Allowing an investor to buy into your corporation or LLC can be a complicated process. While it may be a great idea for some dealerships, it may be unsuitable for others. Every case is unique, and whether to add an investor involves a series of important personal and business decisions that you should only make after careful thought and consultation with professional advisors.
This article provides a brief outline of some of the issues that you may want to consider; it is not comprehensive. Every case is different. Consult experienced dealer counsel for further information.
Bringing in an investor is typically done for many reasons, including (1) raising additional capital; (2) estate planning (you do have a succession plan, don’t you?); (3) management assistance; (4) golden handcuffs; and/or (5) a potential exit strategy.
Adding an investor may lead to personal conflicts. If your co-investor owns 50% of the business or a majority of the business then management disagreements and deadlocks may arise. You will have to share profits with the investor and decisions about write downs, owner benefits, distribution of earnings, and “business as usual” may become a thing of the past. Even if your co-investor is a minority owner, he or she may possess certain rights, such as the right to examine records and possibly, a reasonable right to a return on investment, under Iowa law.
Things to Consider Before You Make Promises About or Enter Into A Buy-In Agreement:
- Your Own Motivations.Think about this and then continue to reflect about it before you move forward with any buy-in: “What is my real motivation for doing this?” Is this the best way to achieve your goals? Talk this over with your family and professional advisors. This is critical!
- What About the Investor?Really knowing a potential investor may prevent a future disaster. In our practice, we have seen the consequences of a seller failing to consider the following: How long have you known the potential investor? Are you really compatible with him/her and how do you know that? Are you comfortable with his/her spouse and how do you know that? Does he/she possess skills that complement your own skills and how do you know that? Slow down here and make a logical and not an emotional decision.
- To Control or Not to Control? Most sellers will want to maintain control in a buy-in scenario. To maintain control, you must retain over 50% of the ownership interests. Your professional team should review your bylaws, articles of incorporation, and/or operating agreement and articles of organization to be certain that there are no adverse provisions involving control issues.
- How to Establish a Value for Your Company.If you decide to move forward, then seek guidance in valuing your business before you enter into any oral or written agreements, including letters of intent. If you want to maximize the value that you receive for the ownership interest that you are selling, then your attorney and accountant must be familiar with auto dealership transactions and especially current goodwill and blue-sky multiples. They must also understand the best techniques for fixed and other asset valuations.
- How Will You be Paid? Before you enter into any agreements you need to be comfortable with the method of payment. Is it cash? Payment from future bonuses? Will there be a promissory note involved? If there is a payment plan, when will the ownership interest transfer—at the closing or as paid? Is there security?
- Enter into an Employment Agreement Concurrently with the Buy-In Agreement. You should strongly consider having counsel draft an employment agreement for the potential investor if the investor is to be a working investor. You should carefully consider the termination provisions and the effect of termination on ownership. In other words, in the event that the investor fails to perform do you want the right to buy back the investor’s ownership interest? This must be coordinated with a shareholders’ or members’ agreement.
- Shareholders’ and/or Members’ Agreements.Shareholder and/or member agreements should be entered into concurrently with the buy-in agreement and the employment agreement. The essential purpose of the shareholders’ or members’ agreement is to ensure that if there is a future dispute between seller and buyer, there is an agreed workout, including, for example a provision whereby the seller can reacquire the buyer’s interest in the business at a predetermined price or formula with specified payment methods.
- Beware of Securities Laws! Generally, small one-time transactions fall within an exception to the necessity to registering shares or ownership interests under the Securities Act. Proper disclosures will protect sellers! Build this in to your buy-in agreement. See your attorney.
The decision and the process for allowing an investor to buy into your dealership business may seem deceptively simple at first glance. In our experience, it requires a great deal of planning and execution. Knowing the benefits, drawbacks, and overall process can help your decision-making process. However, nothing substitutes for the knowledge of an experienced auto dealer attorney who can walk you through this complicated process.
Puffery: advertising copy that indulges in subjective exaggeration in its descriptions of a product or service, such as “an outstanding piece of luggage.” Puffery is always a matter of opinion on the part of the advertiser and often will use words such as “the best” or “the greatest” in describing the good qualities of a product or services. Sometimes puffery is extended into an exaggeration that is obviously untrue and becomes and outright parody, such as, “This perfume will bring out the beast in every man!”
– Jane Imbler & Betsy-Ann Toffler, Dictionary of Marketing Terms 458 (2000).
As Judge Learned Hand aptly explained, puffery is the “kind of talk which no sensible [person] takes seriously.” Puffery is not a foreign concept to the average automotive dealer. However, there is occasionally a fine line between puffery and fraud or misrepresentation. Of course, a customer likely cannot effectively bring a successful action against a dealership for puffery, but they can bring an action against a dealership for fraud, deception, or misrepresentation.
Iowa, like many other states, has enacted legislation to deter businesses from misleading consumers in contract terms, financing agreements, or advertisements. Under the Iowa Consumer Fraud Act, the Attorney General can bring a case on behalf of a citizen who feels they have been subjected to deceptive or misleading business practices. Further, in 2009, Iowa enacted the Consumer Fraud – Private Right of Action, which grants consumers the ability to bring a suit on their own behalf should they feel that a company has misrepresented information or deceived them in any way. Of course, this legislation only covers misrepresentation or fraud and does not extend to actions for puffery. As such, dealerships should beware of the line between puffery and misrepresentation.
Like Iowa, Indiana has similar legislation designed to protect consumers from deception in relationships with businesses—the Indiana Deceptive Consumer Sales Act. A recent case involving this act may help you find the line between puffery and deception. The Indiana Supreme Court addressed an issue where a dealership advertised a vehicle as a “Sporty Car at a Great Value Price.”
In evaluating the advertisement, the court determined that it was a statement of opinion, rather than a statement of fact. The court gave a counter-example: using the phrase that a truck is “road ready” is an affirmation of fact that the truck will actually drive on the road. Further, the court noted the significant difference between flatly stating that the car has cruise control when in fact, the cruise control does not work. While the cruise control statement is not technically false, it still misleads the customer into implying that the cruise control is functioning.
It is possible that a statement be part puffery and part statement of fact. As such, the court in this case took pains to evaluate each word in the advertisement before determining that the phrase was simply puffery. The court determined that in order for a term to be deceptive, and fall under Indiana’s Deceptive Consumer Sales Act, it must first be a representation of a fact, and not a mere opinion.
The court also noted the devastating effects that may plague the automobile industry if the court did not determine that this statement was puffery. If dealerships were so concerned that they may be sued for puffery, then they may be more inclined to list only the actual features of the car. That is, there may be no advertisement involved at all, just a list of the vehicle’s features. This would greatly reduce the dealerships ability to advertise generally.
Since the court took an in-depth look at each word in the advertisement, it is important that dealerships take a lesson and do the same. Does the describing word give a customer a promise or an opinion? If you are unsure, experienced dealer counsel should step in to help evaluate your advertising.
The Federal Trade Commission (FTC) was established to be a watchdog against businesses that may not have consumer-friendly business practices. In particular, it attempts to corral businesses that may not be entirely truthful or are misleading the average consumer, intentionally or otherwise. One of the FTC’s more recent projects is “Operation Steer Clear,” announced January 9, 2014, which focuses on automobile dealer advertising. The FTC describes the program as, “a coast-to-coast law enforcement sweep focusing on deceptive TV, newspaper, and online claims about sales, financing, and leasing.”
In order to sell vehicles, every dealership knows that you have to get the customer to the dealer. Generally, automotive dealerships do that by advertising their vehicles, providing special financing offers, giving incentives, or generally lowering prices. While all of these methods may seem acceptable, the FTC recently investigated and will potentially fine (in one case, up to $16,000 a day) ten dealerships who overstepped their bounds in advertising.* Those dealerships are not only involved in settlement negotiations with the FTC, but they are listed on the FTC’s website where FTC solicits public comments. Therefore, in addition to having a legal headache, the dealership’s reputation is permanently tarnished.
The dealerships involved in the investigation had locations across the country, including California, Georgia, Illinois, North Carolina, Michigan, and Texas. Violations ranged from failing to disclose lease terms (a violation of the Consumer Leasing Act and Regulation M) to failure to disclose credit-related requirements (a violation of the Truth in Lending Act and Regulation Z). At least one of these dealerships is also involved in a lawsuit at the state level.
One dealership advertised pricing that did not include the down payment. Another dealership advertised no down payment, but there were actually a substantial amount of one-time fees that the customer had to pay to acquire the vehicle. Still another dealer failed to disclose that their low monthly payments would eventually go up. One used a mailed “sweepstakes” to get customers in the door, but the customer did not actually “win” anything even though their mailer said otherwise. You can see samples of these advertisements here.
It is sometimes difficult to balance persuasive and effective advertising with advertising that complies with state and federal law. The FTC provides a list of “potholes” to avoid when considering your advertising and financing campaigns. They suggest avoiding deceptive pricing, including misleading “teaser” payments, undisclosed balloon payments, or hidden financing rates. While real prizes can be a great promotion, fake prizes are probably not a good idea. The FTC also suggests advertising should be upfront about lease terms and rates, thereby avoiding violations of the Consumer Leasing Act and the Truth in Lending Act.
The NADA stated that the FTC’s efforts “highlight the need for diligence by all auto retailers . . . [to] ensur[e] that their legal counsel review all advertising.” While the average dealership may know some of the nuances of these complicated federal laws, only experienced legal counsel will be able to ascertain whether your advertising conforms to both state and federal laws. Arenson Law Group, PC, plans to provide a “BrakeDown” of the need-to-know advertising laws that affect Iowa dealerships in its upcoming newsletter. If you are not already a subscriber, you can sign up here. You can also e-mail firstname.lastname@example.org or call 319-363-8199 for more information.
*The FTC and nine dealerships have settled these charges. You can find more information about their settlement here.