Friday, May 11, 2012

I Sold (or am selling) my Business...now what?

I provide location advice to owners and to occupants of industrial buildings in Southern California. The media today is filled with news of mergers and acquisitions...probably more so than anytime since the middle of the 2000s. This trend is witnessed by business owners big and small. So let's explore the circumstance of a sold (or soon to be) business and the disposition of the location(s) that the business occupies. As my commercial real estate practice centers around industrial properties, I will assume that the occupant is a manufacturing or distribution company. In order to frame my discussion, I will look at three scenarios of location disposition...business sold, location is leased long term (more that two years); business sold, location is leased short term (fewer than two years); business sold and location owned by the business owner.


Business sold, location is leased long term: Chances are that the purchaser of your business considered the location and the remaining term of the lease. If the purchaser opts to occupy the location, generally, an assignment of the lease obligation should be requested. Any options to extend are personal and typically cannot be assigned, however. Also check and see if any personal guarantees of the lease's performance can be vacated. Generally owners of locations want as much security as possible in the performance of the lease, however, if the purchasing entity has a larger net worth, sometimes owners will vacate previous personal guarantees. If the purchaser does not intend to occupy the location, you as the occupant must deal with a term of lease that must be satisfied...without the benenfit of a business to generate income. Some owners are happy to work with an occupant that is paying a rate substantially below market. This hasn't been the case for several years as lease rates have declined. Please address the lease term (and the resposibility for it) in your letter of intent.

Business sold, location is leased short term: This can be tricky if the owner of the location believes that the occupant has such an investment (distributed power, AQMD permits, ISO 9002 permits, paint spray booths, offices, freezer/cooler space, conveyor systems, etc.) in the location that moving would be too costly. The owner may attempt to negotiate a higher than market rate assuming that a move would be too costly. Be well advised to determine the buyer's desire to stay in the location and attempt to negotiate an extension. Otherwise, your buyer may negotiate a lower price for your business based upon the uncertainty of the occupancy.

Business sold, location is owned by the business owner: Frequently in closely held businesses, owning your location can make a great deal of sense. You fix your location costs and you control the occupant (it is your company), you benefit from the location's appreciation, and there are some potential tax benefits individually. I explained in great detail the characteristics of a company that should own its location in a previous post. You can click here if you are interested in learning more about those characteristics. When you sell the business that occupies the location (even if the purchaser of your business signs a lease with you), the question you ask should be, would I want to own this location if it were vacant? Remember when you were the occupant and the owner, the dynamic is different than being the owner but not the occupant. You are now an investor who must compete with many other investors for your tenant's occupancy...are you prepared for that potential risk? As explained in a previous post, the cost of originating a new lease is staggering. If the answer is no, then there are steps that you can take to minimize the risk of owning a vacant building. First, analyze your location's monthly carrying costs...debt service, taxes, insurance, common area maintenance, miscellaneous maintenance, etc. You should maintain a 9-12 month cash reserve of this total amount. Second, determine how marketable the vacant location is. A location advisor familiar with the current market can provide this for you. How many vacant locations similar to yours exist? What is the current appetite (including market time) for such a location? What is the current vacancy rate for locations such as yours?...like yours specifically...not a market wide vacancy of all locations. How special purpose is my location? Third, determine what the location is worth to an arm's length investor with the new lease. This amount less any debt owed against the location and less any closing costs of sale (net of any taxes) determines the proceeds that can be deployed into an alternate investment. If you choose to deploy the funds into another real estate investment, the gain may be tax deferred if the upleg purchase meets certain criteria. You may be wondering why you would sell one piece of real estate only to buy another? The simple answer is to lessen the risk. By selling a special purpose single tenant location and investing in a general purpose multi tenant location, the management is greater but the downside is more  manageable...ala selling stock in a single company and buying a mutual fund of many companies.

Pay attention to the disposition of your location(s) and you will be glad that you did!