Author Archives: bkshadmin

Biden’s proposed capital gains tax increase spurs car dealers to sell now!

The threat of nearly doubling the long-term capital gains tax rate is pushing more dealers to consider selling their stores now.

 

The threat of nearly doubling the long-term capital gains tax rate is pushing some families to sell their dealerships now to try to avoid losing potentially millions of dollars in proceeds, buy-sell experts say.

On April 28, President Joe Biden in his American Families Plan proposed boosting the long-term capital gains tax rate to 39.6 percent, up from 20 percent today.

 

That jump would significantly reduce a dealer’s after-tax sale proceeds. Most dealers who have owned their stores for many years would have no tax basis in their dealerships. That means upon sale, nearly all of their blue-sky value — the intangible value of a dealership, including goodwill — would be subject to the capital gains tax.

 

Dealers could possibly pay an additional $1.7 million in capital gains taxes under Biden’s proposal, accountants say.

 

An increasing number of dealers and dealer families who were considering a sale before the presidential election have fast-forwarded their plans and are actively seeking an exit in 2021, with the expectation that capital gains taxes will not increase until 2022.

 

Some dealers have told Automotive News that the capital gains threat was a factor in their decision to sell stores this year.

 

It is the ideal time, if you were ever on the fence about selling, to go ahead and head for the exit. You have the combination of record earnings, it’s a red-hot buy-sell market out there for dealers, and now you potentially have a tax increase coming down the pike. So if they do decide that I want to sell next year, or the year after that, and the tax proposal does go through, then I’m going to be selling at a lower earnings amount and at a higher tax rate.

 

Starting when?

There’s even a possibility a capital gains increase could be retroactive to some point in 2021, buy-sell experts say.

 

Congress hasn’t taken action on Biden’s plan, and some dealership accounting and buy-sell experts say it’s too early to say what parts of the proposal will stick.

 

Just the possibility of the tax hike has been a motivating factor for some clients to sell — and get it done in 2021. They are intent to get the transaction done before the end of the year. Nobody knows if there will be a tax increase or how much it will be. But I think there is a conviction that taxes are going to go up.

 

Plan taxes, timing

The difference between good and poor tax planning can be significant for dealers. They need to be more focused now, especially with this looming potential [capital gains tax] change, of not so much what they sell for, but how much they keep of what they sold for.

One option is a deferred sales trust, allowed under the IRS Code Section 453. A deferred sales trust would allow a dealer to defer capital gains taxes on the real estate and blue sky.

Proceeds can be distributed into another diverse portfolio, with income taken over time.

Dealership sales must be approved by the manufacturer, which decides whether to transfer the franchise to a new owner, and that process takes time.

Let’s just say Biden is able to pull something out, and maybe it’s not retroactive this year; let’s just say it starts Jan. 1. You may have a rush for the exit. But OEM approval of transactions, for most dealers, does not happen overnight. And if every dealer decides they want to sell in October, what are the odds that they will be able to get OEM approval before Jan. 1?

Dealers who know they’re going to sell should probably get started sooner rather than later.

It’s not like putting your house on the market and being able to get to close in 25 days.

Value Determinations

A number of factors impact a dealership’s value. In addition to the dealership’s performance, potential buyers, brokers, and valuations experts examine the dealership’s geographic market, future potential, its competition as well as the brand’s desirability.

 

To accurately determine value, each of a dealership’s departments needs to be examined. A parts department sells high-volume, low-cost items; the new and used vehicle sales departments sell lower-volume, higher-cost units. Then there’s the service department and body shop, which sell labor, and the financing department, which brokers loans and other products. Each department has different operations, profit drivers, and potential landmines. What this means in a transaction is that looking at a dealership’s performance as one unit isn’t a great measure of its value or its earning potential.

 

Further, the sale of a dealership involves a wide range of assets, including real estate, fixed assets, inventory and personal goodwill. Each of these has its own value to both buyer and seller, who ultimately need to come to an agreement for a sale to be successful. How pricing is allocated between these asset types can also have a substantial tax impact. Note that a valuation calculated for purposes of GAAP may differ from the valuation calculated for tax purposes.

 

Manufacturer’s Right of Refusal

Auto manufacturers can intervene in a potential transaction involving the franchise. A manufacturer might do so, for example, if it isn’t happy with a potential buyer, has a different buyer in mind, or is concerned with concentrations of ownership in a geographic market. In these cases, the manufacturer may elect to exercise its right of first refusal.

 

Confidentiality

Confidentiality is a significant factor in any deal, and sellers are often surprised by how quickly it can be lost, despite their best efforts to keep a deal private. The dealership business is a fairly close-knit community, and once people learn a dealership may be for sale, information tends to spread quickly to the marketplace.

 

This can result in a workforce issue as the dealership’s employees scramble to plan for the situation. As a result, it’s critical that a dealership has all its contingency plans in place and is well prepared for the sale leaking to the marketplace.

 

Tips for a Smooth Transaction

Knowing what surprises and complications you may encounter is a large part of making any potential transaction go smoothly. To get ahead, perform sell-side due diligence early—even before you’re ready to initiate a transaction. This not only helps you anticipate questions but also illuminates opportunities for your dealership to increase its potential value.

 

Further, make sure you work with professionals who know the automotive industry. From your tax accountant to your legal advisor to your valuations experts, each one needs to understand the nuances of the accounting methods, tax provisions (especially deferrals), and entity structuring arrangements that are relevant to your business.

By Gregory P. Dougherty, CPA, and Ronald Sompels, CPA, Crowe LLP

In the midst of a strong market for dealership sales, more owners are weighing the sale of their businesses. Once they make the decision to sell, determine the sales price, and assemble the necessary professional assistance, it’s time to move forward with marketing and sale of the business.

 

That means finding the right buyer and closing the deal promptly. This final stage typically involves several steps.

 

Preparing marketing materials

To identify the best potential buyers who might have an interest, a dealer must develop materials that provide those individuals with sufficient information to determine if they should make an offer to purchase. A dealer usually will first create a “teaser sheet,” which is a very basic summary describing the opportunity without making it possible to identify the seller. For example, the teaser might tout the opportunity to purchase a Nissan dealership in Central Florida with X volume of new and used sales per month.

 

A buyer who expresses interest will be required to execute a nondisclosure agreement (NDA) to receive more information on the target opportunity. When the NDA is executed and returned, the seller will furnish a more detailed prospectus. Generally, the prospectus – sometimes referred to as “the Book,” which summarizes all the information that was considered in the determination of the dealership’s value.

 

Production of the Book requires the collection of a significant amount of data, including:

• Financial statements for at least the preceding three years
• The volume of vehicles sold
• Summary of fixed operations
• The add-back schedule
• Customer satisfaction index ratings from the manufacturer
• A real estate appraisal
• Human resource information, including both pay policies and information on high-level managers

 

The selling dealer likely will need to bring some high-level managers into his or her confidence during this stage so they can assist in gathering the necessary data. The professional team working on the sale (such as CPAs, brokers, and attorneys) also will be helpful in gathering and assembling the data in a manner that puts the dealership in the best light.

 

Identifying potential qualified buyers

Armed with the appropriate marketing materials, the broker will work with the dealer to ascertain those parties that the dealer believes would make good strategic buyers and have an interest in the dealership. The broker, CPA, and attorney probably will know other potential qualified buyers. The initial distribution of the teaser sheet should be limited, though, going to only the top five or so potential buyers.

 

What makes a qualified buyer? The most important qualifications are the abilities to pay and to secure manufacturer approval. Most dealers also want to sell to reputable buyers who will carry on the tradition they have built. In addition to how a buyer will conduct the business, a dealer should consider the buyer’s reputation for closing deals quickly – avoiding those with a history of dragging their feet, trying to renegotiate at the 11th hour, or simply not completing deals.

 

The dealer normally will control the list of potential buyers. If a dealer wants to exclude certain buyers for whatever reasons, he or she can do so.

 

It is always good to have two or three potential qualified buyers. This not only is helpful in maximizing sales price but also provides a competitive price check on the dealer’s own idea of the value of the business.

 

Moving from letter of intent to purchase agreement

Assuming the process has run properly, it will lead to a letter of intent (LOI) from a buyer, which lists important sales agreement terms such as the purchase price and payment terms. If the transaction will be an asset sale (as most are today), the LOI also will describe how the assets are to be valued. It will contain various contingencies as well, including being subject to manufacturer approval, environmental inspections, and due diligence.

 

Often, some of these post-LOI activities are not initiated until the purchase agreement is drafted and agreed upon. But, because most transactions are structured as asset sales and most of the asset valuation methods are now standardized, the length of time to go from LOI to purchase agreement is relatively quick.

 

The rigor and amount of due diligence will depend on the amount of preparation done beforehand, the quality of books and records, and the seller response time. The typical due diligence period will run 60 days, and the results could prompt further negotiation, which might drive down the initial agreed-upon purchase price.

 

Beyond the dollars and cents

Although the final process involves several steps, the result is a successful sales closing. It’s important to remember, though, that even the smoothest sales process can be a very gut-wrenching experience for the selling dealer, peppered with numerous ups and downs and twists and turns.