News from MD Johnson Inc.

Mark D. Johnson, President

Unfortunately these are trying times for many domestic automobile dealers for a number of reasons. The depth of the problems has much to do with the brand, the market and the dealers' personal situation. For many, losses or a lack of profits is starting to take its toll not just on the bottom line but on the operators and their families, their relationship with the factory and their employees. I have some examples that, unless witnessed, can be hard to appreciate. Hopefully my description will shed light where it is needed, understanding where it must and empathy where it should.

   Imagine working for years and years and reinvesting the balance of the 65% (35% tax) of the 2% (average net on sales) you earn while selling, servicing, painting, detailing, buying and wholesaling vehicles. Balance means the part you live on keeps you from investing it all. The sad part is most dealers love their business so much and believe in it so ardently, they would never think of investing in anything else, even if they did have the extra money. Extra money to a dealer means paying down or paying off the real estate or putting some extra in the CMA account to generate less of an interest payment. For the most part, most dealers just want to sell iron and make money doing it and to put money back in their business.

This article is not about the fabulously wealthy Toyota, Lexus, BMW, Mercedes, Honda dealer. This article is about the guy or the family hawking iron made by companies who keep the money they make (hopefully) in this country, not take it out and loan it back to us. Our country is built on the tenet that if it's legal, you can buy it and sell it and get rich doing it, as long as it is legal. I have no axe to grind with the imports, many are my clients. They simply don't face the same issues. It is also fair to say that at the end of the day, the majority of dealers could care less what they sell as long as they make money.

So, the domestic dealer has plowed money, time, energy, etc., into their business over a period of years and has had the opportunity to pay down some debt, pay off some cap loans, own some used cars and generally have a healthy business with some degree of insulation from the ebb and flow of car sales. The problem probably starts when the ebb lasts a long time where a strong economy exists and interest rates and employment rates are good. Car guys see this picture and get a little nervous. A lot of "what if" scenarios start going through their minds. If I used to make x number of dollars and now I am not breaking even after breaking my behind in a relatively strong economy, what is the deal? This has to be the best kept secret that this is going on, widely, today.

   That being said, a number of domestic guys are getting into different brands or getting out. Based on the pricing that is currently in the market, getting out seems to be the most likely. The decision to get out has been reached and now comes the "it's just another car deal mentality", as the dealer starts to think about what to do next. Here is a piece of advice "it's not another car deal". This few page observation is designed to illustrate the shortcomings of such a mentality. Many of the individuals getting out or are being taken out, are minorities. These minorities were financed by the factory, often in stores no one else wanted. The car companies kept these stores churning out cars by churning out operators. Some of the operators were good, some not so good. The nice thing about the factory was they were consistent in blaming the operators. We should take a count of how many Toyota dealer investment operators are going out of business. This article is not directed at minorities or minority programs but isn't it interesting how when things get tightened a notch, the minority dealers seem to be the first to get crushed?

Some of these operators were lucky enough to end up in some good stores. Maybe not with great brands, but, great areas and great locations within those cities or towns. Here comes the moral to this article. When many of these operators finally bought out and bought the real estate, the factory often placed a very restrictive agreement on the property itself. Often called option agreements or site control agreements, these minority acquired stores all seemed to have the same theme; a very one sided option agreement. A typical site control agreement gives the factory the option to purchase the real estate when offered for sale by the selling dealer or to keep the dealer, for some period of time, from selling to a non brand user of the real estate. This was to protect the factory from not having a place for a dealership when, inevitably, the property value increased to the point where no dealership could afford to pay the rent.

    In the case of these minority agreements, the factory set the price, sometimes for a term as long as ten years, with the option to purchase the property from the dealer for the same amount they originally sold it to the dealer for, plus improvements. This would be like the bank saying if you sold your house for the next tens years, we get the increase in market value but you make the payments. Toyota's dealer investment group does not pull this on its dealers by the way.   So, if you were in one of these minority programs, you put up ten or fifteen percent of the operating capital and the value of the real estate, financed it with the factory and the captive finance company, paid the factory their share of the profit, just like a partner, paid the C corp. tax (dealer development deals are C Corps) and then redeemed stock. This would be like paying 24% interest. So now you buy out the factory's share of the dealership, which normally had the real estate in the corp. You now take it out and pay capital gains on the fair market pick up, put it into your own LLC and start paying yourself rent. You also get your mortgage from the very same captive finance arm of the ex factory partner you just paid off, because you may not qualify with a standard bank. I don't know why that would be, but that is what I hear.

You now think that you are on your own. During this flurry of paperwork when the factory was telling you what to sign, you dared not ask any questions about the forms, or they could decide to bestow their gift to someone else less inquisitive. Fast forward. Times are tough and you need to sell. Falling in and out of trust with the captive finance arm, low on operating capital, it is time to do something. This is where you "just make another car deal" and sells the store.

First problem. The option or site control agreement has "triggers" which you may have inadvertently violated, such as being out of trust, insolvent etc. Five, six, seven years have gone by and now your property is worth double what you paid. More than likely, if you were to sell to anyone except another dealer of the brand vehicle you sell, the factory has the right to exercise their option on the real estate. Your deal, along with your equity, is gone forever. Millions of dollars gone.

   Second problem. The highest bidder for your property is Walgreens. Sorry. You can't sell to Walgreens. If you do, we exercise for the original sales price. Read the previous paragraph.

Third problem. You finally come to grips with the fact you can't cash in with Walgreens and decide to sell your franchise to the adjoining dealer so he can put your franchise on his property and then you want to sell the property to the Toyota or Lexus dealer who is expanding. Sorry, you can only sell to someone who will operate your brands at your site. Safe to say, if you are in a domestic brand, this deal is going to cost you a few million dollars of lost opportunity. Domestic buyer versus import highline? Who can pay more for your real estate?

   Fourth problem. You decide to just lease the property to the buyer and wait for the site control document to either revert to fair market value or expire. You do the deal and you sign the lease with the buyer. Your lawyer is getting ready for the closing and gets this call. "You want us to release our lien on the assets, no problem, just pay off the mortgage". Oh. The mortgage document states that if you are no longer a dealer or don't have a wholesale floor plan, you need to pay us off. You have to now go out and refinance your dealership as a non owner occupied investment so you can sell and hold a lease. I think this is why dealers say not have your eggs all in one basket. You now feel like you fell off a ladder and hit your head on every rung on the way down.

    Fifth problem. That old dealer development C corp. you converted to an S corp. is not ten years old yet so your sale proceeds get taxed like a C corp. Check with your accountant and get the built in gains tax number from him.
     Here is what you're going to do.
1.      Every document you exchange, every email you exchange related to the transaction concerns two buy sells. One for personal good will and one for corporate good will.
2.      Hire a firm to do a personal goodwill appraisal. Moss Adams does a great job. Whatever they say your personal goodwill is goes in that document, the balance goes to the corporation and you owe C corp. tax on it if your S Corp. is not at least ten years old, doesn't have adequate built in gains, etc. This is for you to talk about with your accountant.
3.      Make sure you know what triggers any options that allow the factory to buy your land for the 5 year old price and don't do any of those things. If you have, get with your lawyer and get it fixed, if possible. Get with them anyway to figure out what to do with the option document.
4.      Most factories will amend the site control document to get a new dealer they like in place. The buyer's lawyer will make this a condition precedent to the closing. The factory will use this to control which buyer you select. This is the one case where you don't want to simply send them a buy sell. They don't have any obligation to amend the site control agreement and conform to the condition precedent.
5.      If you want to keep the property, get it refinanced prior to making a deal. If you can't, then sell it and put your money in something else. Don't lease the property and try to figure out how to refinance while you have a buy sell pending.

Thoroughly review your mortgage documents, site control documents and option agreement documents with your lawyer before doing anything related selling your business and leasing or selling your property. Discuss with your accountant how he will calculate your post tax net for the purposes of your return. If you are a C Corp, discuss a personal goodwill and a corporate goodwill appraisal. Use professionals and have someone "manage" the transaction. It is not a car deal. Don't spot deliver yourself after signing 5 contracts and the finance guy telling you he will call you when he gets your deal bought.
The bottom line here is that when considering an exit; get the help of people to who do such work. It is second nature to us to put deals together that take all of the issues into account and then build the best deal, that is the most like to be approved. Fail to plan or plan to fail. Something like that.

Closure Check List

Resignation/Termination/Shut
Down

Debbie Cupples, VP, Analyst

Mark D. Johnson, President

A Termination decision is not easy and should not be made overnight. More importantly, it should not be implemented on short notice. A thoroughly pre-planned termination will be much more effective that one done with little foresight.

ASSEMBLE PROFESSIONAL ADVISORS
Inform and consult with your CPA and attorney on all issues. Make decisions after advice and counsel.
Provide advisors with copies of all pertinent document (i.e. all agreements including franchise agreement, vendor and finance contracts, loan documents, leases, and guaranties).

CONTRACTS AND LEASES
Identify all contracts and leases that you currently have.
Identify all contracts and leases that you currently have a personal guarantee on.
Read the contracts carefully for terms, expiration dates and termination requirements.
Be cognizant of automatic renewal provisions.
Calendar and properly send termination notices.
Create a contract schedule (attached), showing all of the information related to the contract
Negotiate payoffs, cancellations and early terminations.
Negotiate with landlords on leased properties for termination or sublease.
Run ads and work on getting property subleased where you are personally liable.
Schedule a Phase I or Phase II Environmental check if vacating parcel.

TRADE PAYABLES
Post all payables
Call all vendors to submit statements via fax or e-mail
Reconcile all vendor statements, call for missing items and post.
Reconcile Accounts Payable Schedule
Reconcile Manufactures DPS, call for missing items and post
Vendor termination letters must be mailed to all vendors.
Lease and Contractual vendor termination letters need to be sent via overnight delivery method.
1099's need to be completed for the year.

TITLES, MCO'S AND LICENSING
Pull all titles and verify that all information has been recorded and included in title package. i.e., release of interest, POA, etc.
Arrange all titles and required documents in Stock Number order.
Complete Wholesale orders on all titles with the purchaser information provided by GSM.
List all inventory with no and/or complete title package, including all information missing. Provide list to Dealership Owner(s) for determination of action plan.
Pull all MCO's and arrange in Stock Number order. List all missing MCO's including reasons why the documents are missing. Provide list to Dealership Owner(s) for determination of action plan.
Prepare a Final list of Inventory by Stock Number and enter information on every unit, both new and used. Check information listed above and determine all missing titles, required documents and MCO's. Use the accounting schedules for this audit. Give final audit results to Dealership Owner(s).
All used vehicle titles with assignments, required documents and wholesale orders must be photocopied and placed in the appropriate used vehicle inventory jackets.
Pay off all trades and auction/wholesale purchases.
All MCO's must be assigned, photocopied front and back along with the Accommodation of Sale document and placed in the appropriate new vehicle inventory jackets.
All sales are to be posted to the General Ledger and vehicle inventory schedules reconciled to zero balances.
Provide Dealership Owner(s) with all State Licensing that has not been perfected by DOL for retail sales. Along with information as to why. Provide deal jacket along with all documents with listing.
Complete sale of personal vehicles and obtain personal vehicle and health insurance.

EMPLOYEES AND PAYROLL
Consider WARN ACT requirements re notice of closing.
Final Payroll checks will include all accrued vacation pay out per terms of pay plan. All vacation pay will be calculated using the accrual method and paid out in accordance to the employee handbook.
Example:
Employee has worked for 8 months at dealership. Employee handbook states vacation pay starts at 12 months at the rate of 1 week. No vacation will be paid to this employee
Employee has worked for 18 months at dealership and no vacation has been paid. Employee will be paid 1 week plus accrued amount for the additional 6 months of employment.
Final paychecks will be distributed, reserve and pay timely.
Provide all employees with separation report. All separation reports must be signed by both dealership management and employee.
Provide all employees any documents that are necessary for the 401K program that is necessary for the employee to terminate the plan. A letter of receipt of documents must be signed by each employee enrolled in the plan. Check with accountant re final return/reporting requirements.
Provide all employees a notice of termination of their Health Plan effective as of closing. Signature of receipt is required on all employees that are enrolled in the Health Plan.
Terminate all employees with Health Insurance Provider.
If dealership administers its own COBRA compliance, all COBRA notification letters need to be prepared and provided in final paycheck package. All COBRA notification letters must have a receipt of delivery signed by the employee.
Final 940, 941 and W-2's need to be completed.
Final Labor and Industries and/or all required State Payroll Tax documents need to be completed.

ACCOUNTS RECEIVABLE
All accounts receivable termination letters must be sent to all receivable customers. Termination dates and terms of payment including PO Box to mail payments must be included.
A schedule of due balances must be complied and given to Dealership Owner(s) for future collection information. All balances due must include copies of Invoices, Repair Order, Down Payment, or other necessary documents required for Owner to collect receivables.
Final AR statements are to be mailed via return receipt.

FINANCE PRODUCTS
All products sold must be submitted to vendor timely.
A listing of pending cancellation refunds must be provided to Dealership Owner(s) for future payment.
A listing of all product submissions rejected by vendors must be provided to Dealership Owner(s) for refunds to customers or adjusted submissions.
All Finance Reserve receivables must be listed and provided to Dealership Owner(s) for collections.
. Reserve for reserve account charge backs from finance institutions

SUPPLIES
Avoid entering into any term contracts.
Immediately stop all automatic supply shipments such as forms. Contact vendors via phone. and return receipt letters. Accept no shipments after notification is given.

SALES TAX AND OTHER MISCELLANEOUS TAXES
Prepare all State Tax forms for the closing month of business as well as any other miscellaneous tax forms your state may require. Initiate payment of these taxes as directed by the Dealership Owner(s).

FIXED ASSETS
Identify all new fixed asset entries that were made to the General Ledger after the date of the Asset Purchase agreement. Invoice copies reflecting cost amount will be required for the closing statement. This includes all Manufactures Special Tools that may have been billed out on the DPS. Supply the listing to the Dealership Owner(s).
Perform a fixed asset audit, tag all items and hire an equipment auction company to conduct an auction of the fixed assets.
Digitally photograph all fixed assets.

VEHICLE INVENTORY
A Physical vehicle inventory is to be completed and reconciled to the General Ledger. At time of physical inventory, new vehicles must be inspected for damage and missing equipment as well as mileage taken on each unit and a listing prepared and given to the Dealership Owner(s).
Used vehicles must be verified with the General Ledger.
Any missing units must be immediately reported to the Dealership Owner(s).

FLOOR PLAN
During final week of business contact your floor plan lender to receive daily floor plan statements.
Reconcile Floor Plan Daily
Identify all in-transit units from manufacturer and supply listing to Dealership Owner(s).
Prepare final reconciliation on book to physical and report any discrepancies to Dealership Owner(s).
Surrendering your vehicles to your Floor Plan Lender is not the same as selling them back to the Factory pursuant to your termination rights. The lender will simply wholesale the vehicles and have you accountable for the deficiency (which you may have personally guaranteed).

COMPUTER SYSTEM
Arrangements must be made well in advance of the sale or shut down of the business. Contractual items must be identified to insure that all items can be transferred or cancelled. The computer system must be converted to a 2 store scenario if the purchasing dealer is keeping the system. The process to deal with this vendor can take up to 6 weeks to research and arrange.
If terminating, need to print final books off within a few weeks of closing. You can usually negotiate to keep the accounting module open and delete all other function.

FACTORY ISSUES
Each state has different laws and you want to make sure you time the resignation to take advantage of any repurchase deadlines.
Have your attorney compare the manufacturer's obligations under the franchise agreement and the State law to determine which is best to proceed under.
Know the alternative buy back provisions and take inventory control measures in recognition of them.
Contact regional representative and request resignation package. Your lawyer needs to review this document and negotiate some specific items before the document is ready to sign.
Factory, depending on terms of franchise agreement and State law, will repurchase the following properties and usually use an outside firm to quality each:
New vehicles at net net subject to criteria such as days in inventory, model year, mileage, damage, and accessories installed or removed.
New and unused parts
Signs and special tools
The manufacturer may be obligated under State law for facility obligations.
The factory will discontinue paying you on your dealer payment statement if they determine that your account with them does not have a sufficient positive balance. You will then have to wait up to six months for your money. You will need to pay off your parts account in full at the time of resignation without regards to the money they owe you.
You Must discontinue use (signage etc) of the manufacturer's brand name If the franchise is being sold and relocated, the buyer will be responsible to pay for the relocation. Make sure the buy sell states this or you could be responsible for payment of sign relocation.
Make every effort to get paid at same time the repurchased property is delivered to the manufacturer as any bankruptcy could limit the manufacturer's ability to pay and the amount to be paid.
Determine what your charge backs are and make arrangements to cover. This means you will probably need to keep your company open for a year to run it out. Most of the captives offer a buy out of your chargeback obligations.

POST CLOSING FINANCIAL OBLIGATIONS
Be prepared for and reserve for post closing obligations including
Charge backs
CPA fees
Attorney fees
Taxes
Broker/consultants
Consider depositing a sum in trust with your attorney to pay such expenses and grant a security interest to the CPA, consultant and attorney.

With Special Thanks To:

Jim Aiken, Esq., Aiken & Fine PS

Oren Tasini, Esq. Haile, Shaw & Pfaffenberger, PA

Alex Kurkin, Esq. Kurkin Brandes LLP