A sound dealership succession plan addresses a long list of issues, including retirement income, transferring wealth to the dealer’s heirs, transferring ownership, dealing with the income and estate tax consequences associated with an ownership transfer, and addressing other issues key to the ongoing success of the business; not the least of which (and often forgotten) is transitioning management.

Here is the first in a two-part series to lead you step-by-step through a successful transition.

Step 1: Identify & Prioritize Goals

You cannot address all business succession issues at once; what happens with one will affect how you handle another. Ideally, a dealer begins planning with a third party professional, one who has industry as well as succession planning expertise. This planning should begin at least 10 years prior to an expected retirement date and should include a contingency plan if death, illness, a family situation or a change of heart require an earlier-than-expected transition date. 

For many dealers, the dealership is like their child. They are committed to their business, to its grooming and success, and their ties to the business are emotional, just like with their offspring. Therefore, succession planning has to consider these emotional ties as well as the financial aspects of retirement, transfer and transition. 

The first step in effective succession planning is to identify and prioritize goals. Succession plans have value for dealers only if they meet their goals. Identifying goals includes determining that they are realistic and prioritizing them to resolve conflicts between mutually exclusive goals. 

For example, if you are selling to a third party, you want a top price for your business, but you also want to minimize the tax burden from the sale. It might not be possible to get both. We recently encountered a situation involving mutually exclusive goals. A selling dealer wanted to reward his employees for their years of service with extended separation pay, but it reduced the proceeds from the sale of the dealership. Ultimately, a good middle ground was reached whereby the employees were treated very well and the dealer was still able to receive sufficient funds to retire comfortably. 

The most common owners’ goals in planning succession are:

• Keep the dealership in the family; transfer to the next generation
• Maintain a successful operation and profitability into the future
• Provide liquidity to the owner or to their estate
• Provide financial security for the dealer’s family members
• Minimize current tax liabilities and the potential estate tax liability
• Maintain family harmony 

Family transitions can be fraught with conflicting goals. One dealer who wanted to maximize ongoing income to his children learned that getting the income he wanted would burden dealership profits to the point of threatening the future of the business. Again, some difficult decisions had to be made regarding balancing these conflicting goals.

A more common issue arising in family transition is either the lack of interest or leadership skills on the part of an incoming family member. Owners should not assume their children’s goals are the same as theirs; they often have other plans that do not involve the dealership. So, succession planning must include determining which family members are “in” and which are “out,” and consider the transition of management (possibly to non-family members) as much as ownership. 

In light of those goals, we can identify five different dealer succession profiles:

1. Owners with children to whom they would like to transfer the business.
2. Owners who want to sell the dealership to a third party outside the family.
3. Owners who want to sell the dealership to invest the proceeds in another business or investment opportunity.
4. Where there are multiple owners, an owner who wants to sell to the partner or partners. Such sales can present troublesome situations, for example, where one partner who is not capable of managing the dealership is being bought out by another. We have seen long, protracted struggles over such issues as control and value. 
5. Owners who want to run the business until their death. For these owners, the contingency planning is particularly important, that is, how to transition ownership and management in case of a serious illness or at death. 

Step 2: Identify & Prepare New Management 

Leadership transition should be addressed very early in the succession planning process. In addition to a long-term management succession plan, a contingency plan should address a death, disability or other event or circumstance that would prematurely prevent the owner from running the business. 

The steps to identifying and preparing new management involve: 

1. Assess the situation. Assess the current and future needs of the dealership and ensure the skill set of the successor matches the needs of the dealership. A comprehensive assessment program needs to be in place even when a family member will succeed. This may be even more critical in a family member succession, as often the owner and manager will not be the same person and conflicts are inevitable.
2. Perform a formal assessment of prospective managers’ skills and character. Owners might want a particular child to take over or the children might lack interest or the necessary skills. A formalized assessment brings objectivity to help the dealer with what can be a troubling decision.
3. Consider recruiting an active board of directors or forming an advisory board to review or conduct the selection process. Non-family board members can: validate the owner’s decision; expand the owner’s pool of candidates; increase available resources (more people, more hours); and, ultimately, serve as mentors for the chosen leader. 
4. Design a plan for developing the successor’s skills and experience. This is particularly helpful in a case where a family member will take over, one with the right skills but who is not quite ready to run the business effectively. 
5. Pave the way with the dealer’s key relationships. For instance, first and foremost, is the manufacturer, whose approval of new management may be required. Other key relationships include bankers; key employees, including those not chosen as successors and how they react to new ownership and management; vendors; and important customers. 

The successful transition of management responsibilities is a critical part of a succession plan and even more critical to the ongoing survival of the dealership. Succession planning includes preparing a competent successor to assume the role of decision maker. Without one, an owner’s retirement, death or a disability will cause the dealership to falter, maybe even fail.

Step 3: Determine Retirement Cash Needs

The optimum succession plan calls for relinquishing ownership and management responsibility prior to death. However, owners are often reluctant to retire due to concerns over how to adequately maintain their desired retirement lifestyle.

The concerns are amplified in situations where the dealership provides for major ongoing expenses, such as a company car and healthcare insurance. So, a major consideration in succession planning is determining the ongoing cash needs of the retiring owner and how those needs will be funded. Even if you do not plan to retire, a contingency plan should be in place to address those issues should you have to surrender ownership or management due to a disability or other unplanned circumstances.

There are many vehicles used to provide retirement cash, such as consulting agreements, payments related to a non-compete agreement, deferred compensation plans, etc. As the surrendering owner, you might also maintain dealership assets. For example, the real estate could provide ongoing rental payments. If the transfer involves a sale, you might use a seller’s note whereby the proceeds are delivered over time. Those agreements need to consider such items as interest and length of agreement and the reliability of the new owner. 

Some funding mechanisms are more or less appropriate when ownership is being transferred within the family. An arrangement we developed recently for a dealer with few assets other than his business involved an income and estate tax-conscious combination of gifting and selling to his son. The retiring dealer will be paid through deferred compensation and rental payments on the real estate. The deferred compensation agreement also included a survivorship clause, which provides for ongoing payments to the dealer’s wife, the son’s mother, if the father is first to die. 

To determine your retirement cash needs:

1. Quantify the amount needed to fund your desired lifestyle. Recognize that, with the exception of fixed payments like a mortgage, you need to adjust for inflation. Even a small amount of inflation will have a significant impact on the value of money over time. For example, just 3% annual inflation means that in 10 years you will need $1,340 to cover $1,000 of today’s expenses. Be sure to include costs being covered by the business, such as the company car, insurances, country club membership and so on.
2. Offset the total cash needs figure with amounts from sources other than the business, such as IRAs, Social Security and other investments, again with adjustments for inflation and interest rate risk. Typically, retirement will also involve reshaping an investment portfolio to a less risky position, say, more bonds than stocks. 
3. The difference between the funding you will receive from other sources and your retirement needs is the minimum amount of cash that will need to be provided by the dealership sale or as part of the ownership transfer agreement.

Step 4: Review Options for Funding the Transfer

It is not surprising that one of the most difficult aspects of transferring dealership ownership is the ability of the successor to provide the required funds. In the ideal scenario, the buyer writes a check for the full amount, but that is often not the case. And, in fact, the availability of funds often limits funding options to ongoing payments in such forms as deferred compensation and payments on assets retained by the retiring dealer, like the dealership real estate. 

In addition to crafting the succession plan agreement, we often assist the buyers and sellers in obtaining funding from such sources as: 

1. The dealership. How much can the dealership afford to provide in ongoing payments? We prepare financial projections to determine how using cash flow to fund the purchase will impact operations, currently and over time. 
2. The retiring owner. This involves quantifying the owner’s ability to finance at least a portion of the transfer. If seller financing is used, you, as the outgoing owner, need to secure the note and consider how interest on the note will be paid or subordinated. The use of seller financing might need to include a personal guarantee from the buyer. 
3. Insurance. If insurance is part of the funding mechanism, there are different types of policies to consider. We conduct such comparisons as the use of term vs. various permanent life insurance and second-to-die policies. Determinations must be made relating to who owns the policies and how the premiums are paid. 
4. Commercial financing. We often help successors obtain commercial financing by locating potential lenders and preparing proposal packages.
5. Equity. Consider offering equity in the company, such as to a private equity group. If private equity is an option, detailed preparations and documents will be required prior to making any offering. 

Where there is value in a dealership, there will be numerous options for funding a sale or transfer. Depending on the successor’s finances, the option could be a combination of funding vehicles. 

Step 5: Planning for Ownership Succession

For purposes of discussion, ownership succession can be viewed from two distinct perspectives: transfers to a family member or members and transfers to non-family members. 

Transfers to Family Members

You can hardly overstate the impact of family dynamics on transferring ownership to a child or children. Beyond business, the transfer involves emotion. While the role of a succession advisor is key to properly transferring ownership under any circumstances, an experienced advisor can be particularly helpful in addressing issues that arise when ownership will remain within the family. The succession plan should serve to:

Divide ownership between active and non-active family members. Some dealers want to divide their estate evenly among their children, but the children within a dealer’s family typically will have different abilities and degrees of interest in the dealership. Equal and fair are seldom the same in such a scenario. It is better to transfer other assets to non-active children, reserving the dealership for the sibling who is active in the business and, most significantly, demonstrates the skills to run a profitable operation. We often recommend using various types of insurance to equalize the dealer’s estate between active and non-active heirs.

Help children active in the business acquire interest in the business. Insurance is only one vehicle for helping active children acquire the business at an owner’s death, but, it can be a useful one. Life insurance can provide the proceeds required to buy the business. There are useful and appropriate roles for life insurance trusts, second-to-die policies and other insurance vehicles, but it is not always a go-to solution. Succession planning should begin well before a dealer reaches retirement age. If planning is done early, gifting or other tax-effective methods can be used. 

Help a dealer understand the pitfalls in transferring ownership to inactive children. Inactive children can serve to undermine the effectiveness of siblings active in the business. Two non-actives can out-vote the active child if ownership is equally divided among the three. It is best to transfer other non-dealership assets (or a minority interest at most) to inactive children and keep control in the hands of actively involved siblings. If minority interests are given to the non-active children, there can be a downside for them. This downside is a non-marketable and non-income producing asset if the majority owner decides not to make income distributions to minority owners. Planning can help avoid such problems. 

Help craft a buy-sell agreement. If a buy-sell is an appropriate succession planning tool, then it must be written so that the provisions produce the desired leadership, economic and tax results. 

Transfers to Non-Family Members

Dealers not passing along their business to a family member might sell to a neighboring dealer or a public or private equity group. Where there are multiple owners, transition can occur inside the ownership circle, a “friendly” if not a family transfer. The advisor’s role can be:

• To determine the provisions in a buy-sell agreement that will serve to keep ownership among the existing partners, if that is desired.

• To locate a buyer when no obvious successor is in sight. Often, employees are willing to buy the dealership, but lack the assets to make the purchase. When an owner must finance part of the purchase, it is critical that the buyer has the ability to operate the dealership profitably and the commitment to ongoing payments is secured. 

Step 6: Identifying Options for Transferring Ownership

Once a successor is identified, the retiring dealer’s cash needs are determined and funding sources are located, we can consider various strategies for transferring ownership, including gifting, selling or redeeming the owner’s interest, selling business assets, tax-free exchanges and others. The transfer option must accommodate:

• The owner’s needs for assets from the business
• The owner’s willingness to incur taxes on the transfer
• The successor’s desire to be insulated from the business’ existing liabilities
• The successor’s desire to reduce future income taxes on the business 
• The amount of cost and complexity the parties are willing to incur

Factors such as funding and the type of business entity can affect the outcome of a transaction.

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