VERNON B. SHCWARTZ OF FALCON FINANCIAL TALKS OF NEW CAPITAL SOURCE FOR AUTO DEALERS

By: Vernon “B.” Schwartz
Falcon Financial

(A new method of financing auto dealership transactions is enabling traditional dealers to compete with the publicly-financed multi-point dealers that are driving the consolidation movement in the dealership business. Falcon Financial, a joint venture with Sun America and Goldman Sachs, is offering what it calls a Franchise Mortgage Program that enables dealers to finance acquisitions without “going public” for funding. Dealer Buy-Sell recently explored the new program with Vernon Schwartz, Chief Executive Officer of Falcon Financial.)

DB-S: Vernon, why is there a need for this new form of financing?

SCHWARTZ: The new, publicly-owned dealerships such as Auto Nation have embraced the strategy that to survive and succeed, growth through acquisition is essential. As public companies, they have been able to tap into the public capital markets to finance their acquisition binge. But even successful, privately owned dealers who accept the acquire-to-survive strategy, often have been unable to obtain the long-term financing to undertake it.

DB-S: Take a moment and explain why that is.

SCHWARTZ: or for various reasons has no desire to venture into that arena? Historically, sources of capital for dealers have been limited and generally tailored to satisfy the dealer’s short-term or working capital requirements. Typically, a dealer has had little difficulty in financing new and used car inventory through floor-plan lines of credit. While the same lenders may be prepared to provide financing for the dealership real estate, they it is sometimes done so reluctantly. These lenders are often equally reluctant to , and it is with equal reluctance that the lender will make an unsecured working capital line of credit available or what is commonly referred to as a “cap loan”. Although available, characteristic of these lines of credit are usually their relative short term in nature, and offer rates of interest that are tied to prime or LIBOR. Hence the dealer is – exposed ing the dealer to refinancing and rate risk, and a lack of flexibility in that these lines of credit are tied together limiting a dealer’s ability to refinance his flooring without repaying his real estate and “cap loan”. Even wWorse, yet, the dealer is exposed to significant personal financial risk since, with few exceptions, the dealer has personally guaranteed the payment of principal and interest.

DB-S: It seems like auto dealers don’t have the same access of financing as other businesses.

survive and join

SCHWARTZ: Exactly.

DB-S: Why is that?

SCHWARTZ: such a dealer In general, the dearth of financing alternatives available to dealers is a consequence of the attitude that traditional sources of financing have had toward the dealer community. These traditional sources typically hold the It is an attitude borne out of insupportable notion, that dealerships are small businesses not deserving of the same level of respect afforded enterprises of the size of the typical multi-point dealer. It is this attitude that has the potential for keeping aggressive dealers in an economic straitjacket. Falcon Financial was created with the belief that a new financial framework is necessary – a framework that treats the dealership like any other major business and affords dealers similar access to capital that other such businesses enjoy as a matter of course.

DB-S: Okay, explain the Falcon program.

SCHWARTZ: Based on the principles that dealers should have access to long-term capital and should be able to borrow against the equity they have developed and nurtured through their ingenuity and hard work, and oftentimes over generations, we have developed the eBecause of Falcon Financial’s experience in the retail automotive industry, the Company has the insight and perspective to enable it to do this. Falcon Financial Franchise Mortgage Program which bases loan amount on dealership cash flow and enterprise value. In other words, the value of the dealership real estate is not a limitation – in fact, the loan proceeds will always exceed the value of the dealership real estate. What makes this possible is that Falcon Financial, unlike other lenders, takes into account the market value of “blue-sky” and tangible net worth in its underwriting. Further, the loans are specifically designed to reduce the financial risk exposure of dealers by fixing the rate of interest, fully amortizing the principal over the term of the loan and not requiring the dealer to personally guarantee the loan.

DB-S: Describe a typical loan allgenerated through With a simple example the uniqueness of Falcon Financial’s approach and the benefits of its Franchise Mortgage Program. will be self-evident.

SCHWARTZ: In the box below, we have set out a hypothetical dealership’s financials and the loan amount they would justify:

Example: Typical Dealer

Gross Profits $5,000,00

Net Profit $850,000

Rent $350,000

Floor Plan Interest $275,000

Net Worth $1,200,000

Approx. Loan Amount $5,500,000′

Based on this example, the dealer could borrow up to $5.5 million. This is far in excess of the $3,000,000-$3,800,000 loan that a traditional lender would offer this dealer. (There are certain facts assumed in the example that may be different for a specific dealer. .)In general, however, it is safe to say that with Falcon Financial a dealer will be offered a loan well in excess of that offered by traditional lenders.

DB-S: Does the dealer’s risk increase under this program?

SCHWARTZ: Actually no. At the dealership level, the risk of the increased debt has been mitigated due to the fact that the interest rate is fixed for 15 years. While the rate on the dealer’s “flooring” will change increase as short-term rates change increase, the rate and payments on the Falcon Financial debt remains constant. Additionally, with Falcon Financial there is no refinancing risk since the loan is fully amortized with no balloon payments. At the personal level, there is no additional risk, since the loan is non-recourse to the dealer principal. The absence of a personal guarantee is in stark contrast to what is demanded by captive finance companies and banks.

DB-S: So, you may ask – where’s the catch?

SCHWARTZ: There is no catch. While Falcon Financial’s approach is unique to the world of dealerships it is commonplace the approach generally employed in other industries. Our Whatprogram simply affords is doing is affording dealers the same capital market opportunities that have been available to businesses of like size and track record. ForDealers have been treated as “second class” citizens for too long, unable to take advantage of market opportunities. It is this status that has allowed outsiders, with greater access to capital, to make significant inroads into the business.

DB-S: What type of collateral does Falcon Financial require from dealers obtaining a Franchise Mortgage loan?

SCHWARTZ: Falcons Financial’s collateral is made up of the dealership’s land, buildings and certain other business assets. The important thing to note is that Falcon Financial’s Franchise Mortgage Program does not interfere in any way with the dealer’s ability to secure floor plan financing.

DB-S: How long does it take to get a decision from

Falcon Financial?

SCHWARTZ: A preliminary indication will be provided within a week and a formal commitment issued within no more than thirty days thereafter. The Company strives to ensure that the total process, from application to funding, does not exceed sixty days.

DB-S: Can you compare the benefits of your program with the

alternative funding source offered by Real Estate Investment Trusts (“REITs”).

SCHWARTZ: Like Falcon Financial, REITs provide long-term capital. H, however, the way they provide it and the consequences thereof are significantly different.

REITs provide capital by acquiring the dealership real estate and leasing it back to the dealer pursuant to a long-term lease. Hence, the capital provided by the REIT is limited to the appraised value of the real estate. Further, since the transaction is a sale, taxes may be payable by the dealer, thus reducing net proceeds. Finally, the dealer not only loses ultimate control of the real estate, but loses the value of its potential future appreciation. By contrast the Falcon Financial Franchise Mortgage Program generates proceeds in excess of the appraised value of the real estate, has no tax consequences, and allows the dealer to retain control through continued ownership of the real estate.

DB-S So, why would a dealer contemplate a transaction with a REIT?

SCHWARTZ: As an estate-planning tool a REIT may be very advantageous. It allows a dealer to convert the dealership real estate into REIT stock and then distribute the stock amongst the dealer’s heirs. No tax would be payable until the stock was sold. While this may be attractive from an estate planning perspective it does not generate any capital for growth, it exposes the holders of the REIT stock to stock market fluctuations and eliminates the opportunity of benefiting from the appreciation in the dealership real estate

(Vernon “B.” Schwartz is Chief Executive Officer at Falcon Financial. He can be reached (203) 967 0000 or by email at schwartz@falconfinancial.com.)

This article was written in 1999.