Many business owners we speak with own the building(s) and land where their businesses operate. Sometimes a separate LLC or incorporated business owns the real estate, sometimes it’s owned by the business, and sometimes the proprietor owns it personally. In any event, most businesses pay rent to themselves or to their own real estate holding company.
No matter how the real estate is held, many owners desire to sell the real estate with the business. There’s only one problem. Many buyers that will want to acquire your business will not have the capital to also acquire the real estate. Or they may feel that parking a significant investment in real estate makes a large portion of their investment capital unavailable for growing their new enterprise. The ideal scenario that creates the largest buyer pool is for the seller to offer the real estate for sale or for lease at the option of the buyer.
If the real estate is owned by the business, you should discuss with your attorney the possibility of transferring the real estate to an LLC or other separate entity held by you. In this arrangement, the business operation, no matter who owns it, pays rent to the holding entity. Before going on the market, get the land and buildings appraised. Get appraisals for fair market sale value and fair market rent value. With these figures in mind the entity that owns the real estate can set the rent at fair market value (“FMV”). Note that these rent and sale values are often subject to challenge at bargaining time in the acquisition process, so be fair and get multiple opinions to arrive at the current FMV.
How Rent Affects Value: You have to consider how the rent affects the value of your company. Keep in mind that when you sell your business, the rent you have been paying has been charged against the business, so it was an operating expense and it is already “baked into” the earnings calculation. It is important that you are currently charging a FMV rent to the business that can be validated through a FMV rent analysis.
Under a long-term lease arrangement with the new ownership, they will insist on a FMV rent. If you are charging the business now with higher than FMV rent, the earnings calculation will be adjusted to FMV rent and will reflect as an earnings increase equal to the amount of the adjustment. If you are charging the business below FMV rent, the earnings calculation will be adjusted to FMV rent and will reflect as an earnings decrease equal to the amount of the adjustment to cover the extra amount of rent the buyer would be paying. However, the new ownership may try to hold you to the below FMV rent. To take this issue off the table during negotiations, it is simply best to make sure you are charging FMV rent to the business.
In summary, as much as you would like to sell the entire operation to a new owner, including the buildings and land, many acquirers will want to lease the property. Consideration should be given to offering those buyers a lease option for your property.