If you’re considering working with a private equity firm in a buy sell deal, be prepared for hurdles you are unlikely to encounter with a traditional investor. There are advantages to working with PE, however.

Who is in control here?

One issue when working with private equity on a buy sell is that PE firms are used to being 100 percent in control of a business they invest in. In the retail automotive world, that isn’t possible.

“The manufacturers won’t allow (that level of control). There has to be a certain level of control by the operators,” says Tim Batchelor, co-founding partner of Open Road Capital, “They don’t want Wall Street Guys coming in and telling good operators how to run their business.”

Open Road is an operating company backed by a private investment management firm.

For example, private capital is often reluctant to give up the right to hire and fire a company’s executives. And PE is used to having a say over a CEO’s decisions. In retail automotive, it doesn’t work that way. The manufacturer had the final say over the dealership operator.

And a PE firm has “no leverage to get an OEM to allow the PE group to have more power,” says Batchelor. Meanwhile, not being able to call the shots also “challenges a PE firm’s fiduciary duties to their investors,” he says.

Indeed, winning the manufacturer’s approval for a franchise sale may require outside capital investors to contractually agree to let specific qualified individuals continue to operate dealerships.

For example, in order for GPB Capital to acquire Prime Automotive Group from David Rosenberg, Rosenberg says he personally talked with the head of Audi to convince the manufacturer to okay the acquisition of the group’s Audi franchise.

“Audi wrote an agreement whereby I could not be removed,” says Rosenberg.

Other manufacturers whose franchises were included in the acquisition also included a provision that Rosenberg could not be removed as operator, he says.

On the other side, dealers are also used to being their own bosses and may resent being told what to do by their new investors.

Investment duration and other speed bumps

While some outside capital is long-term in its investment outlook, private equity generally wants to exit after seven or eight years. For example, a transaction Faris Syed, founder and president of SAR Partners, is working on involving a dealer and a private equity firm stipulates that the PE firm will exit after seven years.

Manufacturers, on the other hand, generally look for long-term, or evergreen, investors when they agree to a franchise acquisition. Syed is optimistic the acquisition he is working on will be approved, however.

“OEMs are reluctant to engage with new entrants in the industry, but I don’t hear they seem afraid or against them,” he says, citing Redwood Capital’s investment in Morgan Automotive Group as an example.

As Halbert Rasmussen of Scali Rasmussen PC explains, “OEMs have varying degrees of concern over the possibility that someone other than the recognized dealer operator might have control or even influence over dealership operating decisions. Unfortunately, for some OEMs, this concern has reached paranoic levels resulting in unreasonable demands, such as demands for all investors to cede 100% of their voting rights to the dealer operator. Dealer franchise laws generally prohibit factory interference with the dealer’s capital structure, so those facing these kind of demands should carefully review their rights under state franchise law. “

Agreeing on valuation for a franchise can also be a sticking point because PE investors read the various Blue Sky reports published by buy sell firms and come expecting to apply the multiples in the reports to a franchise, says Syed.

In reality, a determining the valuation depends on the franchise, the location, the management, and much more.

“A traditional dealership group is much more flexible when it comes to valuation,” says Syed.

He has also found getting to the actual signing of the purchase agreement can take much longer when a PE firm is involved. Their due diligence process takes much longer, says Syed, and they ask many more and varied questions than a traditional buyer.

In one deal, “you got a list of at least a hundred questions which normal traditional buyers don’t ask,” he says.

For example, the potential buyer of a Ford franchise wanted financial performance information for 10 years though the operator had only owned the dealership for three years.

“Even the seller was kind of frustrated,” says Syed.

Access to capital

Private equity does have some advantages over traditional investors, however.

“If a young operator is going in for the first time, this is his way of getting a major investor behind him,” says Syed.

PE brings experience in business processes, expense control and creating a better capital structure, he says.

And if that young dealer is looking to grow, private equity can be a good option because of its access to capital at better rates than through a bank, says Syed.

When a dealership does need to borrow from a bank for expenses such as flooring, the PE firm can often negotiate a better rate with the bank than the dealer would be able to, he says.

Access to more capital for expansion can also be easier. In the deal he is working on, the young operator wants to grow aggressively. If he proves himself with the initial acquisition, the PE firm will fund expansion, says Syed.

“I don’t think PE would be a good partner if you are just looking to buy one or two dealerships,” he adds.

This article was written for Getting to Go, a buy/sell newsletter from Scali Rasmussen.