It is very common for small business owners to own the real estate from which their business operates. This is often a very good strategy and, for many, the decision to acquire real estate has resulted in a very good investment. Unfortunately, when the time comes to sell the business, real estate can add complexity to the process.

Tax and legal advisors often advise business owners to separate the ownership of real estate from ownership of the business. Sometimes, they advise the owner to place the real estate in a separate entity and for the operating business to pay a fair market rental to the real estate entity. That is usually a very good idea.

The problem arises when the time comes to sell the business. The owner who has directly or indirectly owned both the operating business and the real estate often wants to sell both the business and the real estate. This creates some serious issues in certain cases. Established methods of valuing businesses are based on the cash flows of the business and would not normally assume real estate ownership. So when a business is valued on the basis of its cash flows and the value of the real estate is added, the combined valuation will often reach a level that cannot be sustained by the current cash flows of the business.

Requiring potential buyers to buy both the business and the real estate will almost always significantly reduce the field of potential buyers for a business. Reducing the number of potential buyers usually reduces the value generated by the business and lengthens the period of time it takes to sell, both big problems for most sellers.

There are at least two alternatives that business owners should consider. One is to continue to own the real estate and collect rental payments from the business purchaser. This can be very attractive and potentially represent a better investment long-term than selling it to the business buyer. It has the additional advantage of facilitating the deferral of taxes that might be payable if the real estate were also sold.

Another alternative is to structure a long-term lease (at least five years) prior to selling the business. The business can then be offered for sale with the lease and real estate can be offered for sale, subject to the lease, as an investment property. Structuring the lease to make the underlying real estate a desirable investment property can be complex and, if this is a situation you find yourself in, I would advise you to consult with an appropriate commercial real estate professional.

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