[caption id="attachment_15728" align="alignleft" width="88" caption="Al Statz"][/caption]
"The most important single central fact about a free market is that no exchange takes place unless both parties benefit." --Milton Friedman
My last article discussed how facility leases can affect the value and marketability of your business when you are ready to exit. Well, what if you own your real estate? Your exit plan must address that asset as well. For this article I looked back at the businesses our brokerage firm sold where the seller also owned the real estate occupied by the business to see what conclusions I could draw for you.
The dispositions of our business seller clients’ real estate fell into five basic categories (ranked from most to least common):
Leased the real estate to the business buyer and held the property for income.
Sold the real estate to the business buyer in a concurrent transaction.
Leased the real estate to the business buyer, with an option to purchase.
Sold the real estate to a separate/unrelated buyer soon after the business was sold (no lease).
Leased the real estate to the business buyer and sold the real estate separately as a leased investment property.
Think of these as five of the options available when you are ready to exit your business.
Option 1, lease the real estate to the new business owner. This is a popular choice with retiring business owners who want a source of post-sale retirement income (and will soon have more time available to manage investments). They are comfortable leasing and managing a property that they know intimately from years of experience as its owner and occupant. They are confident in the future prospects of the business in that facility. Of course they also believe that real estate is an attractive long-term investment.
Option 2, sell the real estate to the business buyer in a concurrent transaction. This scenario is usually preferred by a seller and a buyer when the property has specialized improvements (e.g. nursing home, theater, marina, car wash, self-storage) or when the risk of relocating the business is extremely high (e.g. preschool, most retail businesses). On this latter point, remember that astute buyers won’t pay as much if there is a high risk of relocation. Sellers also prefer this popular option when they would rather reinvest in something with higher returns, lower risk or less management.
Option 3, lease with a purchase option. In our experience this occurs when a buyer is cash strapped and can’t purchase the business and real property concurrently or for some reason can’t obtain bank financing. If a seller’s plan is to reinvest his real estate proceeds, financing a sale isn’t an option, so the next best alternative for both parties is often a lease with an option to purchase. The seller can enjoy a few years rental income while the buyer builds cash reserves or stabilizes business performance to the point where banks are willing to lend.
Option 4, sell the real estate, unoccupied, to a separate/unrelated buyer after the business sells. This occurs most often when a buyer transfers the acquired business to an existing facility and consolidates operations under one roof, e.g. distressed business sales and strategic acquisitions. Another factor behind this outcome is when a property’s highest and best use is no longer that of the existing business enterprise. Or sometimes the business has grown or declined, and the business and property sizes are no longer ideally matched.
We recently sold a manufacturing business to a company that rented the facility for a few months before relocating it out of state. As soon as the business sold, the seller’s building, which was readily adaptable to other uses, was listed and sold by a commercial real estate firm.
Option 5, lease to the business buyer and sell separately as a leased investment property. We’ve only seen this happen when a buyer simply doesn’t want to own real estate assets. Based on what’s happened in the commercial real estate market in the past few years, these buyers may be geniuses.
If maximizing value is your overriding objective, the first question is whether the business and real estate are more valuable and marketable as a package or separately? As a business broker I can tell you that businesses with real estate are, on average, more valuable and marketable, however every situation must be evaluated on its own merits.
If you decide to sell (versus hold) your real estate, you also get to decide whether to pay taxes on the gain or avoid taxes by purchasing a similar or like-kind investment property (a 1031 exchange). When selling commercial property, many different types of properties are considered like-kind for purposes of a 1031 exchange. Exchanges of personal property (e.g. fixtures, equipment, vehicles and intellectual property) can also be exchanged but are subject to more restrictive rules and are rare in my experience.
One of our clients had a difficult-to-sell distribution business. It was in a highly competitive, volatile industry and was marginally profitable. The seller wanted to keep the real property as an income-producing asset by leasing it to the new business owner.
Our eventual buyer insisted on also purchasing the real estate. We negotiated a package sale and immediately connected our client with a commercial real estate broker who specialized in 1031 replacement properties. Our seller exchanged into a professionally managed multi-tenant retail commercial property with national tenants, with the added benefit of diversifying his real estate holdings outside of California.
I’ll end with two key lessons from our firm’s transaction history involving business and real estate assets. First, plan early for best results and involve the appropriate professionals. There are many more considerations than we touched on here. Second, stay flexible and be prepared to get creative. The deal you envision may not be the best deal the market has to offer.
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Al Statz is president of Exit Strategies Group Inc., a business brokerage, mergers, acquisitions and valuation firm serving closely held businesses in Northern California. He can be reached confidentially at 707-778-2040 or alstatz@exitstrategiesgroup.com.
