I often consult with business owners with over 30 years of operational history. They usually own all their vehicles, equipment, inventory, and real estate completely debt-free. This is a great accomplishment, and they should be proud to have paid down their debt!
Unfortunately, a side-effect of owning everything outright is that business owners often reduce their expenses by discontinuing any rent payments, which can have the unintended consequence of making their business unsaleable.
Why do owners do this? Because they reason they can get by “just fine” now that all their debt has been paid, and perhaps even take more money home than before. They relax into a business pace that is comfortable and sustainable, then ease their foot off the “gas” regarding sales and marketing.
Since the owner is no longer keeping up with market rents and real estate prices while seeming to earn a greater income, they become unaware of their business’ real-world declining cash flow.
The owner has created a business model that is only sustainable for a business buyer if he’s also allowed to continue using the business property rent-free!
Of course, it’s always possible the interested buyers will want to purchase the real estate and the business together, but this can only happen if the cash flow of the business is large enough to pay the new mortgage on the property, as well as, any debt service on necessary business loans. Sometimes the real estate has appreciated to such a high value that it makes financing unlikely for any buyer with an income based solely on the business being purchased.
What about the business buyer’s cash investment? – How likely would it be to find a buyer interested in a business earning $150k/yr, who would also have $500k extra cash lying around to purchase the commercial real estate debt-free? – Not very likely.
The would-be business buyers have essentially been “priced-out” of buying the business because it was operated without a market rent expense.
If the rent expense had continued to be included in the financials it could be adjusted back into cash flow to 1) cover the future mortgage on the real estate, 2) use for relocation to similar commercial property, or 3) continue to pay the seller rent as their new tenant.
The owner will be faced with either closing the business and selling the real estate and assets separately or carrying the difficult financing themselves on what would seem to be a risky venture based on the debt-to-income ratio of the buyer.
If you’ve been operating your business in your own debt-free building for some time, do some research to find out what your real estate might rent for. Create a P&L worksheet and add the rent as an expense. Then ask yourself, “Is my business doing as well as I think it is?”
If you’re interested in a free, confidential financial review of your business, please contact me, Angela Graham, at email@example.com or 256-503-2806.
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