Dec. 22, 2008 – A booming acquisition market?
December 22, 2008
Filed under Features
The upcoming Obama administration and its potential new tax policies could trigger an increase in the number of powersports dealership acquisitions in the near future.
The new administration is expected to raise the federal capital gains tax rate, a move that figures to prompt more dealer principals nearing retirement to sell while they can still take advantage of current tax rates. This presents more opportunities for buyers, said Jim Krendl, a Denver-based attorney who has been involved with a number of acquisitions for both Harley-Davidson and metric powersports dealers.
Media reports have pointed to the current federal capital gains tax rate of 15 percent — the lowest rate since before World War II — perhaps increasing by 5-10 percentage points, if not higher. Of course, no one knows if or when new tax rates will go into effect, not to mention when the possible rate hike would go into effect. It is possible, however, that such a bill could raise tax rates at a date prior to the time that the law is passed.
Overcoming a hurdle
In the past, dealership sellers commonly were paid the entire, or nearly the entire, purchase price in cash at the time of closing. Since most buyers, even well-heeled ones, don’t have that kind of cash available, such purchases have been financed to a large degree by banks or other traditional lenders, Krendl says.
However, if sellers are to take advantage of the current low tax rate, then they’ll likely have to use some sort of creative financing, Krendl notes. “It’s awful out there,” he said. “Bank loan officers will virtually say, ‘I’m not making loans these days.’”
To overcome that hurdle, Krendl advises sellers essentially take on the role of the lender. Instead of the buyer signing a promissory note —– a basic lending agreement —– to a bank or financial institution, they sign the note to the seller.
“One of the things I always get is a buyer will say, ‘Gosh I have to sign a promissory note and it will have penalties in it and they can collect attorney fees if I don’t pay them?’” Krendl said. “So I’ll say, ‘What kind of promissory note do you think you would have signed to the bank?’”
Krendl notes such an agreement could prove to be beneficial to the buyer, who is likely to get more reasonable terms within the loan agreement from a seller than a bank. As an example, Krendl pointed out that one major bank he deals with has a standard provision in its loans that essentially says, “If we decide that there have been regulatory or legal changes that require modification in your loan agreement, you agree we can make those changes.”
For the seller, this type of financing means they must be cautious about who they sell to since if the buyer’s business turns for the worse, then getting the full loan amount could prove to be difficult.
Krendl says sellers can have the same rights that a bank or other lender would have to investigate the buyer, ask for financial statements or other information or collateral to secure whatever payment is due to them. “However, by and large I don’t find that’s much of an issue,” he said of potential buyers’ backgrounds. “If a buyer walks in and has, out of a $3 million deal, a million dollars of his own money that he wants to put down as a down payment, it’s pretty hard to believe he’s not a substantial guy.”
Plus, connections within the industry often prove useful in deciding the business acumen of a potential buyer.
“If I’m representing a dealer who wants to buy a dealership from another dealer, they are in the same business,” Krendl said. “They know each other. They know the same people. My experience is a typical seller knows pretty well when he sees the buyer if this is reputable guy who’s well known in the industry for being able to run a dealership successfully. The seller probably knows that better than a bank knows that.”
Besides creative financing, Krendl also delved into another area key to both buyer and seller: Exactly what should be included in the deal.
Many dealerships are set up as corporations because of tax regulations. As a result, owners of corporate dealerships face a potential “double whammy” of taxes when they go to sell, Krendl said. If the corporation’s assets are sold, then the selling dealer principal pays 35 percent corporate tax plus an additional personal capital gain tax when the corporation distributes the remaining money to him. And then there may also be state taxes.
That double whammy can be avoided if the buyer purchases the corporation’s stock rather than just the assets, Krendl said. “The difference is enormous,” he said. “It can make about a 30 percent bottom line difference to the seller if he is able to sell stock rather than assets of the operation.”
The buyer perspective
Buyers, however, are more apt to only want to purchase assets and avoid any potential unforeseen difficulties that come with purchasing stock, like lawsuits or other unresolved financial matters, plus pick up some tax depreciation benefits. However, Krendl notes buyers are likely to get a better deal purchasing stock and that even buying only assets does not guarantee the lack of any surprising issues down the road.
“The number of problems you can pick up even if you don’t buy stock is scary if you spend much time thinking about them,” he said. “If there’s an environmental problem with the property, for example.”
Krendl advises buyers to require that the purchase agreement allow for a portion of the purchase price to be held back for a certain period of time to deal with any unresolved issues, like a lawsuit. This portion of the purchase price, which often averages 20-30 percent of the total cost, could then be used to pay for whatever issue comes up within a year or two of the purchase date.
This holdback amount is advisable in any stock deal, but it also ties into the earlier idea of using the seller to provide financing. The holdback becomes the buyer’s promissory note to the seller. The seller benefits by selling stock and getting better tax treatment; the buyer benefits by eliminating the need to borrow money from a bank, and the buyer is protected against whatever additional risks are involved in a stock purchase by the holdback provisions in the promissory note.
Because of the creative financing that often must be employed, this holdback portion could be increased, Krendl says. The purchase of stock also could give the buyer leverage to get better interest rates from the seller than a bank would provide.“What I’m saying to buyers is, if you want to make a good deal for yourselves, buy stock and not assets and let a good lawyer solve whatever problems that creates,” he said. “And I would say to the seller, put up with some deferred payments and holdback provisions because that’s the best way to get a deal done in this economy and take advantage of what are still low tax rates.” psb