What do you do if real estate is involved in the business sale?
This is a question we get all the time. You meet with the sellers; you find out that either the business owns the real estate or that the sellers own the business and the real estate in the same name and they want to sell both. What if they want to sell only the business? How do you handle a situation like this?
If you’re a business broker or M&A intermediary, there are several types of real estate situations that you’ll encounter as you list and sell businesses. One is where the business is located in a building owned by the owner of the business but held in a different name or entity. Another is where the business itself owns the real estate. A third is where the owner owns both and holds them in his name or in the name of one entity. A fourth is where a business leases its space from an unrelated third party. (If the business leases its space in an “arms length” transaction, it is likely that the only real estate issue will be negotiating a transfer of the lease to the buyers of the business and negotiating an extension of that lease to suit the needs of the new owners.) The best situation is the first; when the owner owns both the business and the real estate but holds each in its own entity.
The reason this is the “best” scenario is because it gives the owner the most and cleanest options. In this situation, the owners can sell both assets to one buyer, both assets but each to a different buyer or either asset and keep the remaining.
The owners can sell the business and rent the real estate to the business’ buyer, thus enjoying years of income. They can sell the real estate – freeing up substantial cash – and keep the business, leasing the real estate from the new owner. They can sell both to one buyer or to different buyers.
The foundation of a situation providing the “…most and cleanest options” is a lease between the business and the real estate entity. Such a lease does not have to exist prior to the sale of the business but the business owners must either have a lease in place when they decide to sell or be prepared to offer one to the business buyer. Many businesses prefer to lease so as not to tie up substantial cash in real estate. However, for this discussion, I want to stipulate that the business owners chose to be real estate investors as well as business owners, a strategy that usually allows the owners to get substantial tax-favored cash out of a profitable business.
For the sellers to have as many options as possible, they would hold the real estate in one entity – ABC, LLC – and lease that real estate to the business which is held in another entity – XYZ, Inc. When it comes time to sell, the owners have three choices: 1) sell the business only; 2) sell the real estate only, and; 3) sell the business and the real estate at once. Here’s how each scenario looks.
Choice 1: Sell the business and keep the real estate. This will allow the owners to “cash out” of the business, perhaps receiving all cash or taking a combination of cash and financing. Regardless of the terms of the purchase, the owners/sellers, having gotten good advice from their business intermediary and planned in advance, will enjoy continued rental income and a good intermediary will structure the deal with an eye to that long-term revenue. The keys to maximizing the results to the seller are several fold (and, for purposes of keeping you faithful readers from nodding off, must be discussed in a future post) but a lease with the longest possible term, plus options, must be put in place and the rental rate and structure must be such to allow the new owner to prosper.
Choice 2: Sell the real estate and keep the business. This option will allow the owners to free up cash that has been locked up in the real estate. This cash can be used to grow the business or simply for long term financial planning.
Choice 3: Sell both the real estate and the business at once. The problem with this strategy is that there are FAR more buyers for each of the individual assets than there are for both of the assets together. I.e., there are FAR more real estate investors than there are business buyers. Likewise, there are far more business buyers that have the capital to 
buy the business than there are that have the capital – and are willing to tie it up – to buy both the business and the real estate.
If the sellers want to liquidate both assets – the business and the real estate – simultaneously or nearly simultaneously, the best way to find the largest pool of buyers is to market them together while also marketing the business by itself. The key to success is to structure a lease in a way that results in the maximum value for each.
Rental Rates Impact the Value of Both.
To revisit our example above, XYZ, Inc shows a handsome profit every year on which the owners have to pay taxes. If they, as owners of ABC LLC, decide to raise the rent that XYZ pays, they are able to get more tax-favored money out of the business and into their pockets. (The rent needs to be “reasonable” when compared to the market or your friendly tax authorities will pay extra special attention.) The higher the rent, the less valuable to business – it will result in lower discretionary earnings – but the more valuable the real estate due to the handsome rental revenue. The lower the rent, the more valuable the business – higher discretionary earnings – but the less valuable the real estate. Getting to the sweet spot will take a bit of calculating but it can be found. (If the sellers plan to hold onto the real estate for a few years, a properly-structured lease will benefit them on both ends of the timeline by making the business more valuable up front and the real estate more valuable down the road. As always, the sellers are advised to consult their tax advisors to see how the lease structure and structure of the business purchase will impact their tax liabilities.)
Here’s How We Handle It
The key to maximizing value lies in planning. With time and the proper structuring of both a lease and a business sale, the sellers can reap the highest return. It is the job of the professional business broker/intermediary, in conjunction with the sellers’ tax counsel, to suggest strategies to maximize that return.
One of the brokers in our system has recently run into a situation where the sellers own both the business and the real estate but did not plan for the sale of either and, as I type, are agonizing over how to handle the quandary they’re in. I’ve used their plight as a case study which you can download here.
The key, again, is planning. If you are a business owner and the business owns the real estate, when it comes time to sell – and it will – you are likely to enjoy a greater return on both assets if they can be sold separately and you will also be likely to bring the transactions to a happy conclusion sooner. If you’d like to learn the gory details of our true case study, let me know above.
Joe