The following is adapted from The Exit-Strategy Playbook.
Most entrepreneurs I have encountered in my career tend to be on the conservative side when it comes to spending money. They don’t like to rent buildings, for example; they prefer to own. In fact, over the past 20 years, I’ve bought more than 50 companies, and at least 90 percent of the time, the company has owned real estate.
These aren’t startups, obviously. On day one, a business owner may work out of their home, their truck, or a rented space. But if you build an empire over decades, chances are you own multiple buildings occupied by your company.
This is typical. And I get it; I really do. It often feels safer to own your own property instead of being subject to a landlord. But here’s the thing. No buyer—strategic or financial—wants to own your real estate! And if you have a lot of it, it can make it that much harder to sell your business for maximum value.
To help you understand why (and hopefully help you avoid the real-estate trap), let me share why you should proactively spin off any owned business property from the company you intend to sell. By dealing with the issue before you sell, you’ll mitigate any associated delays relating to real estate.
Real Estate Is A Long-Term Investment
Let’s start with the biggest reason owning real estate can be a liability when it comes to selling your business. Nearly 50 percent of all companies sold today will be sold to a private equity buyout fund. The focus of a private equity buyout fund is to acquire established companies with real revenue and a track record of being in business over an extended period of time.
Private equity funds tend to have a 10-year maturity and a typical hold period of five years on the companies they buy. Real estate is considered a very long-term investment and thus is not capital efficient when private equity seeks to generate three times the return on its money over a five-year period of time. Real estate can trend down or up, but you can’t typically complete a full real estate cycle during the hold period of private equity.
That’s not to say that there aren’t specialty funds in private equity whose sole purpose is to make real estate investments. If you are in the business of owning and managing real estate, then your universe of potential suitors includes specialty funds as financial buyers.
For the rest of you, your financial buyer comes from private equity buyout funds. If you’re an entrepreneur who has a portion of your net worth tied up in real estate, know that the private equity firm or strategic buyer has zero interest in owning the real estate. The prospect of real estate can make them run away—fast.
Extract Real Estate to a New Entity
So what if you’ve already purchased real estate? Well, in that case, you need to take steps now so it won’t affect a potential sale of the business in the future.
Real estate issues should be addressed one to three years before you sell because you may need to spin out your real estate into a separate entity. After you spin the real estate out of the business, you need to put in place a fair market lease between your business and the real estate. In essence, you’ll become your own landlord.
Meet with your advisory team—your lawyer, tax advisor, accountant, and investment banker—to discuss the pros and cons of how you structure that real estate deal. There are tax-efficient and non-tax-efficient methods, and each situation is different.
When you sell your company, your ongoing income stream may include lease payments from the company for rent. Moving is expensive and a hassle. Provided you have a reasonable fair-market lease with a duration of five to seven years, chances are that the new owner will continue that lease for the full term.
Understand How Real Estate Impacts Your Business
If I’m being perfectly honest, it’s not the end of the world if you own real estate as an entrepreneur. Asset diversification is a good thing! Kudos to you for building an empire! The key is to understand the impacts on the sale and how you can continue to own and even generate new income as a landlord.
Trust me. By addressing any real estate issues now, you’ll be in a much better position to sail through the sale of your company and eliminate a large potential headache during diligence.
For more advice on what you need to know to sell your business for maximum value, you can find The Exit-Strategy Playbook on Amazon.
(Royalty free image: https://unsplash.com/photos/nxZDMUQhN4o, Credit: Unsplash / Abbe Sublett)