flooring lenders, both captive and independent, have added acquisition financing to the list of features offered to induce dealers to establish long term flooring and financial relationships with them. Taking a page from the specialized lenders, these financial services companies have also increased the complexity of their loan documents in acquisition situations. However, some have demonstrated that they are more willing to negotiate loan terms than other lenders. Additionally, flooring lenders tend to be especially willing to fund acquisitions where they can link the overall transaction to their brand. Some lenders will finance several franchises even if only a small portion of the overall set of loans involves dealerships within their franchise. But a captive finance lender will want to link franchise defaults to loan defaults, which can expose buyers to more liability in the event of either type of default.
- Seller-Provided Financing
Seller-Provided financing represents a unique challenge to buyers and sellers, but can sometimes be a creative solution that benefits both. A Seller is uniquely familiar with the real and tangible property it is selling and financing unlike a normal lender that needs to do greater due diligence on such assets before financing them. Sellers providing financing may also have less formalistic borrower requirements than a typical commercial lender. For example, a private seller may be less interested in over-scrutinizing title concerns or attorney opinion letters. Owing in part to their relative lack of sophistication, and inability to take dealership assets as collateral (due to the flooring lender generally having an all-encompassing security interest), private sellers may be more insistent on protections relevant to the individual buyer or its principal owners, such as a personal guaranty.
Buyers using acquisition financing often have some leverage in encumbering dealership assets, since their purchase is often conditioned on obtaining financing (whether as an explicit condition to close or as an internal consideration that buyers review before allowing their deposit to become non-refundable). Acquisition financing often turns on whether it is possible to leverage real property equity (by providing the finance source a lien on the real estate) to secure the purchase of tangible dealership assets. Additional considerations applicable to acquisition financing include:
- Loan Agreement: Acquisition financing generally includes (in addition to notes, security agreements, and, where real property is involved, deeds of trusts) a comprehensive loan agreement filled with a host of invasive provisions, including, but not limited to:
- Covenants: Promises made by the borrower (on penalty of putting the loan in default if not kept) to have the business perform in a defined way. Can include covenants to maintain certain debt/equity ratios. The more exotic the lender, the more exotic the covenants.
- Negative Covenants: Covenants to avoid certain actions, such as covenants against issuing any shareholder distributions.
- Management Prohibitions: management changes, such as the removal of general managers or chief financial officers (unless lender consents), are often prohibited.
- Cross-Default Provisions (or a separate agreement): lenders often require borrowers to agree that any default of any agreement with the lender will constitute a default under all other agreements between borrower and lender.
- Cross-Collateralization Provisions (or a separate agreement): These allow a lender to foreclose on borrower property other than the property subject to the acquisition financing.
- Buyer counsel issuing an opinion letter to lender
- Lenders often seek legal counsel’s representations, such as:
- That the buyer entity is in good standing under the laws of the state of its incorporation and operation;
- That the buyer is not a party to any bankruptcy or other legal proceedings that could materially affect the transaction;
- That all necessary shareholder or member votes or written consents have been obtained to move forward with the transaction; and
- That the Loan Agreement and related agreements are valid and will not violate other buyer agreements.
- Legal counsel often seeks qualifications or exceptions to their representations, such as:
- The effect of bankruptcy law and other laws affecting the enforcement of creditor rights;
- Issues with the enforceability of loan agreements that arise from contract law;
- Laws limiting late fees, interest amounts, or other amounts chargeable against a debtor; and
- Debtor protections provided by applicable surety statutes and laws limiting collection of deficiency judgments.
- Lenders often seek legal counsel’s representations, such as:
- Work on related surety issues, including any personal or entity guaranty that lender requires.
- Buyer and Seller’s review of title and work on title issues relevant to lender’s needs.
Legal counsel will often become more involved with due diligence and negotiating deal agreements when acquisition financing is needed because a lender’s needs will also be crucial to making a deal. We always recommend seeking experienced retail automotive counsel early on in considering any transaction, but this is especially important when acquisition financing is involved.
Scali Rasmussen’s attorneys are thought leaders in the automotive industry, often called upon to provide their opinions on new and trending issues on auto distribution and franchise, F&I, employment and advertising issues. The firm drafted the CNCDA’s 2015 and 2017 Advertising Law Manuals, providing auto dealers with practical guidance on advertising practices.