Heading for the Offramp: Selling your Dealership

By: John Yiokaris and Jason Brisebois

Having explored the topic of succession planning for automotive dealer principals in the January 2020 issue of Canadian AutoWorld (read here), we now consider another exit option available to dealer principals: selling your dealership to an unrelated third party.  Leaving your dealership to the next generation or a family member isn’t always a viable option for principals looking to exit their business.  As a result, dealer principals (and dealership groups) should understand the key issues when it comes to selling their dealership.

Preparing for the Sale:

Before beginning the search for a purchaser, principals looking to sell should critically analyze their dealership.  Consider how the dealership has been performing over the previous months and years, whether the dealership has outstanding obligations (facilities upgrades for instance) that will need to be addressed prior to its sale, what the state and health of the local automotive market is, and what the dealership’s outlook is for the future.  From an early stage, it’s critical to understand your business and the market in which it is operating to properly assess the value of the dealership, and what steps will need to be taken to unlock any potential value.

Equally critical upon making the decision to sell is to ensure you’re properly managing your dealership’s inventory levels, both with respect to vehicles and parts.  Potential purchasers will typically not purchase obsolete or unauthorized vehicle and parts inventory that they’ll struggle to resell.  Moreover, old and obsolete inventory adversely affects your cash flow, as you are not able to fully recapture funds tied up in this inventory.  To ensure you maximize your return and avoid costly negotiations, you will need to manage your inventory in the leadup to a sale and begin to sell-off or dispose of any items that a purchaser will not want.

It is critical to involve your business and accounting advisors early in the sale process to help determine a fair asking price, and what the potential tax consequences may be for your business and you personally.  It’s crucial to ensure that, well in advance of any sale, your financial and tax records are current and that you’ve discussed the topic of tax planning with your accountant.  In most cases, effective tax planning will help secure more money for yourself once the transaction closes.

It’s equally critical to engage your legal advisors from an early stage to assist you with structuring a potential transaction (as further explored below), and addressing potential roadblocks to closing the sale, including:

• ensuring that your manufacturer is prepared to consent to the proposed sale and what requisitions it may impose on both you and the purchaser as part of any transaction;
• understanding the requirements of your dealership agreement;
• ensuring that the corporation’s legal records are up to date and that contracts necessary to the operation of the dealership can be assigned to the purchaser, if necessary;
• ensuring that the proper consents have been obtained from the landlord and other third parties in order to effect the transaction without risk to the dealership, its operation, or its continued possession of the dealership premises, as applicable;
• managing any potential environmental liabilities that may exist on the premises as a result of the dealership’s operations;
• addressing employment law considerations, and minimizing risk arising from potential employee transfers or layoffs at the time of sale;
• addressing any outstanding litigation or potential litigation concerning the dealership and its operations that may impede its sale; and
• tax and estate planning, which is crucial to consider as part of the sale process to proactively manage potential personal tax and legal exposure.

Most of these processes take several months to complete; as a result, it’s crucial to engage your legal advisors as soon as possible after making the decision to sell.

How to Structure the Transaction

The eventual transaction can be structured in two different ways: an asset sale or a share sale.  Both transaction structures have unique advantages and drawbacks (especially with respect to tax planning), and your legal and accounting advisors should be consulted well in advance of any sale to determine which structure is most beneficial for you and your business.

In an asset sale transaction, the buyer purchases your business’ assets (often including equipment, land and building, customer lists, inventory, and goodwill), but does not purchase or take control of your operating corporation.  As a result, you retain the unpurchased assets and all liabilities (including any debt) of your operating corporation.  This structure allows the buyer to pick and choose what assets it would like to purchase, while avoiding any liabilities owed by the seller.  As the seller, you will still be required to address the obligations and liabilities associated with your corporation (including paying down outstanding debt on or before closing), and you may be required to use some of the proceeds payable to you on closing to pay off any existing loans, financing arrangements, etc.  At the end of the day, the purchaser’s lawyer will not permit the transaction to close unless he/she has confirmed that the assets the seller is selling to the buyer are free and clear of any and all liens and encumbrances.

Asset sales are generally less risky for the purchaser, as they won’t be assuming any unforeseen or then-unknown liabilities associated with the operating corporation.  Nonetheless, the purchaser will have to ensure they’re able to transfer all purchased contracts, licenses, and permits into the purchasing corporation’s name, and that the new business will be able to secure the approval of the Ontario Motor Vehicle Industry Counsel (or similar bodies).

In a share purchase transaction, the buyer purchases all of the outstanding shares in your operating corporation.  At the culmination of the transaction, total legal ownership of your corporation is transferred to the purchaser, who assumes all assets and liabilities associated with this corporation.  This form of transaction is generally simpler, as there is (generally) no need to effect the transfer of assets, specific licenses, or permits to a new corporation.  Nonetheless, any personal assets of the seller, or any assets the purchaser does not wish to purchase (ie. obsolete inventory), will need to be flushed out from the seller’s corporation prior to the sale, which may have negative tax implications on the seller.

In a share transaction, keep in mind that the resulting change in control of the operating corporation may nonetheless require consent and approval from other parties relevant to the business, including the manufacturer, landlord, and major suppliers.  Typically, these consents take time to obtain.

Consider the Terms of your Dealership Agreement

In addition to ensuring that the transaction is organized in a manner that won’t prejudice your interests, dealer principals also need to ensure that the sale is not running afoul of the requirements found in their dealership agreement.  In particular, be on the look out for the following types of provisions:

• Manufacturer’s Consent: Manufacturers will typically require that you seek and obtain (1) their consent to you selling your dealership, and (2) their consent as to the acceptability of the proposed purchaser. Manufacturers will generally reserve broad powers to reject sales or the proposed purchaser should they not deem them to be in the best interests of their brand or dealer network. Be sure to understand what steps must be taken to obtain the manufacturer’s consent, and understand that obtaining such consent can take time.
• Right of First Refusal: Consider whether the manufacturer has the right to exercise a right of first refusal (ROFR) to purchase the dealership if you receive an offer for your dealership.  If so, consider if the manufacturer has a history of triggering this ROFR, and ensure the proposed purchaser understands you’re subject to this right. Purchasers may be hesitant to explore a transaction (beyond making an initial offer) if a manufacturer does not first waive its ROFR. It’s crucial to understand what information the seller must provide the manufacturer in light of a ROFR existing, and its equally important for both you and the buyer to understand the timelines for dealing with a manufacturer’s ROFR.
• Reimaging and Renovations: Consider whether there are requirements that, upon the sale of the dealership, reimaging or substantial renovations must occur at the dealership.  As a result of such requirements, it may even mean that the manufacturer will require your dealership to relocate to new premises better suited for such reimaging or upgrades.  Such renovations can be extremely costly and complicate the transaction (especially if new premises are required), and it should be verified if the manufacturer will require them as part of any sale to ensure adequate capital can be allotted for this work.
• Leasing and Financing Records: Manufactures often require that all original records relating to the dealership’s leasing and financing activities are kept at the dealership premises, despite a sale.  You will need to ensure that all such records are in fact in existence and readily available to the purchaser on closing.

Each dealership agreement is different, and failing to abide by its provisions as part of a transaction can endanger the transaction and your operation of the dealership itself.  Be sure you understand the obligations placed on you by your dealership agreement, and plan in advance as to how best to comply with them.

Conclusion

Selling a dealership is a complicated matter, and sufficient time should be allotted to carrying out the work associated with preparing and planning for such a transaction, obtaining the necessary consents to undertake the transaction, and coming to terms with the buyer and other interested parties.  Remember that a deal isn’t complete until all of the agreements are fully signed, the conditions to the transaction have been fulfilled, and the purchase price has made into your bank account.

John Yiokaris, Sotos LLP

John Yiokaris is a partner with Sotos LLP in Toronto, Canada’s largest franchise law firm. He has been recognized by Chambers Canada, LEXPERT, Who’s Who Legal, Lexology, and Best Lawyers in Canada as a leading Canadian franchise law practitioner.

John practices business law with a specific focus on the automotive industry, franchising, and disputes and he is trusted counsel to both automotive dealers and manufacturers. John can be reached directly at 416.977.3998 or jyiokaris@sotosllp.com.

Jason Brisebois, Sotos LLP

Jason Brisebois is an associate with Sotos LLP in Toronto, Canada’s largest franchise law firm. He is head of the firm’s personal services franchise practice area, and practices business law with a focus on franchising, distribution, and licensing. Jason can be reached directly at 416.572.7323 or jbrisebois@sotosllp.com.