By Kevin E. Timson, Esq. and Joseph F. Gentile, Esq., Bellavia Blatt, PC
On some buy-sell transactions, dealers may sell all the assets to a dealership but remain as dealer-principal after the sale. In this article, we outline when this scenario occurs, why this arrangement may be advantageous to sellers, buyers and automotive manufacturers and how sellers and their attorneys can draft key provisions to protect sellers from any inherent risks.
This scenario may occur when the buyer is a private equity firm, family office or larger multi-store dealer that is financially solvent but cannot provide a qualified dealer-principal candidate within their organization in time to close the dealership sale. To keep the transaction progressing, the parties may agree for the seller to remain as dealer-principal. Under this arrangement, the seller would transfer the dealership assets to a new entity. Under this entity, the seller would retain the minimum ownership percentage that the manufacturer requires (e.g., ten or fifteen percent) and the buyer would become the majority owner of the dealership.
All the parties involved in the transaction may benefit from this arrangement. The seller can immediately reap the financial benefits of the sale. The buyer gets help with retaining key managers by having the seller remain with the dealership and also gets more time to identify a replacement dealer-principal. The arrangement also benefits the manufacturer, who can continue working with an experienced individual who knows and understands the dealership, the local market and the manufacturer’s needs.
While advantages exist for this arrangement, there is some level of risk for sellers when they go into business with a buyer, especially if the parties have not previously worked together. First, what happens if the buyer does not find a replacement dealer-principal within a reasonable amount of time? The seller will not want to remain as dealer-principal indefinitely, but how can he or she exit the dealership without a replacement dealer-principal?
Second, how can the seller work with a new majority owner to avoid making decisions that may harm relations with the manufacturer? As dealer-principal, the seller will be the official representative of the dealership to the manufacturer. Yet the buyer, as majority owner, will effectively have control over every aspect of the business. Any misstep resulting from the buyer’s exercise of majority control over the dealership can harm the dealer-principal’s relationship with the manufacturer. This is a concern especially when the seller has other franchised dealerships with the manufacturer or is considering acquisitions of additional dealerships in the future.
Lastly, how can the seller address the risk of dealership defaults on financial obligations related to floorplans, sales tax and rent? While a buyer may be financially solvent, a seller may want further assurances that the dealership’s financial obligations will be met on a timely basis.
To mitigate these risks, a seller should consider executing an agreement with the buyer that directly addresses these concerns. The agreement should include a specific timeline for when the buyer must replace the seller as dealer-principal with another individual. Such a deadline should provide enough time to identify a dealer-principal candidate and get that candidate approved by the manufacturer.
If everything goes as planned, the candidate should be in place within the agreed-upon timeline. However, if that does not happen, the agreement should provide an alternative exit for the seller. For instance, a plan might provide that if the seller is not replaced as dealer-principal in two years, then the parties shall pursue a sale of the dealership in the next 12 to 24 months. If no sale occurs, then the seller can repurchase the majority ownership share of the dealership from the buyer at an appraised value or seek a termination of the dealership’s point and distribute any compensation from the manufacturer for the termination by the percentage of ownership interests of the buyer and seller.
To help preserve the seller’s relationship with the manufacturer, the agreement should detail how the dealership should be managed in accordance with past practice in several areas, including: hiring and supervising staff; setting sales and service profit margins; and enacting and enforcing policies and procedures in the sales, service, parts and F&I departments. This level of detail is necessary to provide the buyer with a clear expectation of how it needs to exercise its majority control of the dealership consistent with how the seller has run the dealership prior to the sale.
Regarding dealership financial obligations, several provisions can be included in the agreement. First, the agreement should require that, upon close of the dealership sale, the buyer provide for the dealership’s floorplan financing and the seller is no longer a personal guarantor to any floorplan financing. Furthermore, the seller should have the right to monitor accounts payable payments of major financial obligations, including rent, sales taxes and any financing commitments (floorplan or otherwise). For instance, the seller could have the right to review profit and loss statements on a weekly basis or have direct supervision over the dealership controller.
The agreement should also set dollar thresholds for expenditures that would require seller approval and provide that long-term contracts only be executed with the consent of both parties. The overall goal of these provisions is to ensure that the dealership does not take on commitments that reduce its working capital to the extent that it cannot make payments for major obligations.
If the dealership does get default notices with regard to these obligations, the seller should have a right of recourse under the agreement to satisfy such obligations. Such recourse should include the condition that the dealership provides reimbursement within a pre-determined period (e.g., 60-90 days), otherwise, the seller can invoke the alternative exit cited above and be reimbursed, with interest, out of the proceeds from the sale of the dealership.
Once the buyer has identified a replacement dealer-principal, the seller is not free from liability just yet. The dealer sales and service agreement and the state DMV licenses for the dealership must be amended to remove the seller as dealer-principal and owner. These activities can take several months to complete. Accordingly, the buyer should indemnify the seller during this period from any third-party claims brought against the seller that relate to the ownership or management of the dealership.