When selling your business, you need to decide what to do with your business real estate. Do you want to sell it or hold on to it? And what should happen if you don’t own your real estate? Those are important questions to answer as you plan to sell.
You lease. Let’s start with businesses that lease from a third party. Ideally, when you sign a lease, you want a clause indicating you can assign that lease to new business owners without the approval of the landlord.
If that’s not the case, and you need to get approval, you must decide whether to approach your landlord early and get things worked out or wait until just before closing and hope it’s not an issue. There are pros and cons to each approach.
Talk to the landlord early so you don’t have any last-minute surprises. The biggest con of this approach is that landlords don’t always understand the importance of confidentiality in a business sale, so have them sign a confidentiality agreement before you start discussions.
Your real estate is an asset of the company. When you have real estate inside the company, it’s a little tricky to get full value for both the business and the real estate.
Let’s say you have a $1 million piece of real estate inside the company and you’re not paying yourself rent. Let’s assume fair market rent would be $100,000 a year, and that your business sells at a four multiple.
By not paying fair market rent, you’ve enhanced your cash flow by $100,000. At a four multiple, you’d be getting $400,000 in value for that real estate asset. Unfortunately, what you really needed was a 10 multiple to get fair market value.
Including real estate within company assets can help with financing because banks like to finance commercial real estate, but in most cases, this deal structure will leave money on the table.
You own the real estate in a separate LLC. This is the most common arrangement, particularly for S-corporations. You own the real estate and lease it back to the business, making you both tenant and landlord.
To calculate value, let’s adjust your financials to account for a fair market rent, as that’s an important part of the estimate of value. By paying fair market rent, you’re essentially driving down your cash flow and reducing the value of your business.
However, selling the real estate separately allows you to capture the full market value for that asset. Using the example prior, selling the real estate at $1 million would net you an additional $600,000 in total transaction value.
To sell or hold. So, if you know you want to carve the real estate out separately from the business, you have three options: sell the real estate to the business buyer, lease the real estate, or (less common) set up a sale leaseback in which a real estate investor buys your real estate and then leases it to the new business owners.
Often, especially in the Midwest, individual owners want to own the real estate and build equity, but private equity buyers generally want a greater return than they can get with real estate. So, those buyers are likely to want a lease arrangement.
Sellers have differing goals. Some want to be out of their business and done all at once. Some worry their property wouldn’t be readily salable to another entity and want to ensure it’s included in the original sale. Others see a lease as a way to defer a certain amount of capital gains taxes.
Sellers who lease also benefit from what is called “mailbox money.” Businesses typically use a triple net lease arrangement, meaning the property owner isn’t responsible for maintenance or taxes. With regular lease income, property owners may be able to leave the bulk of their other investments alone to grow and compound.
which option is best for you. If you know you absolutely want to lease or sell, target buyers who fit that criteria.
The good news is that your investment banker or adviser will be able to take care of the real-estate transaction right along with the business sale.
Scott Bushkie is principal of Cornerstone Business Services.