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Buy-In: Adding an Investor—Pros, Cons, and Pointers

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.

The Pros:

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.

The Cons:

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:

  1. 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!
  2. 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.
  3. 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.
  4. 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.
  5. 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?
  6. 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.
  7. 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.
  8. 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.

 

 


Iowa Supreme Court Defines “Oppression:” Lessons for Closely Held Corporations—Including Auto Dealers

Under Iowa law, a court can order the dissolution of a corporation if the minority shareholder can prove oppression. If the company dissolves, the minority shareholder will receive their appropriate share of the company’s assets. In addition, the Iowa Business Corporation Act (“IBCA”) provides a similar statutory remedy for oppression, but also allows the majority shareholders to purchase shares instead of dissolving the company in its entirety. However, Iowa law did not define “oppression” until Baur v. Baur Farms, which was decided on June 14.

The Court held, “majority shareholders act oppressively when, having the corporate financial resources to do so, they fail to satisfy the reasonable expectations of a minority shareholder by paying no return on shareholder equity while declining the minority shareholder’s repeated offers to sell shares for fair value.” In this holding, the Iowa Supreme Court provided an expansive definition of oppression based on reasonable expectations. The Court will determine whether a minority shareholder is being oppressed by considering the minority shareholder’s “reasonable expectations” regarding return on their investment. Additionally, the Court will also consider all of the circumstances of the business before determining whether there is oppression.

In Baur, the minority shareholder could sell his shares to a third party, but he first had to offer his shares to the other shareholders, and they could purchase the shares at fair value. This provision is somewhat common in closely-held corporations, including some auto dealership corporations. However, the majority shareholder refused to buy the shares at reasonable value and refused to pay any dividends to the minority shareholder. As a typical minority shareholder, he had little market outside of the corporation.

The bylaws in Baur provided a method for calculating the “fair value” of the shares, but the company failed to update those numbers since 1984. Since the value of the corporation’s assets skyrocketed, if the minority shareholder sold his shares at the 1984 price, then he would be selling them at a significantly reduced value. Importantly, the Court made it clear that if the “fair value” had been computed properly, then the written agreement would have been upheld. Therefore, if the written contract is reasonable, then it will be upheld.

Baur provides two major lessons to closely held corporations, including auto dealership corporations. First, majority shareholders should take an objective look at how they are interacting with their minority shareholders. A majority shareholder’s actions should be within the Baur standards. If you are concerned that your actions might fall into the Court’s definition of oppression, then you should speak to an experienced business and auto dealer attorney.

This case also illustrates that the bylaws of closely held corporations may need to include provisions that realistically address adjustments to corporate control and shareholder buyouts. The Baur family would have saved time and money with a well-developed set of bylaws. Since the Court will generally uphold written agreements, you should have an attorney examine your corporation’s bylaws if you are concerned about future corporate governance. Contact experienced auto dealer counsel to discuss what this case means to your closely held corporation.