Often, business owners frame their own future in stark, binary terms — either I keep the business or I sell it. This binary thinking becomes most pronounced as business owners begin to contemplate retirement or an ownership transition. In reality, there are a variety of options that can span those two outcomes. For many business owners contemplating a retirement or transition event in the next five years, simply keeping or selling are suboptimal outcomes — either tying up critical value that could otherwise be used to diversify or foregoing the potential upside value in their business. In addition, these binary outcomes often overlook other important value drivers for business owners such as legacy, succession, well-being of current employees and the continuity of their current business. When evaluating which options to pursue, it is critical for business owners to first establish clear goals that define what they want to accomplish and when. This includes an honest assessment of their personal and professional desires and other value drivers (including those mentioned above). While these options each present unique opportunities and risks, they offer business owners a more tailored and optimized approach to achieving their future liquidity, retirement or transition objectives. Mezzanine debt recapitalization A mezzanine recapitalization will often allow business owners to seek partial liquidity or growth capital, without significantly diluting their ownership. Business owners can use the proceeds to diversify their holdings, while retaining equity control and the potential upside of the business. However, this option will add incremental, high coupon leverage to the business and could limit operational flexibility in periods of economic or business distress. ESOP — employee stock ownership plan ESOPs allow business owners a tax efficient roadmap toward partial or full liquidity while creating a mechanism for transferring ownership to employees. This allows business owners to maintain short-to-medium-term ownership and helps to preserve business consistency and legacy. It also rewards employees for their hard work and loyalty. However, once the ESOP has been established, it can significantly restrict ownership flexibility. MBO — management buyout MBOs allow business owners to achieve either partial or full liquidity while maintaining operational consistency throughout the organization. The MBO also rewards management’s loyalty and performance with the opportunity to acquire a significant stake in the business. However, MBOs often require management to partner with outside equity or debt providers — which can be time consuming and introduces new partners and influences on the business. Minority investment Minority investments from an outside investor (either institutional or individual) will allow business owners to seek partial liquidity, or growth capital, while maintaining a majority stake in the business going forward. The minority partner can bring valuable outside perspectives and skill sets to supplement your own. However, most minority investors tend to be only passively involved and often require onerous ratcheting provisions that could give them control if the business fails to meet operational objectives. Partnership transaction A partnership transaction will allow business owners to seek significant immediate liquidity while preserving some ownership and elements of control in the business going forward. Business owners can use the proceeds to diversify their assets, while maintaining potential upside in the business. The new partner can bring many valuable strategic and financial resources to bear to strengthen the business and pursue growth and value enhancement initiatives. However, new partners will seek elements of control and often utilize leverage to affect the partnership. Understanding the many options available to business owners will help lead to more tailored and optimal achievement of personal liquidity, retirement and transition objectives. Josh Harmsen is a principal at Solis Capital Partners (www.soliscapital.com), a private equity firm in Newport Beach, Calif. Solis focuses on disciplined investment in lower middle-market companies. Harmsen was previously with Morgan Stanley & Co. and holds an MBA from Harvard Business School.
Businesses are successful in part by remaining keenly focused on a core product or service offering. This focus includes allocating management time and cash to support and grow the business. Often companies that own their real estate are able to redeploy these resources for additional growth by executing a sale/leaseback strategy.
“Many companies that own real estate are able to generate substantial proceeds through a sale/leaseback,” says Ben Smith, vice president of Plante Moran CRESA.
In addition to monetizing an owned real estate asset to provide cash flow to reinvest in your core business, sale/leasebacks can allow you to devote more time to your business.
“Being a tenant in your building instead of an owner may shift the responsibility of property management to another party,” he says.
Smart Business spoke with Smith and Josh Lanesky, senior associate at Plante Moran CRESA, about who can benefit from sale/leasebacks and how to approach them.
What is a sale leaseback?
A sale leaseback occurs when a business sells a building that it owns and occupies to an outside investor and subsequently enters into a long-term lease agreement with that investor as part of the transaction.
Once any pre-existing debt on the building is retired, the company is able to utilize the sale proceeds to reinvest in its core business or to meet other financial obligations. While this results in an ongoing lease obligation, the return on investment on redeployed capital can often outweigh this cost.
What are the drawbacks?
Because of the dramatic reduction in real estate values that has occurred since 2008, the existing debt on a building may exceed its market value, even with a lease in place. If this is the case, it is not advisable to perform a sale/leaseback transaction until that debt obligation is reduced. There are also instances, particularly in family-owned businesses, whereby the corporate real estate portfolio is held in a separate entity also controlled by the family. Often, this is considered a separate profit center and is used as an estate planning tool.
What kinds of companies qualify to execute a sale/leaseback?
Companies or other organizations with a strong balance sheet and owned real estate are excellent candidates to enter into a sale/leaseback transaction. It is important to note, however, that to successfully execute this strategy, the company must be willing to enter into a long-term lease with the investor purchasing the building.
At a minimum, the financial and risk metrics of the transaction will not be palatable to an investor unless a lease term of at least 10 years is in place. Effectively, these investors are purchasing a stream of future rental payments, so the investment is analyzed based on the overall risk and stability of that future cash flow. Accordingly, investors seek companies with a healthy balance sheet and a proven operating history. This allows for easier leveraged financing for the investment, and supports investor interest in the transaction.
Finally, sale/leaseback transactions often occur as part of a merger or acquisition transaction. If the purchasing company does not desire to acquire the real estate with the business, it will many times conduct a sale/leaseback transaction concurrently with its acquisition of the business.
Why is now a good time to consider this?
The current state of the capital markets is extremely favorable for investors — interest rates are at historic lows, and this low cost of capital allows investors to earn greater returns on leveraged investments such as real estate.
Additionally, many market analysts expect inflation to occur over the next several years. Deploying capital at low interest rates in stable real estate investments allows investors to ‘hedge’ against inflation and protect returns.
Where can a business turn for assistance with a sale leaseback?
Any organization considering a sale leaseback should consult with an independent, professional real estate adviser to ensure that its interests are represented. Your adviser should have the ability to assess the transaction holistically, understanding the perspective of the investor and providing advice as your fiduciary to ensure that the value of the transaction is maximized and the terms are fair. Utilizing this perspective, your adviser can present the investment to a broad marketplace of potential investors to fully leverage a competitive environment and help you identify and select the best offer.
How can a business initiate the process?
The first step is to consult a professional real estate adviser who can help identify the parameters of the transaction and the potential value that could be generated by the sale/leaseback. Together, you can determine the value and impact of the transaction to your business and define the best path forward and implementation strategy. Your adviser will help you gather and review the due diligence items required for the transaction, including financial statements, environmental reports, surveys, historic operating expenses, maintenance records and title work. These items are crucial for investors to review when determining the risk and return associated with doing the deal.
How long does a transaction take to close?
The timing can vary, but typically there is a defined marketing period for the investment, followed by a ‘call to offers.’ This can last from 30 to 60 days. Once offers are reviewed and one is chosen, the investor will require additional time to review due diligence items and arrange financing. This period could be up to 90 days. Once that is complete, if the investor opts to move forward with closing, the transaction should be complete within 30 days.
Ben Smith is vice president of Plante Moran CRESA. Reach him at (248) 223-3275, email@example.com or visit www.pmcresa.com. Josh Lanesky is a senior associate with Plante Moran CRESA. Reach him at (248) 603-5092 or firstname.lastname@example.org.
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