Did you know that one misguided real estate decision could jeopardize the successful sale of your business? Surprisingly, this is true regardless of whether you rent or own your space.
Most business owners are unaware of potential consequences—until they try to sell and find that their company is now undervalued because they failed to think about real estate strategically.
This happens far too often, which is why we decided to write a two-part series. To do this, we mined the knowledge of some of Verity’s top real estate advisors to share more about the different ways real estate can affect the sale of businesses.
While Verity’s advisors have diverse experience and knowledge in commercial real estate, we’re not in the business of selling businesses. However, it is our job to help clients think about real estate as a strategic advantage, so we wanted to share some factors every business owner should be thinking about, even years before you sell your company.
In part one of our series, Verity’s advisors shared ways they guide clients to think about how real estate affects a valuation. Here are some important questions to ask as you make decisions:
1. What are some real estate considerations that often get overlooked by business owners when it comes time to sell their business?
Whether you own or lease space or sell or move, consider your long-term goals and objectives, as well as your desired return on the sale or purchase. Also, before entering into any real estate venture be sure you have the structure of the business solidified. Limited liability companies (LLC), incorporated (INC), sole proprietorships, and partnerships will affect the terms and conditions in the agreement differently.
Also review your current real estate agreement. Common terms and conditions that could help or prevent you from accomplishing your goals are lease expiration, contingencies, and renewal options.
- Personal Guarantee – The most overlooked and misunderstood impediment to the sale of your business is a personal guarantee in the lease. Landlords want to ensure that they will be paid regardless of your business’ success—so, they ask business owners to personally back and guarantee rent payment. This means that if you personally guarantee a lease, you’re still personally liable for rent even if you sell your business. Prior to selling your business, renegotiate your lease to ensure you are released from your personal liability. If the landlord won’t fully release it, try to renegotiate your liability down to a smaller amount or reduce the length of time you’re obligated to pay it.
- Expiration – Short- and long-term lease agreements can work for—or against—you, depending on your business and its goals and strategies. Generally, short-term leases work well for startups and long-term leases work well for businesses that are buying the location and its clientele. If you’re a doctor, patients affect the value of your business. You most likely want to sell the real estate along with your business. Keeping the original location ensures you will retain the clientele.
- Contingencies – Contingencies could restrict your ability to move or sell your business at your convenience, so it’s important to understand the different types.
- A mortgage contingency means the purchaser will only buy if they get a certain loan approved.
- An inspection contingency makes a sale dependent on the space or building condition getting up to code.
- Other sale contingency is used when the purchaser won’t buy until they sell a different piece of property.
- A contingent liability is a potential liability that is dependent upon the outcome of certain future events. Examples of contingent liabilities are warranties, lawsuits, guarantees on debts, and liquidated damages. This potential liability can influence the investor’s decision to buy your company or creditors considering lending capital since encountering it could negatively impact assets and cash flow.
- Renewal – Be aware of any renewal options agreed to in the original agreement. Generally, tenants want renewal rates fairly negotiated and renewals not denied for minor lease violations. Likewise, a landlord wants to ensure fair market price for rent and to release a bad tenant.
Yes, absolutely. Knowing the lease expiration and terms is critical to the successful business sale. Timing is everything and your lease expiration date could cause delays and complications.
Often, we see business owners who want to hold off on selling their business until the lease has expired. What they don’t realize is doing that could kill the deal, especially if the location and an established customer base play an important part in the value of your business. After all, there is no guarantee that the new tenant and owner will agree on rate and terms, which would mean moving to a potentially less profitable location. Some potential solutions include completing the real estate deal prior to the sale of the business or building a contingency into the real estate terms for the potential buyer. Also, don’t forget to look at the current agreement; there may be an option to sublease to a potential buyer until the current lease expires.
3. Should owners buy the real estate and business together or separately?
Deciding whether or not to sell your real estate with your business depends on how it will affect the value of your business and your goals.
Most business owners don’t wrap the sale of the business and real estate together because it’s not always an attractive option for either the buyer or owner. For example, if there are three years left on the current lease agreement, the new tenant may have to accept the three-year liability under terms the original owner negotiated. Plus, it can be inconvenient, costly, and time-consuming for the owner who has to manage the property and find new tenants every time the lease is up.
If you’re a buyer, first decide if you really want to buy the space with the business. Does it truly suit your goals and business culture? For example, if you’re buying the space for scalability, it might not be a good fit because your capacity to change under the current terms will likely be limited. However, if you’re in the retail or medical industry, you may want the space since the business’ value and profit is tied closely to location and customers.
If you’re a business owner who is selling, you also have a few things to consider. Some business owners see their real estate as an investment and prefer to sell only their business, holding on to the real estate so they can lease it back to the new owners/buyer. While office condo and building deals can be done this way, be aware that, in most cases, the tenant walks away at the end of the lease term leaving the owner with empty space to fill with a new tenant. If you choose to hold on to the real estate as an investment, ensure it is well maintained and marketable to other businesses to make it easier to find new tenants quickly.
Both commercial real estate and selling your business in a complex process. The best way to approach the sale of your business is to consult a CPA or valuation firm and find a commercial real estate advisor that approaches real estate from a strategic advantage rather than transactional. The most successful outcomes occur when two experienced experts work together for you.
Verity can help you align your real estate strategy with the sale of your business. Fill it out The Strategic Real Estate Diagnostic worksheet to assess how you’re managing your real estate. Send it to us and we’ll give you a free assessment with recommendations.
For more - Read Part 2