It makes a difference to both parties if some of the “blue sky” is allocated to fixed assets. For the buyer, it can result in a much larger depreciation expense in the first five to seven years of business. This larger deduction in the early years will save the new dealer income taxes when they normally need it to preserve cash flow. Goodwill, for federal income tax purposes, is normally deducted over 15 years. For financial statement treatment, goodwill amounts must be reviewed annually to consider if the amount of goodwill has been impaired in value. If so, generally accepted accounting principles (GAAP) require the dealership to reduce the amount of goodwill to the new value. If it is not considered impaired, then the existing amount is not changed. This results in a book-versus-tax expense difference for the tax returns. A financial statement adjustment reduces your net worth and capitalization of the dealership for factory franchise purposes.
If you are the seller, you want as much of the purchase price allocated to “blue sky” as possible. This will save you income taxes because it will normally be treated as capital gains and not a recapture of depreciation on fixed assets, which will be taxed at a higher income tax rate.
In a normal asset purchase, the new dealer buys the new vehicles, less various credits for holdback, rebates, carryover allowances, floor plan interest assistance, in-transit interest, excess miles, damage to any vehicles, prep and conditioning not performed, etc. They may or may not buy any used vehicles. These vehicles are normally appraised using current wholesale values, taking into effect the mileage and condition of each. Depending on the type of credit, they may be prorated based on the number of days the selling dealer has owned the vehicle.
Parts and other inventories, such as work in process – labor, sublet repairs, tires, oil and grease, etc. – are purchased based on physical inventories, arrived at by an independent inventory service. Parts not included in the current factory price books are normally considered obsolete and excluded from the physical inventory amount the new dealer purchases.
There may be other assets purchased also, such as prepaid advertising and other items. These are normally smaller amounts to consider and can require an analysis of how much benefit the selling dealer has received from the assets.
The buyer should always review any and all existing leases of the dealer. Based on the assets purchased, some of these leases may have to be assumed by the buyer. Some examples include dealership management systems (DMS) used for accounting, parts, service, vehicle sales, CRM, parts cataloging, service estimates, etc. Other types include office equipment such as copiers, faxes, scanners, furniture, etc. Service equipment includes alignment racks, tire changers, diagnostic tools, etc. Obtain a complete copy of the lease from the vendor directly to ensure you have the final signed copy and the complete lease agreement with all addendums. The existing dealer may not be able to readily furnish the entire existing agreement.
When reviewing the leases you will assume, obtain a current listing of equipment and furniture, etc. included in fixed assets. Compare the leased equipment to the equipment list, to make sure you don’t purchase the same equipment twice. Inquire if the leased equipment was capitalized and depreciated or recorded as a lease expense monthly. If recorded as a capital item, there may be an existing note/lease payable you will be assuming as part of the purchase, which will reduce the total amount of cash to be paid to the seller at closing.
The total assets included in the purchase will normally be reduced on the closing documents by the amounts of new and used vehicle floor plan liabilities the buyer will be assuming based on the vehicles they are buying. These floor plan amounts are determined by the existing floor plan lender, which will be paid off at the closing. Other reduction examples are real and personal property taxes to be paid in the future by the buyer and unpaid bills such as telephone, cable, Internet, etc. which have been prorated based on the number of days used by the seller.
The existing dealer may pay other indebtedness from the cash you will pay at closing, for the difference of the total assets purchased, less any and all credits and liabilities assumed. You need to make sure all liens on the assets you are purchasing are going to be released.
One of the things you should do before signing the buy-sell is consider what floor plan source you will use for financing the vehicle inventories. Also, arrange preliminary bank or other financing if possible for the purchase of fixed assets, goodwill, etc. that you will not be paying cash for. This will enable you to know the terms of the loans to assist you in the preparation of the factory’s dealer application, including the source of funds statement. Also, contact the DMS provider you will be using to ensure a smooth changeover.
Most franchises will not start the process until they receive a signed buy-sell document. Only then will they have the buyer start completing the franchise applications and other forms involved with the transfer of ownership. Normally, an initial balance sheet proforma and an income projection of the first year in business will need to be completed to help the factory determine the working capital and capitalization requirements you will operate under and whether you can make money with the dealership.
Good luck in your negotiations and closing!
Vol 4, Issue 12