Preapproval of Dealership Changes in Virginia

skin-in-the-gameSome franchised dealers find it advantageous for a senior manager to have “skin in the game” – an ownership interest in the dealership that enhances the manager’s rewards and risks because of the dealership’s performance.  Some franchisors will even require this if the dealer wishes to designate a franchise successor, which should be done.  The most common way to achieve this is by selling an equity interest in the business to the manager.

Any dealer who considers allowing such an opportunity should keep some things in mind.   A written agreement with the manager covering the investment and ongoing equity ownership is a must.  Here are some important considerations when designing the deal.

  • Tax Impact of the Price.  A dealer may wish to reward the manager for years of service by providing a bargain price for the interest.  However, that may have an adverse tax impact.  The difference between the market value of the interest and the bargain price that the manager pays could be deemed income to the manager in the year of purchase.  After digging deep to make the investment, the manager could wind up with a large and unexpected tax bill.  A dealer thinking of selling an interest to a manager may want hire an expert to value the dealership to prevent this problem.
  • Annual Income Tax.  Another consideration should be the ongoing liability of the manager for taxes on imputed income if the dealership is a Subchapter S corporation or an LLC.  The agreement should provide for profit distributions annually sufficient to cover the tax liability of the owners, provided that this does not impair the capitalization below that required by the franchisor.  Further distributions should be at the discretion of the Board or the majority owner.
  • Duration of Ownership.  The purpose of the ownership interest is to provide an opportunity while the manager is employed.  But what if the manager leaves or becomes disabled?  Unless the agreement provides that the manager must sell the interest upon employment termination, you may find yourself with a permanent, non-working, minority shareholder.  And the same is true with the heirs if the manager dies.  The agreement should detail what happens if the manager is no longer employed, including the terms under which the manager must sell the equity interest.
  • Shareholder Agreement.  The agreement should address numerous issues covered in any shareholder agreement such as voting rights, go-along obligations (the requirement to go along if the majority interest holder decides to sell the stock of the dealership), any opportunities for future performance-based investments, and the like.
  • Franchisor Approval.  Always remember that no that no equity transfer should take place until the receipt of manufacturer approval. Dealer sales and service agreements generally provide that a transfer of an interest to a new equity owner is subject to consent by the manufacturer. Under Virginia law a manufacturer has very limited grounds for rejecting an applicant. While Virginia law may prescribe the standards that a manufacturer must use in considering an application, the law does not eliminate the need for the dealership to provide the proposed new equity owner’s application for approval. From the franchisor’s standpoint, it has the right to know who will own part of the dealership and whether the person qualifies under its standards as limited by state law.

If you are selling an interest to a manager, don’t just accept payment and issue the stock. (1) Think through the terms by which the manager will buy the stock and hold it, and discuss them with the manager. (2) Consult a knowledgeable attorney to prepare an investment and shareholder’s agreement. (3) Submit the agreement to your franchisor to commence the approval process.  (4) Have the proposed new shareholder complete an application to the manufacturer, submit it, and await approval. (5) Once you have approval, go to “closing” on the transaction. Then the manager will properly have “skin in the game” under terms that protect everyone’s interests.