Most dealership businesses are closely-held or privately-owned companies. Often, the owners of these privately-owned businesses also serve as corporate officers and directors, and work in these businesses, as dealer principals, managers, controllers, and the like. Against this backdrop of collaborative business responsibility, control over who might wind up as an owner in the business, especially given various requirements under a dealer’s franchise agreement, can be crucial. Moreover, limitations on market opportunities, coupled with franchise ownership requirements, may serve to constrain an owner’s ability to freely sell or transfer his or her ownership interest.
In an effort to handle some of these issues, owners of closely-held dealership businesses may enter into a “buy-sell agreement” (also referred to as a “shareholders’ agreement” or “stock purchase agreement” or “business continuation agreement”) that provides for the future sale or disposition of the owners’ interests, such as shares of stock, thereby creating a “market” for these interests. In the buy-sell agreement, dealership owners can also prescribe certain restrictions on the disposition of the interest or company stock in certain select circumstances. For example, many buy-sell agreements require the repurchase of a shareholder’s stock on the occurrence of agreed upon enumerated events, such as: retirement, death or disability, insolvency, withdrawal, resignation or termination of employment (voluntary or involuntary). This creates a “market” for the owner’s interest and can even provide a source of liquidity for the dealership business.
With a buy-sell agreement in place, there may be provision for the company or the surviving owners of the business to purchase the deceased or withdrawing owner’s shares in the business entity. Generally, the shareholders’ buy-sell controls when the dealership owners can sell their interests, who can buy their interests and the price to be paid. Ordinarily, in addition to spelling out the circumstances in the buy-sell of a mandatory or optional buyout, the buy-sell often includes a formula for determining the price of the shares to be purchased, provision for determining the proper valuation dates, the payment terms of the buy-sell obligations by those purchasing the shares, and the kinds of transfers of an owner’s interest that may be permitted or prohibited by the agreement. For example, the buy-sell agreement might include a right of first refusal provision such that if an owner receives an offer from an outside party for his or her shares, that owner must first offer the stock to the existing owners at the same price being offered by the outside third party. If the remaining owners decline to purchase the shares, then they are offered to the company for purchase.
Fundamentally, a buy-sell agreement for the disposition of the dealership owners’ interests might also include a mechanism for determining the value of the stock or interest, and equally important, a source of funding to make the buy back. The valuation of privately-owned stock is most generally prescribed by the buy-sell agreement. The valuation of a closely-held business is outside the scope of this article, however, buy-sell agreements often utilize customary valuation methods. These might consist of using: a mutually agreed upon price (updated annually in the agreement) representing a fair valuation of the stock or ownership interest; a book value; a multiple earnings valuation; or an appraised valuation. Importantly, the Internal Revenue Service may scrutinize closely-held buy-sell agreements between related parties, such as family members. For this reason, it is important to ensure the buy-sell agreement would measure up against regulatory scrutiny.
Another important aspect of the buy-sell agreement is to address the source of funding to make the purchase of the selling owner’s interests. For example, with the death of a dealership owner, the preselected mechanism to ensure funding availability might be a life insurance policy purchased by the company. The proceeds are used to purchase the deceased owner’s interest from the deceased owner’s estate. The interest might then be allocated to remaining owners in the business, again depending on the buy-sell agreement provisions.
An extra word of caution to consider in planning and preparing the closely-held dealership buy-sell agreement between owners - each of the manufacturers’ sales and service agreements contain varying provisions that could impact an owner’s ability to sell or dispose of his or her ownership interest or stock, including without limitation, notice and financial wherewithal requirements. While there are some protections afforded under the Illinois Motor Vehicle Franchise Act, the manufacturers’ requirements relative to ownership transfers should not be ignored.
Dealership buy-sell agreements help provide a road map for the transfer of ownership interests between business owners in certain circumstances, such as, retirement, death, disability or other prescribed occurrence. These agreements can provide stability, certainty and continuity for dealership owners’ and their legacies.