How a Lease Factors into a Business Sale

A business sale is a complicated process, and one thing that can often be a source of stress is the buyer’s ability to either assume the seller’s current lease or get a satisfactory new lease for the business location. We have seen landlords “kill the deal” a few times, and while that is incredibly unfortunate, it is just part of the process. Here we wanted to educate both buyers and sellers on how leases normally factor into a business sale. That way everyone can prepare and be aware of different requirements or pitfalls when it comes to leases. The more we can anticipate and prepare in advance, the smoother the business sale process will be. 

 

How Sellers can Prepare for a Sale

How much a seller can prepare their lease for the impending sale of their business is going to depend 100% on their situation, and this will obviously be different for every seller. Ideally, you want to have a reasonable lease, with several years left on it, and if you can get it to be assumable by a future buyer of your business, that is the best-case scenario. Unfortunately, landlords, especially large commercial property management or leasing companies, typically won’t allow their lease to be assumable, but it’s always worth a try.

It is very difficult to sell a company who is about to lose their lease or work with sellers who refuse to renew their lease, so just keep that in mind. Finding a buyer who is willing to find a new space, fund a construction build-out, and move the business is going to be quite tough. Furthermore, especially in retail situations, the owner benefit can be highly dependent on location, and if the new location isn’t directly comparable, then the value of the business could actually decrease.

If you have a great relationship with your current landlord, you might choose to let them know that you are listing your business for sale and then you can feel out their thoughts about what lease terms they might offer to the new tenant. Most sellers don’t involve their landlord in the process until after due diligence is over, because they don’t want to rock the boat unnecessarily. However, it is completely up to the seller as to when they let their landlord know that they are selling.

If the seller owns the real estate and will become the landlord, then the process is much easier, and both parties just need to hammer out an acceptable lease during due diligence. So, think about the lease terms you’d like to see in advance, and do some research on what the going rent would be. If you don’t currently charge yourself rent on your tax returns, make sure that your business broker has included a “negative add-back” for rent in the recast of your business’s financials, so a rent expense is accounted for in your advertised owner benefit. Rent can often be one of the biggest expenses a business has, so you want to make sure it’s in the bottom-line numbers that the buyer is looking at. 

 

SBA Lending and Leases

Most buyers who are going to be getting financing to purchase a business will be utilizing an SBA loan. As part of the loan approval process, the lender will require that the lease length with options be for the entire length of the loan, which is typically 10 years. So, a lease can be 5 years with an option for another 5, or a 3-year lease with seven years of options, but any way you slice it, it will need to total 10 years.

From time to time we run into landlords who do not want to offer a lease that is acceptable to satisfy the lending requirements. Unfortunately this can be a “deal killer.” The buyer either needs to find an alternate location that will offer them the required lease, or they won’t be able to move forward with the SBA loan. If they need the loan to purchase the business, then the deal will be dead if the seller isn’t willing to offer seller financing. Now the seller knows that their landlord won’t be willing to offer a lease that will work for a buyer with SBA financing. Cash buyers will be the only option, and this will limit the buyer pool significantly, unless the seller is willing to carry a note and offer financing to a buyer who has a good down payment. 

 

Negotiating with the Landlord

As mentioned above, sellers typically don’t get their landlord involved in the business sale process until after due diligence. Once due diligence is lifted, then the buyer is pretty certain they are moving forward with the sale, as long as other contingencies are met, such as securing a lease and financing. This is usually the point in time where the seller introduces the buyer to the landlord, and the seller should do their best to help the buyer either assume their existing lease or negotiate a new lease with the landlord.

Sellers will want to help the buyer get similar lease terms to what they have currently, since the rent cost is already factored into their advertised owner benefit. If the landlord wants to do a large rent increase with a new lease, this will definitely change the bottom line for the buyer and could result in the value of the business going down. In these instances, often purchase price gets re-negotiated, because the buyer has a much bigger rent expense than they were anticipating. 

In most Purchase Contracts, the buyer will have a lease contingency. That means that if they are unable to secure a satisfactory lease, then they don’t have to move forward with the purchase. If the landlord isn’t willing to give them a favorable lease or a lease with the terms required by their lender, then the buyer can either look for another space or pull out of the deal and get their deposit back. That’s why it’s in the best interest of the seller to help the buyer negotiate with the landlord as much as they can. It’s always advisable for the buyer to run the new lease by their attorney before signing, and to seek legal counsel if they need assistance with the lease. As business brokers, we don’t typically get involved in negotiations for new leases with landlords or advise on the lease, but we can definitely jump in to mediate between parties where needed.  

 

How Deposits are Handled

The seller has paid a security deposit to the landlord. Per most Purchase Contracts, that deposit will be the property of the seller at closing. However, how that gets handled can vary widely based on the landlord and the business closing. Sometimes landlords will keep the original deposit paid by the seller, and then the buyer will need to pay the seller back for that deposit at closing. That will be a line item on the settlement statement as a debit to the buyer and a credit to the seller. Sometimes a landlord will insist on returning the deposit to the seller, and then in that case, the buyer will just pay their own deposit when they sign their new lease. In this situation, nothing will be noted on the settlement statement at closing, because it was handled outside the sale. It doesn’t really matter exactly how it happens, but all parties just need to communicate with their business broker and closing attorney as to how the lease and deposits are being handled.