After so many years, it may be hard to see your shop as anything besides an extension of yourself. In fact, it may be hard to imagine life without it. In many cases, your entire family may have worked in the shop, discussed it endlessly, used it as an education and a proving ground for the children, and practically turned the shop into another family member.
On the other hand, you may view your business as a burden due to the long hours it requires. Maybe you can’t wait to get rid of it, since you’re tired of the constant aggravation with insurance adjusters, parts suppliers and technicians.
Or, perhaps you entered the collision industry with the notion that it would be a short-term opportunity and that you’d sell whenever you got a decent offer.
Regardless of your situation, you’ll likely be faced with the following question at some point: What should I do when I want out of my collision shop? This question invariably raises a host of others: Should I sell to my employees? To a competitor? To a consolidator? Should I turn the shop over to my children? Should I move on to other interests or retain a role in the shop’s future?
Without a doubt, selling your shop will be one of the most important things you’ll ever do because, unlike virtually every other business decision you’ve made over the years, you’ll only do this once. You get one chance to put a price tag on your many years of effort – and once you sign the purchase agreement, it’s over.
While a multitude of areas are important to the seller of a collision repair shop, the one that’s most often misunderstood is how sellers get their money. To help you better understand this area, I’ll cover the various forms in which a Buyers and Sellers Agreement can structure payment for a collision repair shop.
Immediate Gratification: All Cash
The best kind of deal in many people’s minds is receiving the entire purchase price for the collision shop in cash at the time of the closing. With this kind of deal, you could walk away from the business, free and clear, get on your sailboat, and head for Tahiti and the good life!
Unfortunately, it’s rare that a purchaser can come up with enough money to pay cash for your shop. This type of settlement is occasionally possible when the buyer is a large corporation or is cash rich.
But neither of these situations are likely to occur in our industry. The largest corporations in our industry today are the consolidators, and at some point in the future, they may be able to pay all cash – but not this early in their development. Right now, they can’t pursue their strategy of aggressive growth by paying all cash; it would run out too quickly. Besides the consolidators, there are very few other cash-rich collision shops (or individuals) out there.
"Why doesn’t the buyer go to the bank and borrow the money to buy my collision shop?" you ask. Not much help there. Generally speaking, banks are hesitant to finance the purchase of a collision repair shop because they have fairly strict lending criteria for any business-acquisition loan. They would require that the business being purchased have a lot of excess working capital, investments, equipment, receivables or inventory, and/or real estate that could be used as collateral for an asset-based loan. The typical collision shop doesn’t fit that profile; the bulk of the purchase price will likely be well-above the value of the hard business assets. (Also consider that most commercial lenders will loan the buyer only 65 to 75 percent of the value of these assets to ensure they’re well-protected if the buyer can’t make the deal work.)
If you’d manage to find a buyer willing and able to pay you all cash, beware: The buyer will expect a discount for an all-cash settlement, and the discount expected could be as high as 35 to 50 percent off the value of your shop. That may be an acceptable loss in some situations, but I’m going to assume you want to maximize the return on the hard work you’ve put into your shop.
So with your dreams of watching the sunset in Tahiti fading, what are your alternatives?
Since the all-cash option is rare, it’s not surprising that more than 95 percent of collision shops sell with seller financing. In fact, carrying a note for some or all of the purchase price may be the only way to sell your collision repair shop – and you’ll certainly get more money than if you insist on an all-cash settlement. Seller financing can also provide a tax break if your sale qualifies for installment sale treatment for capital-gains tax consideration. Seller financing can also be a godsend for the buyer because he’ll have more flexible qualification standards and more lenient terms than a bank would offer.
On the downside, if you allow the buyer to pay you off slowly over time, you’ll retain many of the risks that come from continued ownership of the shop while giving up control of its management. In most cases, the buyer’s ability to make the payments will depend on the future success of the shop, yet your buyer may know little about your shop, your insurance relationships, your technicians or even the collision industry itself. If this is the case, the buyer can quickly mismanage your shop down to nothing if you don’t keep an eye on him.
Every seller’s worst nightmare is the buyer coming in, destroying his business and leaving him with nothing. If the buyer does run aground and stops making payments, your only recourse may be to foreclose on the note and repossess the shop, which can mean you’ll have to start the selling process all over again. In a worst-case scenario, you’ll have to jump back in and build the shop up to a point where it can be sold again. And depending on your reason for selling in the first place, that may not even be possible.
The basics of providing seller financing are simple: The most common structure is to have the buyer make a down payment. Generally, you should insist on a down payment that’s as large as possible. (Take a clue from the bankers, and insist on at least 25-35 percent.) You’ll then hold a note for the rest of the purchase price.
The shop itself and the significant business assets provide the primary collateral for the note, and a lien on the business assets is filed with the secretary of state’s office so other potential creditors will know it exists. If real estate is involved, you can choose either to lease it to the buyer or sell it with the business. The real estate portion will be documented by either a lease or a mortgage. In any case, all should be cross-defaulted, so if the buyer defaults on the note, the lease or the mortgage, you’ll be first in line to step back in and take over the shop.
Aside from its simplicity, this type of deal can be very flexible; you can adjust the payment schedule, interest rate, loan period or any other terms to reflect your needs and the buyer’s financial situation. You will, however, need expert tax and legal representation to make sure the documents accomplish your goals. This area is one in which cutting corners may come back to haunt you, big time!
In some cases, the buyer may have lined up a bank to finance only a portion of the deal, and he may want you to take back subordinated debt for the remainder of the price in a variation of the popular leveraged buy-out (LBO) of a few years ago. In that case, you’re second in line if the buyer defaults on the primary loan. Obviously, this isn’t as desirable a position for you, so this type of structure should be avoided. If you agree to it, demand a significantly higher interest rate and other protections (personal guaranty, outside collateral, second mortgage on personal residence, etc.). You should also think about maintaining an equity position in the company so you have a voice (even if not the controlling voice) in the management of the company.
Earnouts: Earn As You Grow
When there’s disagreement about how much a collision repair shop is worth, it’s fairly common to include an "earnout" as a term of the purchase deal. An earnout is a contractual arrangement in which the purchase price is stated in terms of a minimum, but you (the seller) will be entitled to more money if the shop reaches certain financial goals in the future. These goals should be stated in terms of percentages of gross sales or revenues, rather than net sales, because expenses are easy to manipulate and thus net sales are too easily distorted.
If you include an earnout, it’s important to state in the contract who will be reviewing the books and verifying the shop’s performance. From the seller’s perspective, you should be more likely to agree to an earnout if you’ll maintain an employment or consulting relationship with the buyer. That way, you’ll be able to keep an eye on things to confirm the buyer is taking all the steps necessary to reach the goals, isn’t making unrecorded sales for cash, isn’t keeping two sets of books, etc.
From the buyer’s perspective, an earnout is a good solution to uncertainty about a shop’s future. The buyer will want to place a cap on the total earnout payments to limit the risks and, particularly if the seller remains active with the shop, the buyer will want to be sure the seller isn’t making a lot of sales that will hurt the shop’s profit margin.
Employment Contracts and Non-Competes
Often, a significant part of the total cash you receive will be tied to your future involvement in the collision shop in other ways. This after-sale involvement can take a number of different forms:
- Seller’s Employment Contracts – It’s a rare buyer who won’t want you to show him the ropes by remaining involved with the shop for a while after the sale – and often the deal won’t fly unless you agree to this. At a minimum, the buyer wants to be sure the shop is indeed a going concern. (The term "going concern" refers to the business’ ability to continue to operate. In the context of a collision shop, the term could apply to a situation where undisclosed problems will affect whether the new owner will be able to stay in business. For example, what if the seller had known for the past year that his painter had been using the wrong primer, which would likely cause the paint to peel within two years. The potential warranty claims could force the business to fold. In this case – if the seller knew of the problem – the business may not have been a going concern.) Beyond that, buyers realize most of the real business knowledge has never been written down and will go with you when you leave, unless the new owner takes steps to learn it from you. Enter the employment contract.
When an employment contract is used in a business sale, the seller becomes an employee of the new owner. The seller should consider this a short-term situation; few entrepreneurs can successfully make the adjustment to taking orders as an employee once they’ve gotten used to calling all the shots. Experience has shown that, in the vast majority of circumstances, this relationship will sour and the seller will leave within 18 months – sometimes causing the entire deal to unravel in the process.
Employment contracts are most frequently used in family businesses as part of a succession plan. When the older-generation founder intends to stick around for a while and the younger-generation new owner can deal with any ego problems and make good use of the founder’s advice, experience and skills, these arrangements can work out well.
- Seller’s Non-Compete Agreements – A buyer doesn’t want to see you sell your shop and then turn around and start another one just up the street, taking most of your customers with you. For that reason, a buyer will want you to sign a non-compete agreement as part of the deal. The agreement will state that in exchange for a specified payment, you promise not to go into a similar type of business within a certain geographic area for a given period of time.
Most sellers think of signing a non-compete agreement as a no-brainer. After all, they’re cashing out, so why not take money for doing nothing? For some shop owners, however, things don’t work out exactly as they thought and they need to work. And when they decide to go back into the industry, a non-compete agreement can stand in their way.
To be enforceable, a non-compete generally needs to restrict you only from starting or working in a collision repair shop in the same geographic area from which the former shop drew customers, and it must be limited to a reasonable (meaning short) length of time. Some state laws generally discourage such agreements, and in some states, they’re virtually impossible to enforce.
Non-competes also have another purpose: to convey more cash to the seller in a form that has tax advantages for the buyer. Prior to the 1993 tax-law changes, the total value of a non-compete agreement could be deducted by the buyer over the course of the agreement. Now, however, all agreements must be written off during a 15-year period, regardless of their actual length. Since most non-competes are for five years or fewer (and must be short in order to be valid), this rule makes them less attractive. Nevertheless, they’re still used in about 80 percent of business sales.
Stock as Payment
If one corporation sells out to another, it’s often possible to structure the deal as a stock swap or tax-free reorganization. This means that, essentially, no capital-gains tax is due at the time of the sale because each party is merely exchanging one type of security for another. The big catch is you must agree to accept stock in the other company as virtually the only consideration for the sale. This is risky, but aside from structuring the deal as an installment sale, a reorganization is the only way to push the capital gains on the sale of your company into the future.
While these types of deals can be attractive with large public companies whose stock is highly liquid, the lack of liquidity of the stock that results from the merger between two private companies should be a major concern. You’ll need to understand the limitations on the sale of this stock, so expert advice is critical here. This type of transaction is definitely not for the unprepared or the poorly informed.
Is there a sale in your future? It might be sooner than you think. The population of collision shops has shrunk from more than 70,000 in 1992 to just a little more than 47,000 at mid-year 1999. Where have they gone? Are they closing their doors, or are they selling out?
The amount of collision revenue has grown somewhat – to about $24 billion per year – so there hasn’t been a big drop off in business that would cause a surge of business closings. (Anyway, if that were the case, a large supply of technicians would be out there looking for work, and we all know that’s not happening. Technicians have been – and are still – in short supply.)
The answer may be consolidation. Industry experts estimate that as many as 40 to 50 shops are being sold each month, and I believe that number is much higher. (The dozen or so highly visible consolidators are only responsible for a fraction of the lost shops.) There have also been some shop closings, along with successful shop owners who are seeing the benefits of multiple locations and buying out other shops in their own or adjacent markets.
All these factors play a part in the decreasing numbers of collision repair shops. Will you add to the drop by selling your shop? You may not have plans to sell, but the fact is, you never know when a buyer might come knocking. If one does, you need to be prepared if you decide to answer.
Writer Thomas Speed is a Financial Markets Specialist with Edwards & Associates Consulting, Inc. Speed can be reached at (800) 979-9904.