When considering a franchise store purchase, discuss your intent with your accountant in advance so you understand what terms and treatment of the purchase will be advantageous to you and what will not be. One of the largest dollar amounts we assist dealers in structuring is the amount of “blue sky” to be paid and how it will be treated for tax purposes and on the factory financial statements after the purchase. When discussing the blue sky amount, you need to consider if any of it should be allocated to fixed assets or other types of assets. Many fixed assets purchased by the existing dealership over the years may have been written off to small tools expense or depreciated aggressively using the IRS accelerated depreciation methods and code section 179 versus the book or internal depreciation method, which utilizes a more reasonable estimated life of the assets.
It affects both parties when 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. On the other hand, recording blue sky as goodwill for federal income tax purposes normally results in a deduction 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.
However, 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 as 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, floorplan 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 or a mutually agreed upon method. Any 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 leases the existing dealer has incurred. 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, 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 monthly lease expense. 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 of all assets included in the purchase will normally be reduced on the closing documents by the amounts of new and used vehicle floorplan liabilities the buyer will be assuming based on the vehicles they are buying. These amounts are determined by the existing floorplan finance company that 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, unpaid telephone, cable, Internet, etc., bills which have been prorated based on the number of days used by the seller.
Other financial obligations of the existing dealer may be paid from the closing cash 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 floorplan 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 potential buy-sell process until they receive a signed buy-sell document from the selling dealer. 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 determine if you can make money with the dealership.
Buying the dealership is just the start of many things you will need to arrange, transfer, buy, etc. so you can start business the first day. It is very overwhelming to think of everything you must do to start the first day. You need to start making your list long before you sign the buy-sell.
I will add a few words of caution due to the current economy. If your dealership has been losing money and/or you have a negative net worth after adding LIFO reserves back to your net worth, you may want your accountant and attorney to complete a mock bill of sale (with payoff of all obligations as if it were the final closing taking place) before you get too far with the buy-sell process. I have attended a few buy-sells over the years where the selling dealers could not close because they (the sellers) had to come up with money to pay off the related debts secured by the assets they were selling. These were not pleasant situations, as they delayed the proceedings and in some cases stopped the buy-sell altogether.
Good luck in your negotiations and closing!
Vol 5, Issue 11