Should I Stay (merge) or Should I Go?

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WEDA Legal Notes

As a dealer operating in an industry that is experiencing a lot of change, you are constantly assessing whether you still “fit” in the industry and whether it makes sense to stay in the business or start thinking about leaving the game. This decision is often made more difficult because simply saying you want to stay and keep doing the same thing isn’t really a long-term option. Instead, a decision to stay usually means you need to be thinking about how your organization will grow. Growth as a necessity for dealerships is being driven by many of the key players in your business … customers are demanding more from their dealers as they grow and go through their own period of rapid consolidation, manufacturers are driving dealers to grow by creating programs that often favor larger dealers and give them a leg up on maintaining profit margins, and your own employees are looking for larger organizations that can give them opportunities for growth.

Unfortunately, unless you are a dealer just sitting on piles of cash (I have yet to find too many of those), growth is a bit more complicated than just pulling out the checkbook. Valuations have been climbing recently as dealers have methodically worked through used equipment gluts from several years ago, making affordability an issue for many dealers. And even if you have the equity cushion in your business to pull off an acquisition, you will find that the equity percentage gets reduced quickly as you pay blue sky for a dealership and take on more inventory that is fully-financed (and creates a corresponding drag on equity percentage or ratio). Dealers who want to stay in the business also may not have the management capability or bench strength to grow.

The Merger Option

Mergers have become a popular option for dealers who want to stay in the industry and need to find a way to grow despite capital and/or management challenges. Although they aren’t easy to pull off, a merger can be used in many different situations to facilitate a dealer’s desire to grow without using capital or requiring outside investors because a merger is simply a transaction where two or more dealers pool their resources in exchange for a smaller piece of a hopefully larger pie. In addition to growth, mergers also can have several positive long-term benefits on both your investment value and organization.

Value Benefits

  • Preserve Operational Value – Increased scale of your organization through a merger should help you maintain (and ideally expand) your margins and ultimately the value of your dealership.
  • Protect Organizational Value – The value of a dealership is often incredibly dependent on the number of potential buyers for your business. With manufacturer approval a necessity in this industry, having multiple adjacent buyers is key to a successful sale price. Mergers allow you to expand your geographic boundaries to create more touch points with potential buyers and sellers and reduce the risk of being boxed in by a single in-line competing dealer.
  • No Tax Loss of Value – Mergers can generally be structured so that they are tax-free. This allows all capital to stay in the organization and be used to generate future growth to enhance the value of the organization.
  • Favorable Changes to Exit Timing – Merged organizations generally increase the number of owners with many of them having different time horizons for exiting the business. While this makes it less likely that the dealership will be sold as an entire business in the future, it creates more opportunities for you to liquidate your ownership interest when the time is right for you. This is a positive benefit because your co-owners become viable buyers for your business and the tax consequences of selling your ownership interest vs. the assets of the business are often better.
  • Attract Different Categories of Future Buyers – There has been significant interest in dealerships by outside investors looking at the equipment dealer industry segment as an investment strategy. While it is still too early to tell if this will be a long-term trend in the industry, what I do know is that your dealership will be much more attractive to outside capital (and likely drive a higher valuation) as it grows in size. Outside investors often set a minimum threshold of profits and/or sales to even have any interest in a dealership.

Organizational Benefits

Dealership growth in general can have many positive benefits on your organization. But growth through merger can accelerate these benefits as mergers often double or even triple the size of your organization in a single transaction while growth through acquisition often involves incremental/slower-paced growth. The benefits of growth on your organization include the following:

  • Management Depth – A larger organization must have solid management and bench strength to be successful. Manufacturers will also generally require strong management or a plan to attract and retain strong management before a merger will be approved. The resources from a merged organization will generally make it easier for you to attract and retain management talent.
  • Professional Management – Larger organizations will gravitate toward professional management who are often better trained to implement processes and strategies to help improve the performance and value of your dealership. It is important to note that “professional management” and “family management” are NOT mutually exclusive terms. Family members of ownership groups may certainly make great managers, but in larger organizations, these positions are much more likely to be earned through performance and should generally be viewed as a positive organizational development.
  • Outside Expertise – The additional resources and scale that come from a large dealer organization allows you to invest more in outside expertise. While you should not give up your management/investment instincts that allowed you to create tremendous value in your dealership, the ability to access insights from other perspectives outside of your organization, whether through advisors or independent directors, can give you an edge that smaller competitors may not have.
  • Limit Risk – As dealerships get bigger, owners can reduce personal risk. This will primarily occur in two forms: (1) eliminating or reducing personal guaranties to manufacturers and lenders and (2) getting more pre-approval of ownership changes from manufacturers. Although change can be slow, I’ve seen this trend play out in multiple industries and the simple fact is that larger organizations that are well run and on good financial footing pose less credit risk and management risk to their industry partners. As owners realize this, they need to take advantage of that opportunity to negotiate a corresponding reduction in their personal risk. The merger process can be a good time to accomplish that.

Conclusion

I understand that change is hard and not something that can be pulled off with the snap of your fingers. But if you decide you want to stay in this business, change through growth will become a necessity for most of you and using mergers to achieve that growth can carry many positive benefits.

This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business. Please note that any estimates of tax consequences are based on the current tax code and could change based on future changes in the law or regulations.


Article Written By Lance Formwalt

LANCE FORMWALT is the leader of the Equipment Dealer Group at Seigfreid Bingham, P.C. The firm also serves as legal counsel to the Western Equipment Dealers Association (WEDA). Lance may be contacted at lancef@sb-kc.com or 816-265-4106. Also see www.sb-kc.com.

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