Many dealers face a dilemma as they consider retirement: the person most qualified to take over the business — the general manager — often lacks enough cash to buy it.
That was the situation facing a Northern California dealer.
“There was no interest from a family member in taking over the business, so the owner planned to sell to an outside party,” explains R. Scott Mahl. “For a number of reasons the original deal didn't fly. That's when I asked him why his GM — who already owned a small minority stake in the business — didn't buy him out.”
The reason was simple: The owner knew he didn't have the financial resources to pull it off.
In many ways, the GM's situation is common; they often have the track record, but lack the financial resources. That's when Mr. Mahl introduced the owner and GM to the financing concept pioneered by his company, Falcon Financial of Stamford, CT whose valuation formula and approach to lending allows it to loan larger amounts of money for longer terms than banks or captive lenders.
“It didn't take long for them to see the possibilities,” says Mr. Mahl. “Six weeks later, that deal was closed and the owner was in the process of selling his second store to the GM.”
Lending against blue sky is the hallmark of an innovative lending program called franchise/mortgage lending. Unlike conventional lenders, franchise/mortgage lenders are able to lend against a dealership's goodwill or blue sky, allowing buyers and sellers to benefit from higher loan amounts and thereby opening up all kinds of opportunities.
By ignoring blue sky value, much of a dealership's value is effectively locked out. By tapping into this real asset, potentially millions of dollars can be used by a general manager to purchase the dealership.
With conventional lending, the loan collateral valuation is usually limited to real estate and tangible net assets. While those are significant, they often don't come close to the selling price any owner would accept.
That is because this figure does not include blue sky, many times the most valuable asset of the dealership and a major determinant of the sales price. By borrowing against blue sky, a general manager — the person who may have been a key player in creating this blue sky value — can get full ownership, and the outgoing owner gets a cash payout.
If the general manager owns 25% or more, a firm such as Falcon Financial can provide all the cash to close the deal. In cases where the general manager owns less than 25%, a still large payout may allow the outgoing owner to comfortably extend a short-term loan to the incoming owner to cover the difference.
Franchise/mortgage programs generally include these characteristics:
Loan amount is based on blue sky, real estate and net asset value
Fully amortizing with no balloon payments
Because this type of lender recognizes and lends on blue sky or estimated franchise valuations, auto dealers are likely to obtain loan proceeds higher than those from traditional lenders. But it may not work for everyone.
“When I get a call — whether from a general manager or dealer — the first thing I need are the financial statements to see whether there may be a viable deal there,” explains Mr. Mahl.
He adds, “It's my job to make sure everybody stays comfortable on the way to the next phase in their careers — whether that's ownership or retirement.”
While franchise/mortgage loans are often used to finance a general manager's dealership acquisition, they are certainly not limited to that particular use. Some of the other uses for which these proceeds may be used include:
Acquisitions: Acquiring other dealerships to expand your market. With the benefits of economies of scale and enhanced brand awareness, a dealer may increase profitability and his or her personal net worth.
Create an Employee Stock Ownership Plan (ESOP): Allowing a dealer to take advantage of tax benefits, increasing personal liquidity while still maintaining operating control.
Refinancing: Reducing the financial risk by converting current short-term (non-flooring) debt with fluctuating interest rates to long-term debt with fixed interest rates.
Partner Buyouts: Gaining control of the business and the ability to shape one's own future by buying out partners.
Facility Improvements: Increasing customer satisfaction by improving the facilities and providing new services and technologies.
Reduce personal risk: Increasing liquidity through a large cash dividend or other distribution.
With access to proceeds available through franchise/mortgage loans, the value of a dealership's tangible assets is no longer the limit. Now we can truly say “the sky is the limit” …the blue sky, that is.
Don Ray is the president of the George B. Jones Companies, an ISO-9000-certified national accounting and consulting group for retail automobile dealers. If you would like to know more about tax issues facing dealers, contact him at 901-684-5643 and [email protected].