Sell the Business, Keep the Building?
How to Think About Your Owned Real Estate When You Sell Your Business
Unless you run a hedge fund, there are few instances when a regular person can exploit an arbitrage opportunity. Arbitrage is known as the practice of making additional profit without putting any extra money at risk. In the world of mergers and acquisitions, we can sometimes accomplish this by segmenting available cash flows.
If you own real estate as part of owning your business, you may have some choices to make when considering an acquisition. Let’s walk through the math of the different paths and where you might generate some extra return.
In most cases it is possible to separate the sale of the business from the sale of the real estate, although this can be problematic if your real estate is specialized or “is the business.” Think of a foundry where the building is integral to the manufacturing process. There are a couple of things to know if you decide to go down this path.
If you are going to separate the real estate from the operating company, you need to add market rent into your expenses and your current and future financial profile.
As an example: You own your building and your business, and as a result, have not included rent in your financial statements. This business made $4.0 million of EBITDA.
Now that you are keeping the building, you need to include rent in your financial statements. This will be $500,000 per year, meaning that the business will now make $3.5 million per year.
Assuming your business cash flows are worth a 7x multiple, this means that if you sell the business and the building together (no rent scenario), you will receive $28.0 million. If you keep the building and have rent, you will receive $24.5 million.
What if I Want to Keep the Building?
You can keep it and be the landlord for the buyer. After all, this is a business (now tenant) that you know and are presumably confident in. Alternatively, you could take the cash flows from the building lease and sell them in a sale-leaseback.
What is a Sale-Leaseback?
Here’s where the chance to go to arbitrage comes in. Oftentimes, cash flows from good tenants in real estate are worth more than operating business cash flows. Let’s say you get 12x on the lease payments from a sale-leaseback firm. That means that your $500,000 rent is worth $6.0 million.
If we combine the $6.0 million for the rental cash flows and the $24.5 million from the operating business cash flows, you get $30.5 million, which is more than if you had sold both assets together.
What Are Some Concerns Business Owners Have When Considering a Separate Sale of the Building?
- No Buyer Would Want to Lose Control of This Important Asset
You would be surprised how many buyers are not interested in owning real estate. In fact, if you don’t do the sale-leaseback of the building prior to the business sale, the buyer just might make the extra return.
In reality, there are ways to give a buyer comfort that they will have effective control over the property.
Most sale-leasebacks are absolute net leases, under which the owner-operator sells the property but continues operating as if nothing has happened. Sale-leaseback buyers are passive in nature — simply looking to collect a rent check — and do not have any reason or desire to interfere in the business operations.
Many sale-leasebacks are negotiated with a long base term that is typically 15 to 20 years. On top of this, you can add renewal opportunities to increase the term further. This takes lease renewal risk off the table, giving the buyer long term access to the facility.
If you decide to be the landlord going forward, you can choose to be flexible with a buyer around lease terms and rental rates.
2. How Can This Mess Up the Sale of My Operating Business?
In the lease document you may find language that allows a landlord to block the business sale. Landlords will worry that with a sale of the business, they may be inheriting a new tenant with fewer financial resources or lower creditworthiness. They also worry that a buyer may load the operating business up with debt, making it more likely to default on its future rent payments. As a result, most landlords will ask for a right to “consent” to a sale of the business.
There are ways to work around this consent request by allowing for a transfer or sale of the business, so long as the creditworthiness is not substantially diminished. In these cases, there will be language in the document that focuses on profitability and leverage ratios.
When you think about selling your business, don’t automatically think you need to include the real estate. You have the ability to price those assets separately, and many times can make an additional return by doing so. Make sure you are protected on the lease side so that the sale of your business is still available to you by addressing the lease terms and the landlord consent provisions. With some simple financial modeling, you can generate extra proceeds from your current assets.