…and then suddenly,
the Buyer changes course and asks for a significant change to the purchase agreement, reducing his offer by $60,000. Sounds like a bad dream for a Seller, but it can happen when the Seller’s landlord is a wildcard.
If you’re considering selling your business and have a lease, it’s critically important to mitigate uncertainty when the Buyer meets your landlord. During this important due diligence milestone, a Seller’s landlord can grow sharp claws with the Buyer, offering the Buyer an unexpected rent increase. In a recent example, a landlord offered the Buyer a new lease with an incremental rent hike of $2,000 per month.
The Buyer walked away from the landlord meeting stunned; but within 24 hours, he realized that the earnings of the business is effectively reduced by $24K per year. The Buyer calculated the remaining math in his head… “let’s see, I paid a multiple of 2.5x on adjusted earnings, and now earnings have decreased by $24K.” He renegotiates the previously executed purchase agreement, with a justifiable case to reduce his offer by $60K.
And that quickly, the Seller lost $60K in proceeds.
How can a Seller avoid this unwelcome surprise?
Here are some tips to avoid a negative adjustment to the purchase price as a result of a surprise lease increase:
- Maintain a long-term lease. Many Sellers opt for a month-to-month lease when they are planning to sell. There is valid logic in doing so. Sellers wish to avoid a long-term commitment when they are planning to sell. However, a month-to-month lease provides the landlord with a strategic opportunity to raise the rent for a Buyer to whatever level they choose. Consider a long-term lease to mitigate this outcome; however, ask your landlord to make sure your lease is transferrable. Furthermore, ensure that at transfer, you will no longer have any remaining liability for the Buyer’s lease.
- Open up to your landlord. If you choose against a long-term lease, you may wish to have an open discussion with your landlord in confidence. Let them know you’re considering selling, that you’re working with a competent business broker, who will identify a qualified Buyer candidate. And most importantly, ask the landlord directly whether they will maintain an equivalent rent agreement with the Buyer when the time comes.
- Adjust for any known rent increase upfront. If the landlord has indicated that a rent increase will apply (or if you suspect this will be the case), discuss this with your business broker at the start of the valuation process. This anticipated rent increase can be built in the financial recast model. And while the known increase will impact the business value, it’s a known quantity rather than an 11th hour surprise.
During a Buyer’s due diligence process, their book review can often uncover expenses which are in excess of a Seller’s existing expense base. And in these cases, it’s common and even justified that a Buyer will request a decrease in deal value. It’s important for Sellers to anticipate forthcoming changes to expenses, in order to support the agreed upon price in the executed purchase agreement.