Three Things to Consider regarding Personal Guarantees in Commercial Leases

https://youtu.be/YEDvuhjH4Pg

 

If you’re a business person and you’re leasing commercial space, you’ve probably come across personal guarantees. Most commercial leases for high quality space include a personal guarantee.  It’s incredibly important that you understand what impact they can have to you personally and professionally. Most small businesses don’t succeed, so it’s important to have a plan for what to do if the business fails.  I always advise a business person to have an exit plan that includes some bankruptcy planning. What are you going do if the business doesn’t do well? So, if you’re signing a personal guarantee, if you’re signing in a shopping center or even you know a warehouse, flex-pay space, complex, that could be a few million dollars. And so, should your business start to fail and you have seven years left on the term of your lease and you have signed a personal guarantee, you could be on the hook for a few million dollars.

 

  • Bankruptcy Planning.  If you’ve got a long line of creditors, your landlord may not want to spend the money to go after you for that or he may have a very low probability of getting anything out of the bankruptcy but you still, when you get to that point, that’s not a great option. So, my advice is always talk to a bankruptcy attorney in advance. Usually, what that means is putting all of your assets that you want to keep in your wife’s name or your spouse’s name or a trust, it means that you’ve thought through and you only are personally connected to things that are connected to the business and that you can afford to lose. So, worst case scenario is that your business starts struggling, you get behind, and suddenly, you luck up and the only option for you is bankruptcy and your house, your car, your stocks, your rental properties, everything is in your personal name. And that means when you start trying to figure out how to work your way through the bankruptcy, the bankruptcy trustee has access to all of those assets. Please talk to a bankruptcy attorney.
  • Franchise Agreement.  Also, look at your franchise agreement. It’s a great idea to have an attorney look at your franchise agreement. Often, there’s language in there about what will happen if the business shuts down.  Worst case, the franchisor may have the right to step in and take the business.  Often the franchisor has the right but not the obligation to satisfy the lease–and this could potentially save you from having to satisfy the personal guarantee.  
  • Waiving the Guarantee.  Finally, there may be a chance with a strong balance sheet, you don’t have to sign a personal guarantee, or the corporate guarantee may be strong enough to satisfy the landlord.  That’s something that could be negotiated away by the commercial broker whose representing you on your lease.  Also, if you’re renewing the lease and you’ve been there for a long time, there may be a way, an opportunity to do away the personal guarantee.  It’s also important to remember that if you sell the business you may not be released from the personal guarantee–this needs to be a part of the conversation if you sell your business.  

Hopefully that’s helpful.  Again, this is Jonathan Aceves. Thanks for watching and have a great day!

 

The Four Primary Uses of Sale-Leasebacks

 

Today we’ll be discussing the four primary uses of sale leasebacks: Financing, Improved Returns, Balance Sheet Improvements, and Exit/Repositioning.  

 

The Four Primary Uses for Sale-Leasebacks

  1. Financing: Allows for off-balance sheet financing (100% of equity can be made available for investment, as opposed to 75% with traditional financing) and at a lower cost
  2. Improved Returns: Firms may earn a higher return on their primary business rather than in real estate, so they consider moving capital to principal business to expand operations
  3. Balance Sheet Improvements: Tool for improving the balance sheet which can be important for exit planning and larger corporations
  4. Exit/Repositioning: When a firm determines they want to exit a given market/location, they can execute SLB to cash out of a given asset in advance, and then have 5-10 years to find new location.

Financing

Sale-leasebacks are a popular means for companies to fuel growth by moving capital out of real estate and into their principal business.  Often, releasing capital in real estate is more affordable and has better terms than bank financing.  With bank financing, you may only be able to release 75-80% of the equity in your real estate, and that loan will likely come with a 3-year balloon payment.  And often the appraised value of the building is the value of the vacant building.  With a Sale-leaseback, a business owner can tap into 100% of the equity in the real estate, with no balloon payment, and often the value of the NNN lease to an investor is higher than the appraised value of the empty building (depending on the owner’s creditworthiness and balance sheet).  Also, a risk of bank financing is that if the appraised value falls below the agreed-upon LTV, the loan is in default and immediately called (think 2008).  The sale-leaseback puts the market risk on the new owner.

Improved Returns

If the returns from a company’s principal business are higher than the returns on the real estate, it often makes sense to move equity out of real estate and invest it in the company’s core business.  The goal is always to maximize return.  For example, if the business is able to gain a 20% return from day-to-day operations, and the ownership of the real estate where the business resides is only netting an 8% return, returns would increase if the business could divest of the real estate to allow for greater investment in the core business.  Through the signing of a long-term lease, the real estate can be sold, the business remains in operation in its current location, and operations could conceivably be expanded with the opening of a new location or other operational expansion. 

Balance Sheet Improvements

As a seller looks to exit their business, it can become important to improve financial statements.  With this strategy, the seller replaces a fixed asset with a current asset. This increases the current ratio (current assets/current liabilities).  Sometimes referred to as the Working Capital Ratio, investors see this as an indication a company’s ability to service its short-term debt. 

Exit/Repositioning

A Sale-leaseback can be a useful tool for a business that knows it wants to move from a given location into another market or trade area in the future.  It can also be a means to exit from an overly specialized or obsolete building.  An example could be a prison or a hospital, or a retailer realizing that growth is moving in a given direction and determining that in 10 years it will move to follow growth, or that they will centralize their operations in a new building. 

 

What are your thoughts on SLBs?  Have you ever performed one?  As a growth plan, have you evaluated a SLB?  What are pros and cons in your opinion?  We’d love to hear from you.  Please comment below, share with friends, and thanks for reading! 

 

Sale Leaseback Overview and Medical Office Case Study

Sale Leaseback Overview

What is a Sale-leaseback and how could it impact your business?  A Sale-Leaseback (SLB) is when an owner of real estate sells their real estate subject to a new long-term lease, and then sells the real estate to an investor.  This can have a variety of benefits and uses including providing a means to raise capital for growth, as an effective exit-planning tool, helping improve the balance sheet, and potentially positioning owner for exit of market.  If a growing company’s returns on their core business outweighs the returns on real estate deal, then it is generally recommended to sell the real estate and invest in operations. Often terms for a sale-leaseback are preferable to debt financing, especially for a growing company.   Many national retailers, fast-food franchises, and medical practices utilize sale-leasebacks to grow their business.  A sale-leaseback analysis and comparison to debt financing should be something every executive should review for their business. 

 

The Definition

  • A Sale-Leaseback is when an owner sells their real estate to an investor, and in the same transaction leases the building back from the new owner. Typically, these leases are long-term triple-net leases. 

 

The Four Primary Uses for Sale-Leasebacks

  1. Financing: Allows for off-balance sheet financing (100% of equity can be made available for investment, as opposed to 75% with traditional financing) and at a lower cost.  This can allow for faster growth.
  2. Improved Returns: Firms may earn a higher return on their primary business rather than in real estate, so they consider moving capital to principal business to expand operations.
  3. Balance Sheet Improvements: Tool for improving the balance sheet which can be important for exit planning and larger corporations.
  4. Exit/Repositioning: When a firm determines they want to exit a given market/location, they can execute SLB to cash out of a given asset in advance, and then have 5-10 years to find new location.

 

Case Study: Exit plan for Medical Office

Hypothetical case study based on real-life business: A local medical practice with an almost 40-year history is determining how to transition from the founders to the two younger partners.  The senior partner owns the building.  The business is grossing about 3.5M per year.  The building has a tax value of 1.4M.  What’s the best way for the senior partner to sell the practice and real estate? 

The building is a 10,000 SF building.  Leased at $18NNN, at an 8% discount rate, that would be a sale value of 2.25M.  Likely an investor could do a little better than that, depending on balance sheet. The 180,000 rent payment would be about 5%, which is within the industry standard of 5-7%.   The building empty would likely sell for around $160/SF, or about 1.6M.  

Executing a sale leaseback could allow the senior partner to cash out of his investment with a lump sum, and finance the business to his partners. The junior partners could also get bank debt to purchase the business and the building, potentially with SBA and competitive terms.  Often, the value of a leased asset can be higher than the value an appraiser would put on the building, and higher than the valuation a bank would put on a building.   Regardless, the value of the lease to an investor can help the senior partner set a value on the practice. 

The Medical Practice engages a commercial broker to create an analysis of the sale leaseback.  Working with a commercial lender and business financial planner, the team reviews the past three years’ tax returns, balance sheets, and P&Ls for the practice.  With this information, the team generates the analysis.  The financial planner gives an analysis of the business sale with and without the real estate.  The commercial real estate broker generates an opinion of value for the building itself and its potential value to an investor subject to a long-term lease.  Also, the commercial lender can present terms for financing for both the business and the building.  

 

What are your thoughts on SLBs?  Have you ever purchased or evaluated a SLB?  If you’re a business owner, what have been your considerations regarding SLBs?

AU Hospital Decision Delayed Again

Decision on AU Health’s ability to build a hospital in Columbia County has been delayed again.  It has been nearly a year since the court ruled in favor of AU’s Certificate of Need to build in Columbia County but appeals have stopped them from moving forward.

 

 “Columbia County is really one of the fastest and largest counties in Georgia  that does not have it’s own hospital,” says Madeline Wills, general counsel at AU Health. 

 

Read the WJBF article: 

https://www.wjbf.com/csra-news/georgia-supreme-court-decision-delays-au-hospital-in-columbia-county/

 

What are your thoughts?  Does Columbia County need a hospital?  What impact will it have to the CSRA to have another hospital?