For most companies, the decision of how to handle ownership of their real estate took place long ago. However, if a company’s goal is to structure the best possible potential sale of both a store and the land it sits upon, it is relatively easy change the real estate ownership structure to enhance, rather than detract from, a potential sale.
Caution: There are extenuating circumstances to optimal real estate ownership that should be verified with each company’s tax and legal counsel. That being said, we believe the ideal real estate structure in the face of a pending sale is to have a company’s real estate owned by a separate and distinct entity that is under the control of the same individuals who own the company itself. This way, the selling owners avoid the delays of getting third-party approval to transfer existing leases to the buyer of the company.
Limit Landlord Approval Rights
If you must lease real estate from a third party, try to whittle down or eliminate the landlord’s right of approval of lease transfer. Many landlords will resist this. One compromise is a notice period that requires the landlord to object based on the financial soundness of the buyer; otherwise, the approval is automatic. Even if a lease says that consent “cannot unreasonably be withheld,” you don’t want to learn your landlord’s definition of reasonable as a result of his delaying the sale of your company.
The next question is: How much rent the company should pay to the separate entity that owns the real estate? If the real estate ownership group is different in any way from the owners of the company, a market lease rate typically prevails. However, we recommend pegging the lease rate to the current market every year or two, regardless of the composition of the real estate ownership group. In this way, the financial results always reflect the company’s performance under a scenario of market-based third party ownership of the real estate. It’s always possible to show adjustments for market rent in a deal book, but then readers of the audit report will have to bear in mind those same adjustments.
Advantages of Market-Rate Rents
With a market rate of rent baked into the numbers, a buyer can assess whether he or she wants to step into the leases on the real estate or else buy the real estate to avoid that expense. It goes without saying that, regardless of who owns the real estate, a phase 1 environmental assessment should be completed on all properties (leased or owned), and the buildings should be maintained in top condition.
The final key decision point regarding real estate concerns whether and how the real estate should be offered as part of the sale of the business. When presenting a company to buyers, a seller is seeking the highest debt-free, cash-free enterprise valuation of the business. To accomplish this, it must be made clear to buyers that the company is being sold separately from the real estate.
The seller should then state his or her preference for the resulting ownership of the real estate. Options include the selling business owner continuing to own the real estate. Some business owners enjoy owning real estate and are focused on the healthy stream of retirement income that can be provided by maintaining ownership of the real estate. Some like maintaining a connection with the company they built. Others view landlord status as a source of leverage if there are any contingent payments that are due to them from the buyer over time.
The Downside of Long-Term Leases
On the other hand, other sellers remember cases in the past when a buyer of a business has fallen on hard times and used bankruptcy laws to break all of their leases. Real estate ownership quickly loses its appeal when that means presiding over a possibly far flung–and unoccupied–portfolio of property. Sellers of companies that fall into this second category will prefer to sell the real estate to the buyer of the company or to a third party institutional real estate sale-leaseback investor.
Thus, the ideal situation for sellers to maximize their proceeds and minimize frictions in a sale is to hold their real estate in an entity they control and to which they pay market rent. Beyond that, when a selling owner is flexible as to the final ownership of the real estate, it is nearly certain that the company’s real estate will not serve as an impediment to a successful sale.