If you are thinking of selling your business, and own the real estate, you may have had someone approach you to rent the business and real estate, from you rather than buy the business and rent the real estate. This may seem attractive. You keep the property and have a tenant. You save on broker’s fees. And, hopefully, the renter is paying you more than a market rate for rent. Despite all of these “benefits”, renting your business is usually a bad idea.
You own a business and you own the commercial real estate where it is located. Each of these has value. Your business generates an income and has value. You have customers, equipment, and employees, and other assets. The business, like the real estate, can be sold. Commercial landlords are, typically, renting an empty space. That has value also and that is what a tenant pays rent for.
I’ll assume, first of all, that you are renting the business and real estate for more than just the rental value of the real estate. If not, it’s really a bad deal. You’ve just made a deal to give away your business. But, even if you are getting more, it’s usually a bad idea. A comparison to a business sale will show you why.
Let’s assume that you could sell your business for $500,000. In most of our sales, the buyer would get an SBA loan for that amount. The buyer would put down about 20% and borrow the rest from an SBA lender. In some deals, the seller provides a seller loan of 5% to 10% of the purchase price. At the closing, you would normally receive $450,000 to $500,000. This is your money no matter what the buyer does with the business.
Now let’s look at your situation if this same buyer rents the business from you. Let’s assume a ten year lease with options – a typical commercial lease. Let’s assume also that, being a smart businessman, you want to get paid what the business is worth over the term of the lease. $500,000 at 6% interest over 10 years is about $3,600 per month. I’m using a typical SBA loan rate for this analysis. An SBA loan is 75% guaranteed by the SBA – a much better guarantee than the personal guarantee you should get from your tenant. Because of the much higher risk and no down payment, the interest rate should be much higher. This rent should be in addition to the market value of the rent for the space.
What’s wrong with this? Here are a few things:
- You’ve hurt yourself tax-wise. Rental income, including the rent for the business, is taxed at normal rates. It’s likely that a large part of the sale of your business will be taxed at capital gains rates which are much lower.
- You may get your business back, if the tenant defaults on the lease. If so, it is very likely that your customer base and equipment will not be in the same shape as when you rented out the business. It’s also likely that many of your good employees will have left. You are not getting back the business you rented.
- Even if the tenant fulfills his obligations, do you want your business back in 10 years? By that time, you will be doing something else, or retired, and the last thing you will want to do is go back into this business.
I would also point out that renting your business is “like” selling it with no money down and a seller loan over the term of the lease. If a business broker brought you this deal, you would probably turn it down fast and tell him, or her, to bring you a buyer with some money. Most of the sellers we work with are looking for as much cash at the closing as possible.
When you are ready to sell your business, sell it. Take the money. Put the business behind you.
