Selling a Business With a Lease
When selling a business, among the myriad issues to address so that a buyer has some level of comfort as to stability is the lease.
Most businesses – including most retail and service businesses – lease their physical facilities. It really doesn’t matter what size the business is, either. Think of logistics and distribution businesses that lease warehouses the size of 10 football fields along major highways near transportation hubs. Think of Amazon’s distribution centers. Size does not matter; most businesses prefer to lease rather than own for the simple reason that leasing does not tie up capital and credit.
If a business were to buy its place of business, it will generally need a sizable cash down payment, its asset will be encumbered by a lien, its asset will not be easily converted to cash if needed and its credit rating will reflect the fact that it owes the balance of the purchase price. Granted, a long term lease will be listed as a liability on the balance sheet as well but anyone reading that balance sheet will know that a 10 year lease is 1) shorter than most commercial mortgages; 2) FAR more easily negotiated out of and; 3) drains less of the business’ capital.
So, what does this have to do with selling a business? Plenty.
I recently read about a small business in Oregon the owner of which had been trying to sell. The business’ lease was coming to an end but it had a provision that gave the owner an option to renew for another five years. The owner decided to renegotiate the option so that he would have only an additional 18 months – because that was as long as he wanted to work.
What’s Wrong With This Picture?
Several things, actually, among them the following:
- The business had been in operation for more than 40 years. The story did not imply that it was suddenly failing. If it was not, it had value. But renegotiating the option from five years to 18 months suggests that the owner, if the business did not sell, was going to close the business and wipe out the intrinsic value and 40 years of good will.
- The only reason anything – a house, a boat, a business or a pound of potatoes – does not sell is that the price is too high. The article implied that the owner had been trying unsuccessfully to sell the business for some extended period of time. Is it priced right? My guess is that it is not – otherwise, it would have sold. Trying to sell a business without the benefit of a professional valuation is almost always a monumental waste of time because if the price cannot be justified – if it is too high – it will never sell. (Conversely, absent compelling or unavoidable circumstances, offering it for something less than market value means the seller leaves money on the table.)
- A buyer will almost always prefer a longer lease to a shorter one for the simple reason of stability. Buyers will be far more interested in a business that has a lease in place – guaranteeing that the buyer’s financial proforma will include occupancy costs that are known – then face the uncertainty of having to negotiate a new lease – or worse, having to relocate the business – in 18 months.
- The viability of certain businesses depends on location. If a business is consumer driven, moving it will almost certainly disrupt the business’ sales, to say nothing of the disruption that will occur to operations and employees by a relocation. Customers will eventually find the business in its new location but even if that’s the case, revenue will fall off for some period of time. In many cases it may never fully recover. A buyer understands this. This is true even if the business can be moved to what the buyer sees as a more appealing location because drawing new business from the new area will take time.
- All of the above suggests that the seller did not assemble the right team to make a sale highly probable. The owner knew his business and industry but had no clue how to value, market or position the business for sale let alone negotiate the terms, help the buyer line up the financing and shepherd the deal to a successful closing.
What Can We Learn From This?
So, what are the lessons from this story? They are manifold.
- Team – You’ve GOT to assemble the right talent for this major, likely once-in-a-lifetime event. Learn who and how here.
- Preparation – You’ve GOT to prepare your business for sale and this phase starts two or three years before you – or, preferably, your team – bring the business to market. Learn what’s needed here.
- Time – You’ve GOT to allow sufficient time. Successfully selling a business is a study in patience. Properly priced businesses can take anywhere from seven or eights months to several years to sell.
- Value – You’ve GOT to know what your business is worth. A professional business broker will be able to tell you what the market suggests that value is. It may not be enough for you – and you need to know THAT, too. Get a valuation done without delay. Your business will not sell if it’s overpriced.
- Stability – You’ve GOT to make this easy for the buyer. The business must appear to be stable. You want the buyer to feel that no surprises or disruptions are on the near horizon. One aspect that falls in this category is the lease. (Though it was written for buyers, more discussion on this topic is here.)
If you want to get a head start on the valuation, we’ve prepare a list of some of the documents you’ll. It free. Just let me know where to send it.
In the case of our example, the seller may simply be burnt out and willing to forfeit the intrinsic value and goodwill the business built up over 40 years. But more’s the pity! Closing it means walking away from that value; flushing it all down the toilet! Even if the world seems to be crashing down on the owner, selling the business for even half its value provides not only proceeds for the seller but also continued life for the business that the seller likely spent many years of hard work building.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. For example, if you’re considering selling your business, what is your biggest concern about the process? Are you wondering how to find out what it’s worth or how to find the right team? Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
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