May 14, 2007 – An effective way to hand over the reins
May 15, 2007
Filed under Features
By Neil Pascale
DENVER — How dealers can convert the ownership of their store to a top-level manager in a fiscally responsible fashion was addressed at a recent Harley-Davidson acquisition conference.
Jim Krendl, a Denver lawyer who has been part of dozens of dealership acquisitions, told an audience of H-D dealership operators, buyers and sellers that he’s developed a way for dealers to slowly turn the ownership of their store over to a trusted manager.
Of course, finding out if a manager is truly trustworthy is the hardest part of any such deal.
Krendl, speaking at the H-D Dealership Sale and Acquisition Conference April 4, says he knows many dealer principals are wary that once they hand over the keys to the store, their top manager will start taking it easy, and revenue and gross profits will start slipping. On the other hand, young, energetic managers have to be careful of ownership promises that are floated one day and suddenly erased years later when the owner’s teenager shows interest in the business.
The key to staying away from either of those real-life scenarios, Krendl says, is to ensure the deal provides incentives for both sides. One way to do that is by using stock options.
Here’s how a typical stock-option plan could play out: The dealer principal, who owns 100 percent of his corporation’s stock, approaches a top manager about a plan to take over the business. The plan does not come with any promises, save one: If the manager performs up to certain expectations — earnings growth or otherwise — they will be given a certain percentage of corporate stock as a bonus each year.
“Watch (the manager’s) eyes at that point,” Krendl said. “Did they light up? Or did he say, ‘Well, how am I going to buy that new car? And my wife wants a new house.’ You’ll find out pretty quickly whether he’s the kind of guy who wants to be an owner of a dealership and is willing to sweat and suffer a little bit to get it.”
Keys to such deals
In such stock deals, there are a couple of issues to keep in mind. First, once a manager receives their stock, they become a minority stakeholder with essentially little, if any, powers. “If I own 10 percent of your dealership, I don’t really have 10 percent of the value of your company because I can’t control it,” Krendl said.
Plus, there is limited resale value for such stock. “Most people don’t want to be a minority shareholder in a closely held corporation,” Krendl said.
However, stock does have value in the IRS’ eyes, meaning it’s taxed just like a cash bonus would be. So it’s not a bad idea to tie a cash bonus with the stock bonus so the manager can financially handle the taxes.
The stock plan should provide the manager an option to buy the dealership after a set period of time, which is often negotiated. Such a plan would come with several qualifications for becoming the majority shareholder, including the manager’s continued performance in terms of earnings growth.
The stock option plan not only provides incentive for the manager to keep growing the business, but also makes financial sense for the dealer principal. Storeowners receive a tax deduction every time they give stock options.
Such a stock deal should include provisions to protect each party in case the plan doesn’t work out. Krendl advises owners require managers to sign a buy-sell agreement, which allows the owner to buy back the manager’s stock at a fair price if the manager leaves the dealership. On the other side, Krendl advises managers to require the value of the stock to rise after a certain number of years — meaning the owner would have to pay more than the original price of the stock — to discourage any arbitrary firing. Plus, the latter agreement gives assurance to the manager that the owner is serious about someday selling the dealership.
Protecting the original owner
The idea of transferring ownership can be a scary thought since “there are a bunch of things you lose the moment you say I’m going to go from 51 percent ownership to 49 percent or any other minority interest,” Krendl said.
While there are several routes that dealer principals could choose to protect the company and themselves in this scenario, “none of them are perfect,” Krendl said.
Still, previously agreed-upon stipulations of the change in ownership, called employment or shareholders’ agreements, should lessen the concern. Such agreements can restrict the new owner’s power and establish a set salary and benefits for the new majority shareholder. Shareholder agreements also can give minority stakeholders certain powers as a member of the corporation’s board of directors. The agreement could require a two-thirds majority — or even a unanimous vote — to deal with future fiscal issues, whether it’s borrowing money or increasing salaries or selling the company. The shareholder’s agreement also could guarantee the former owner’s membership on the board of directors.
For a prior owner, “it’s hard to get him affirmative control,” Krendl said, referring to events that the past owner would initiate, like selling a company. “But it’s pretty easy to get him negative control that allows him to prevent things from happening,” he said.
Of course with these types of shareholder agreements comes the difficult question of “how many handcuffs do you want to put on the new owner?” Krendl said.
Dealer principals who are thinking about giving up their controlling interest also could be concerned about outstanding liabilities they might face as a minority owner.
“There are certain areas where a shareholder can be liable for things,” Krendl said, “but they’re pretty rare and well-written agreements will probably protect him from that.”
Krendl notes the stock bonus plan is just one option for dealer principals, who could also pursue other stock routes once they reach the decision to sell their store.