When I’m working with a company that intends to sell its business and hasn’t yet entered into a letter of intent (LOI), one of the first things I ask them is, “Do you rent, or do you own?” Why? The answer to that is going to really impact how they negotiate the terms of the sale (and landlords can present another challenge but that’s a different blog). Too often owners don’t understand that they are selling two assets and how they structure the purchase matters, particularly if the potential buyer wants the real estate but doesn’t intend to pay market rent.
Since “Mama doesn’t do real estate” (commercial leases aside), when I’m faced with combo building and business deals, I typically associate a real estate lawyer or a broker in (if one isn’t already in the deal). One of the people I rely on regularly is Susan McCall, Owner of Commercial Property Connect, a Mesa-based broker with 20+ years of experience. I’ve asked Susan to talk with me about some of the most important issues she sees in deals where there is both business and real estate in the mix.
Juliet: Owners often own the real estate they are running their businesses in. What mistakes do you see owners make generally with this arrangement?
Susan: When you own the real estate, you must realize that is a separate asset from your business and should be treated as such. Businesses should have a written lease between the property ownership and the operating business and pay themselves market rent. Make sure you are using appropriate lease terms and structures that are present in the market.
Juliet: What is a Broker’s Opinion of Price (BOP) (sometimes called a Broker’s Opinion of Value) and what role does it play in a transaction?
Susan: A Broker’s Opinion of Price is a report that provides analysis done by a commercial real estate broker to aid in maximizing the real estate asset. The analysis can include some or all of the following areas of importance:
- The appropriate market lease rates, terms, and structure.
- A recommended listing price of the property if the property were to be sold vacant for a new owner’s use.
- Lastly, a BOP can provide a recommended list price to sell the property as an investment property with the tenant in place that assumes a lease has been executed at the current market rates and structure that are included in the report. This basically serves as a road map to maximize the list price of the property.
Juliet: Should the sale of a business and the sale of the real property be handled by the same professionals—why or why not?
Susan: Both your business and real estate are certainly some of the most valuable assets a person acquires in their lifetime. Business brokers know the ins and outs of business sales but often don’t pay as much attention to the real estate piece of the transaction and vice versa. It is very important that you have a professional that is specifically licensed and an expert in the type of asset you are analyzing. Ideally, one should have a business broker represent the business owner in the sale of the business and a commercial real estate broker to advise you and represent you on the real estate piece; whether that’s to lease it to the new business owner or to find a new tenant and then of course to set up that lease correctly so that the impact on the eventual sale as an investment property is maximized. Of course, you should have a strong business attorney as well to advise you overall, draft the contracts, and work with both brokers. It’s important to note that the sale of your business can be very emotional for you, and it is very common to get caught up in the idea of giving the new owner of your business a break on the rent and terms of the lease. This can be a disaster and very difficult to unwind or fix later. You should have someone looking out for you and helping you navigate through how to accept terms that are lower than market, but only for a limited time so as not to dramatically affect your retirement.
Juliet: What is the most frustrating scenario you see as a commercial broker related to the sale of an owner’s commercial property?
Susan: A short-sighted lack of planning. Many times, the real estate seems to be an afterthought to selling the operating business. If a lease is executed with the incoming business owner with poorly planned terms, you may have negatively impacted your asset SIGNIFICANTLY and it is difficult to remedy. There are solutions that can still make a win-win situation for all the parties involved. This is the age old ‘an ounce prevention is worth a pound of cure.’ Usually when we see this happen, it is because there is an emotional investment that the seller can’t see beyond, and they end up making poor decisions. This can fall under the ‘you don’t know what you don’t know,’ where it is unfortunately all too common for a mistake to be made which could have been avoided if there was a commercial broker involved to guide the seller. A seller needs to be able to look further down the road as they are making decisions about how to help their new buyer succeed.
Juliet: If you decide to work with a potential buyer and give them a break on rent, how can you do that without damaging your own interest long term?
Susan: This is the perfect example of finding a resolution that is a win-win for all parties. Having the numbers presented to you in advance that illustrate what the bottom line to you is in each situation will equip you to know what the dollars and cents are. With proper planning, you might have negotiated an introductory period of reduced rent in the term, but the legal document would plan for the escalations to market rate over a set period of time. This provides planning for the owner to perhaps sell the building as an investment at a future date. Again, knowledge and planning are so powerful here.
Takeaways
First, planning does matter. Second, too often I see owners who are way, way far into the deal and are now backed into a corner on a building rental rate that is below market. If you are keeping your real estate, don’t make the mistake of playing too nice in the sandbox up front. You don’t need to tank the deal, but you do need to think about this before the LOI stage. Ideally, you should have a lease with market rent in place at least two years before you sell, so time your best exit. Finally, if you intend to sell both the business and the real estate, make sure the right professionals are in the room and at your side.
