Selling a Business: Dealing with the Real Estate
31 March 2025: Selling a Business: Dealing With the Real Estate
Selling a business requires, as this blog has flogged for years, a valuation. But an accurate valuation requires good numbers. In our nearly than 25 years of brokering businesses, one of the situations where we see problems arise FAR too often is a situation where the business owner/seller also owns the real estate that the business operates in.
When such a situation exists, there is no shortage of potential complications but there is one specific issue that we, as business brokers, must be aware of. That is, how is the business paying for its space?
When the business and the business’ real estate share common ownership, the potential for all sorts of mischief exists.
Is the business paying the rent on time? Is the rent going to an entity owned by the business owner? Is it going directly to the owner? Are financial records current and, more important, accurate?
First Things First
The first thing we must determine is who owns what?
Is the business a legal entity such as a corporation or limited liability company (i.e., LLC in the U.S.; GMBH in Germany; SRL in Spain, etc.) or partnership, etc.? Does the business own or lease the space in which it operates? Does the owner of the business own the real estate personally or through a separate entity?
If the business owner also owns the real estate – or even if the real estate is owned by the business – we know we have to counsel our client that he or she has two assets to sell – and that there are multiple ways to approach the sale and the best way will probably depend on the seller’s current financial situation.
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But structuring the sale of a business – or the real estate that business occupies – could be impacted by tax considerations, the seller’s immediate or future plans, the condition of the real estate or the locality’s anticipated growth. But “structuring” the sale is actually Step 3. Knowing who owns what is Step 1.
Clarity of ownership is important from three standpoints:
- Getting to an accurate valuation (Step 2, for anyone who’s wondering)
- Knowing what you’re selling
- Knowing how to market what you’re selling
Because “knowing what you’re selling” is discussed in an earlier post – and because we’ve long counseled clients and the brokers we train that separating the business from the real estate is usually the best way for the seller to reap the highest value for each – this post focuses on situations where the businesses and real estate are owned by separate entities and both entities are owned by the same owner(s); a situation in which the business entity pays rent to the entity that owns the real estate.
The Rent Expense
One of our U.S. clients operates a very successful service business. Her business is located in a building owned by a limited liability company – let’s call it Freedom, LLC – that is owned by her and her husband. Her business pays rent to Freedom LLC.
One strategy used by the owners of successful businesses to reduce the tax liability of their successful business is to draft and execute a lease between their business and themself – or preferably their real estate company – at a rate that is marginally higher – sometimes significantly higher – than the market rate.
For example, our client’s business is paying rent of $18.50/ft in a market where comparable space is available for $15.00/ft. (Our advice to clients is ALWAYS, “don’t be greedy”.) What this does for the company is that it reduces the net income on which its tax liability is determined. What it does for Freedom, LLC is increases the rental income – essentially allowing the owner of the business to pull money out of the business, nearly tax free.
How is that?
Tax treatment of real estate income in the U.S., as in many other jurisdictions, favors real estate investment. In the U.S., depreciation, property taxes, maintenance, etc., are all expensed. The depreciation itself shelters a significant amount of the income – income that the owners of Freedom, LLC, can reinvest. Maintenance, insurance and other expenses associated with the real estate can, in a properly drafted lease, all be the responsibility of the tenant; the business.
But from a business broker’s standpoint, when recasting the earnings of a business with this type of related-party interest, we have to be aware of not only how the ownership is structured but also whether the rent paid by the business accurately reflects the market rate.
In this case we advised that the business owner that she should, at least one year prior to the date she plans to sell her business, execute a new lease with Freedom, LLC, this time at market rate. This will reduce her rent expense, thereby increasing discretionary income – in turn, increasing the value of her company. Granted, this will reduce the revenue to Freedom, LLC, but our objective is to get the highest value for the business.
We also advised her to consider selling only the business; retaining the real estate.
There are several benefits of this strategy:
- There are FAR more buyers for a business than there are for a business and its real estate. Many business owners prefer to husband their financial resources for their business. They also don’t want to deal with the headaches that ownership of real estate can entail.
- After selling their business, the real estate will continue to provide a monthly revenue stream for many years to come.
- “Time” favors real estate. Over the continued ownership, the real estate will appreciate in value all the while the tenant is essentially paying off the real estate debt.
The Flip Side
But this situation works in two ways.
Another client of ours owned a retail business that was only marginally successful. Our client also owned the real estate the business operated in. Being aware of how such ownership structures can provide many incentives to manipulate rents, when we did our valuation, we looked closely at this relationship and discovered that the business was paying rent at a discount to market of about 40%! This was, it turned out, the only reason the business was even “marginally” successful.
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REALTORS! Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
Don’t Miss Out on the “Silver Tsunami”!
Our business valuation report had to include considering what the business’ financial condition would be if it was paying market rent. We had to explain to the owner that the only way to get the value suggested by the current discretionary earnings is to sell the business at the current rent – a below-market lease rate. Doing so, of course, results in the real estate being valued significantly lower than it would otherwise be.
The Bottom Line
There is tax “evasion” and tax “avoidance” – and I’m not suggesting that business owners are or should be doing anything that can get them in hot water with the taxing authorities. But my many years of business experience has led me to believe that most business owners feel a strong sense of ownership of the money they make – and a completely justified belief that they are much better equipped than some bureaucrat in Washington, Paris, Madrid, London or anywhere else – to figure out how to best use that money
Business brokers have to be aware of all sorts of financial machinations in order to arrive at a defensible business valuation. It’s our job to make sure the numbers are correct – and to explain to our clients what impact certain decisions have on value.
“In business, there’s such a thing as an invaluable person, but no such thing as an indispensable one.”
– Malcolm Forbes
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at
jo*@Wo*******************.com