Smith Holland M&A Resources  

How to deal with real estate when selling your business.

A great way to create an additional revenue stream for your business is to construct a new manufacturing facility or commercial building and lease space to other companies. This is especially true when business owners understand how expensive rent becomes and what a great investment real estate can be for their company. Even if business owners simply purchase real estate for their owner company, there are complications that arise once they consider selling the business. Should the company and real estate be sold together? Is it more profitable to keep the real estate and sell only the business? What are the tax implications between different sale options? These are just some of the basic questions that should be considered when selling your business.

 

Real Estate

Once the decision has been made to sell a business, the first step is to value the real estate separate from the company and determine it’s worth. This can be more complicated if the company owns the property but much easier if the real estate is owned by a separate entity. Meaning, if the real estate revenues and expenses are already separated and not included in the business financials, then property valuation will be fairly straightforward.

 

Unfortunately, if the company owns the real estate, then more often than not, revenues and expenses are intertwined. In order to determine the true value of the property, these revenues and expenses need to be separated to establish the actual market price. The best option would be to hire a professional real estate appraiser or a sell-side mergers and acquisitions (M&A) advisor that will help clarify fair market valuation for the property. Otherwise, issues will arise when a buyer and seller present different market valuations for the real estate being sold.

 

Include Real Estate or Sell Separate

After a professional has determined fair market value for the company’s real estate, the decision remains, to sell separate or include with the sale of the business. While each M&A deal is unique and there is no wrong answer, there are obviously advantages and drawbacks when deciding to including real estate or sell separate.

 

Some advantages to including real estate with the sale of a business is the ability to walk away and cash out, instant liquidity. Also, if real estate is included with the sale the buyer basically purchases the complete package without any overnight changes from a new location or new building which could result in decrease sales revenues. When a company is sold, it is usually best to preserve location and maintain operations until it is fully understood how variable changes might benefit or diminish revenues. This is especially important if the M&A deal has an earnout clause.

 

In addition, when real estate is sold with the company, another advantage is the fact that the seller no longer has to be a landlord. Maintaining property, leasing agreements, pricing, terms and conditions are all factors that can complicate an M&A transaction. These factors can be further compounded with the uncertainty if the buyer of the company intends to relocate or sell the business in the near future, leaving the original seller with an unoccupied building. Including real estate with the sale of the business allows the seller to avoid these issues that can make a deal more complex.

 

Alternatively, there are drawbacks if real estate is included with the sale of a business. The most common issue involves the buyer and their decision to purchase real estate. With property included, company valuations will be much higher and some buyers would prefer to take on less risk in a transaction, leasing the property rather than owning. Unfortunately, sellers might drive away a potential buyer that would have provided the best valuation for their company but decided not to purchase because real estate was involved.

 

Other drawbacks of including real estate with the transaction are taxes and loss of rental income. Sellers often elect to retain real estate to avoid the huge tax bill assessed when selling a property. Also, the seller would receive rental income in the short term and defers those capital gain taxes. While there may be more hassle involved with leasing agreements, if a seller includes real estate with the sale, they are giving up any equity or appreciation the property might acquire in the future. Of course, this assumes that all real estate property will go up in the future, which is never guaranteed.

 

Leasing Agreement

If the decision is made to retain real estate and not include property with the sale of the company, it is vital to have a professionally written leasing agreement. As stated earlier, more often than not, businesses and real estate revenues and expense are intertwined and can be difficult to separate. It is crucial to ensure any maintenance or repairs associated with the property are understood and taken into consideration. As the property owner, the buyer needs to know upfront what the fair market rental rate, terms, conditions and modifications to the property can be made so both parties are on the same page.

 

In any case, it is beneficial to note that an experienced M&A advisor can determine if a company is paying over fair market rental rate. By taking advantage of any difference in rent payment vs market rental rate, an expert can use that addback in a multiple to increase valuation for a seller. When deciding on how much to addback, there are many factors to consider and should be assessed by a professional M&A firm who understands the market.

 

Conclusion

There are many variables to consider when selling a company and real estate is one of the most critical. While each M&A deal is unique and there is no straightforward answer, there are obviously positives and negatives when deciding whether to including property with the sale of a business. Early discussions with a sell-side M&A advisor can determine which decision is best for each individual company. After real estate has been appraised, a dedicated M&A advisor can guide sellers through all options and help decide the most profitable way to present a company to the market for sale. It is important to discuss all real estate strategies with a professional since the structure of a business valuation can be the difference between a deal or no deal.

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