The Sale Leaseback M&A Acquisition – A Glitch in the Matrix.
A few months ago, my client asked me to draft an LOI with him for a new deal. We discussed structure and he said, the business owns real estate, but I do not want the property.
I said, have you considered a Sale Leaseback (SLB) to fund your acquisition of the business.*
He said, “Huh?”
I said, hear me out.
It feels like we are landing multiple planes on the same runway simultaneously, but when it works, it feels like magic. I will guide you through it.
When six months later, we closed his deal he told me, you must tell no one about this; okay, at least give me a 6 months head start before you post it.
6 months has passed. Here is how an SLB – M&A Acquisition works:
The Seller’s EBITDA was $1.1m. The Seller the business for $4m.
Optionally, he was willing to sell the real estate for $2m. For the buyer, after closing costs, he would be in it for $6.5m for the business and the real estate.
The real estate was appraised at $2m.
I told the client, reach out to an SLB broker and get a quote. He sent the SLB broker the address and they came back with an estimate of $5.5m.
My client was shocked, how could that be???
I explained, the new landlord (the SLB Landlord) is attributing an 8% cap rate and valuing the property based on higher rents and 2% YoY increases for a 15-year lease. They are paying the present value of a long-term stable lease with a AAA tenant for a mission-critical property and valuing it at $5.5m.
Thus, I suggested we get debt of 2x EBITDA (even after building in higher future lease payments DSCR was fine) of around $2m loan plus the $5.5m from the SLB Landlord and buy the business and the real estate for $6.5m.
My client bought the business and pocketed $1 million at closing.
He told me after the deal that his investment of $1500 for me to draft his LOI was the best ROI he would ever have.
I closed 3 SLB – M&A deals last year and while this was the only one where a client pocketed money at closing, each resulted in the sponsor putting $0 into the deal and owning 100% of the equity.
Magic.
From a legal perspective, we have to be very careful. We drafted into the purchase agreement the right to buy the property but allowed the assignment of that right to the SLB Landlord. At closing the property passed directly to the SLB Landlord, but they never came in contact with the seller (beware of tax issues if this is done wrong).
Here is what you need to know. It does not always work that the SLB Landlord is willing to pay more for the real estate than the appraised value, sometimes I send deals to an SLB broker and there is not much of an SLB gain, so you have to quote it out at the LOI stage.
Second, expect much higher costs. Legal costs are higher for these deals because they are much more complex. You also need a real estate lawyer who understands SLB-M&A deals and local laws (not easy to find). You pay a broker's fee and various other diligence fees (e.g., property appraisal and Phase I, at minimum).
And, you need advisors that know what they are doing. This is easy to mess up, especially, around tax issues (e.g., purchase price allocation). Anytime I even touch an SLB deal, I bring our Chair of Transactional Tax, Josh Siegel in from the beginning.
Caveat: I have not been successful at closing this deal with an SBA 7a loan. I believe the SBA lender will not consider SBA gain to be an equity injection. However, I imagine if you can come up with the funds at Closing and then reimburse yourself with the SLB gain, that could work (after tax repercussions).
Finally, nothing is free. You pay for this over time in increased lease payments and entering into a long-term lease. Also, if you look to sell the business your higher lease payments will diminish EBITDA, but it is the cheapest form of financing you will find. Plus, you will be paying a lease payment in any event.
Now do you see why this is a glitch in the matrix?
*I also suggested combining an SBA 7a business acquisition loan with a 504 loan, which could give longer amortization in some cases.