Considering selling your business? If so, here’s an essential reminder: sometimes investors are interested in acquiring your business operations only. These buyers will likely want to deploy additional funds into related business investments, not commercial real estate. If this scenario sounds familiar, a sale-leaseback (SLB) can offer a variety of benefits to you as the seller, such as making your business more attractive to potential buyers and increasing your total proceeds from the sale.
In an SLB transaction, an asset’s owner will sell the asset to a counterparty and then lease back the asset from that counterparty. In real estate, for example, a property owner would sell the property to an investor-landlord and then continue to occupy the property as a lessee.
Here are four reasons this type of financial transaction could be your best bet for maximizing both profit and satisfaction when selling your business.
When it comes to commercial real estate, your property is valued differently from your business operations. If you sell your business, the overall value will change depending on whether your real estate is sold separately or as part of the business. Lumping your commercial real estate into the sale of your business, however, may mean you are leaving money on the table.
Commercial real estate is valued through capitalization rates—net income from the property, divided by market value—whereas a business is typically valued based on a multiple of EBITDA. A capitalization rate can be compared to an EBITDA multiple by taking the inverse (1/capitalization rate). For example, say your business has a valuation based on 5x EBITDA. If your real estate capitalization rate is 20%, the cash flow of your business would be valued the same as the projected cash flow of your real estate (1/20 = 5x multiple). A capitalization rate lower than 20% would mean your real estate may be more valuable if you sell the property separately from your business (for example, 1/15 = 6.6x multiple).
As a business owner, you need to understand the different ways your particular real estate and business cash flows are valued. In a potential sale of your business, you may be able to add value on your real estate by separating the cash flows of your real estate from the cash flows of your business.
A business owner looking to sell the company typically needs to repay third-party debt with the proceeds of the sale, then keeps the remaining cash. Entering an SLB will help decrease your total debt or increase your cash, so you’ll receive higher net proceeds after the sale.
A simultaneous business sale and sale-leaseback is generally the most advantageous for the seller; you can negotiate the new long-term lease with both the business buyer and the real estate buyer as a part of the business transaction. Real estate buyers often perceive a higher value for your property based on the length of the cash flows the real estate is expected to yield—the longer the lease agreement, the higher your real estate value should be. Because a new lease is negotiated during the business transaction, and the lease term likely will never be longer than when the lease is originally signed, this is usually the optimal time for completing a real estate leaseback.
In some cases, such as when you’re facing less-than-favorable market conditions or hoping for additional rental income from the real estate (with the option to sell to a third party down the road), you may want to delay the SLB until after the sale of the business. Remember, however, that selling your real estate after your business has been sold will make for a shorter lease term—which means an investor will enjoy a shorter period of guaranteed cash flow from the lessee and may deem your real estate less valuable. Furthermore, the shorter lease term may present a potential buyer with more trouble in securing long-term financing for the real estate transaction. A financer wants to see long-term cash flows and financial information on the lessee—in other words, a level of certainty that the lessee will abide by the lease agreement and pay rent. The length of the lease and the information available about the lessee are normally at their most favorable during the sale of your business.
On another note, sale-leasebacks may provide cheaper and more flexible financing for distressed businesses that may or may not be actively looking to sell. Your company may need cash to pay off debtors, maintain operations, or make investments that achieve greater returns. Whatever your cash-related need, conventional financing can be costly. An SLB presents an alternative financing option without stringent covenants, excessive interest payments, or business ownership dilution.
An SLB also provides certainty to both parties that their investment circumstances will not change post-acquisition. During a business transaction, buyers want the certainty that business operations will remain stable; by entering an SLB, buyers can lock in to a long-term lease that mitigates concerns about operations needing to be moved in the future to another facility with additional costs. From your perspective as the seller, an SLB alleviates the perceived risk of owning real estate but having no control over the tenant. It offers the opportunity to diversify your investments without worrying whether the new owners will continue the lease.
Sale-leasebacks may have tax benefits for your business and potential new owners if your rent payments will exceed the amount of interest and depreciation resulting from current mortgage financing. It is common for a business’s rental deduction to exceed depreciation deductions if
In fact, SLBs can raise a variety of tax considerations. Speak with an expert for more information on the tax effects of your sale-leaseback transaction.
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Sale-leasebacks can deliver flexibility in a sale as well as an excellent opportunity to increase your proceeds, all while reducing risk and leverage. As a business owner, you’d be wise to evaluate your circumstances with an SLB option in mind—but be sure not to enter a sale-leaseback transaction without consulting experts throughout the process.