The (Blue) Sky's the Limit
By Don Ray Ward's Dealer Business, Oct 1, 2007 12:00 PM

Having recently joined the world of dealership financing, I have become involved in blue sky lending, a concept that should be useful to know about for anyone overseeing the finances of a dealership group.

Unlike conventional lenders, franchise/mortgage lenders lend against a dealership's goodwill or blue sky, allowing buyers and sellers to benefit from higher loan amounts and thereby opening all kinds of opportunities.

By ignoring blue-sky value — which also takes into account a dealership's future potential performance and profits — a significant portion of a dealership's value is effectively locked out from a financing perspective.

With conventional lending, whether from a bank or a captive lender, the loan collateral valuation is usually limited to a portion of the real estate and/or tangible net assets.

While those components of dealership value may add up to a significant amount of money, they often don't come close to the selling price any owner would accept. That is because this figure does not include blue sky, often the most valuable asset of the dealership and a major determinant of the sales price.

Uses for which these franchise/mortgage financing proceeds may include the following:

• Acquisitions: Acquiring other dealerships to expand your market. With the benefits of economies of scale and enhanced brand awareness, a dealer may increase profitability and his or her personal net worth.
• General manager's dealership acquisition: Allows a general manager to buy out his boss's dealership and gain the accompanying independence.
• Create an employee stock ownership Plan (ESOP). This may allow a dealer to take advantage of tax benefits, increase personal liquidity while maintaining operating control.
• Refinancing: Reducing the financial risk by converting current short-term (non-flooring) debt with its fluctuating interest rates to long-term debt with fixed-interest rates.
• Eliminate the need for partners: With the availability of more loan proceeds, a dealer may not need to take on partners and their needs for large returns on their investment.
• Partner buyouts: Gaining control of the business and the ability to shape one's own future by buying out partners.
• Facility improvements: Increasing customer satisfaction by improving the facilities and providing new services and technologies.

Franchise/mortgage financing is one of those rare exceptions to the old saying, “If it sounds too good to be true…” But even franchise/mortgage programs have limits.

Because this type of lender recognizes and lends on “blue sky” or estimated-franchise valuations, auto dealers are likely to obtain loan proceeds higher than those from traditional lenders. But it may not work for everyone.

The down side of this type of financing is simple. A larger debt is accompanied by a larger fixed monthly note. While there is typically some flexibility on the term of the loan and its amortization period, it is important to be sure that the dealership operations can fund the debt service during the term of the debt.

Of course, the loan's interest rate and term are determined by several factors including:

• Amount of loan
• Value of the real estate
• Franchise of the dealership
• Profitability of the dealership
• Financial strength of any guarantee by the dealer.

With access to proceeds available through franchise/mortgage loans, the value of a dealership's tangible assets is no longer the limit. Now we truly can say “the sky is the limit;” the blue sky, that is.

Don E. Ray is a CPA and a senior vice president with AutoStar. He can be reached at 901-907-0134.

Questions or comments about this column? Send us an e-mail at Dealers@wardsauto.com.