By Kevin E. Timson, Esq., Bellavia Blatt, PC
Buyers often acquire a franchised auto dealership through an asset purchase agreement, where they purchase all, or substantially all, of the dealership assets. In an asset sale, a buyer can often acquire the most desirable assets of the business without many of the accompanying liabilities. However, it may be more advantageous in some instances to instead use a stock purchase agreement to acquire a dealership – i.e., purchasing equity in the seller’s company rather than purchasing the dealership’s assets.
Stock purchase agreements may be the preferred route for the buy-sell scenarios identified below. With each of these scenarios, it is important to consider drafting specific provisions in the stock purchase agreement that protect the buyer or the seller. A few of these provisions are examined below.
When the Seller Desires a Long-Term Exit
In some buy-sell transactions, a dealer may not be immediately looking to exit from a dealership but may be compelled by their manufacturer to make financial commitments to the dealership that extend beyond the dealer’s expected retirement date. For instance, a dealer may be presented with a scenario where they are looking to retire in three to five years, but their manufacturer is looking for a facility upgrade with a financial commitment that would take ten to fifteen years to recoup.
In this scenario, it might make sense to execute a stock purchase agreement where a buyer purchases an ownership interest in the dealership that provides the necessary capital to undertake the facility upgrade. For example, if the dealership is owned through a corporation, the buyer could purchase non-voting shares of stock with a preferred dividend, allowing the seller to retain control of the corporation while giving the buyer priority on stockholder dividends.
These shares could be convertible to voting shares upon a future date when the seller’s is exiting the business and/or upon the completion of the facility upgrade. Similar arrangements could be made if the dealership is owned through a limited liability company – i.e., the seller could maintain control over the company as manager of the LLC while the buyer could receive priority distributions.
Alternatively, if the buyer seeks control of the corporation at the closing of the transaction, the seller could offer an ownership interest to the buyer without such voting or management limitations in exchange for the seller having a long-term employment contract with the dealership.
When the Seller Continues as Dealer-Operator
Executing a buy-sell transaction under a stock purchase agreement may make sense when the buyer might have challenges getting approved as a dealer-operator by a manufacturer. Maybe the buyer is not experienced enough with the dealership’s particular brands. A buyer might also have an existing dealership with another manufacturer, but that dealership’s customer satisfaction score does not meet the criteria set by the approving manufacturer to allow the buyer to be the dealer-operator for the seller’s dealership.
Regardless of the reason, if the seller agrees to this arrangement, the buyer can acquire a partial equity stake and execute a management agreement to run the dealership, thereby demonstrating over time the buyer’s managerial qualifications to the manufacturer. The buyer and seller can then agree to a provisional period during which the manufacturer becomes more comfortable with the buyer and makes the buyer the appointed dealer-operator, whereby the buyer then becomes the sole owner of the dealership.
The buyer’s attorney should draft the management agreement so that the buyer can take the necessary steps to control all aspects of the dealership’s operations and finances. Such steps include (1) managing all personnel in the sales, service, parts, F&I and accounting departments (2) approving all policies and allowable profit margins for new and used vehicle sales, parts sales and service work and (3) reviewing and approving of all financing arrangements with lenders used to finance the purchase of vehicles by customers.
Additionally, a buyer may want the management agreement to contain provisions that provide him or her with a direct and immediate financial benefit from the dealership once the transaction closes. A buyer should seek to manage the dealership in exchange for a portion of the net profit derived from the dealership’s operation going forward.
For sellers, it is important that the management agreement ensure that buyer is also responsible for the payment of dealership expenses and assumes of portion of the dealership net losses. To ensure that these obligations are met by the buyer, a seller should require additional rights and obligations related to the operations and finances. For example, a seller can request the right to receive from the buyer a full accounting at least once a week of all parts, accessories and service sales and all related sales tax that is due. Also, the seller could require that the buyer deposit his or her own working capital into the dealership checking accounts.
Special Considerations for Well-Financed Buyers
A stock purchase agreement with certain asset-related provisions may benefit a well-financed buyer such as a private equity firm or family office. For example, a private equity firm may be interested in buying a group of dealerships from a seller. If the firm cannot find a good dealer-operator candidate for the dealerships, it may want to keep the seller as a dealer-operator until it can find a replacement. A stock purchase agreement would be used so that the seller can remain co-owner of the dealerships while he or she continues as dealer-operator.
A well-financed buyer may be able to get the seller to agree to provisions to whereby the buyer gets stock in a new company that contains all of the assets of the dealerships without most of their assumed liabilities. In such a scenario, the buyer may have sufficient leverage to make this request to the seller if fewer buyers exist with the financial wherewithal to purchase all the dealerships.
For the buyer, limiting legacy dealership liabilities becomes more important when purchasing multiple dealerships — while these liabilities (e.g., indebtedness, long-term vendor contracts, litigation claims and liens against the seller) could be an acceptable risk when purchasing one dealership, these risks become more significant when assumed in aggregate across multiple dealerships.
Under this arrangement, it is important that the stock purchase agreement contain the same representations and warranties on the transferred assets that are provided under a typical asset purchase agreement (e.g., that the assets are in good, working condition, free of encumbrances, allowed to be transferred etc.). The purchase agreement should also allow for a disclosure of these assets to the buyer and allow the buyer to inspect and confirm the existence of the dealership assets prior to closing.
While the buyer’s attorney may need time to draft and review these additional asset-related provisions, such time is well spent, as the transfer of dealership assets into a new entity provides the best way for a buyer to enter into a stock purchase agreement and operate these dealerships without being obligated to honor much of the liabilities incurred under the seller’s previous business entity.
Kevin Timson is an associate of Bellavia Blatt, PC, with offices in New York, Illinois, New Jersey and Connecticut. He can be reached at (516) 873-3000 or KTimson@Dealerlaw.com
