When considering a sale leaseback for your business or your portfolio company, you will quickly realize that it is a complicated, nuanced process requiring careful consideration and strategic planning pre and post-closing. This article will guide you through the essential steps to successfully navigate the sale leaseback process and highlight how engaging the right parties at the right time is critical in order to maximize your outcome both from an economic and flexibility standpoint.
Structure a Compelling Offering
The first step in the sale leaseback process is to land on the terms of the offering. This involves a deep dive into the economic and market landscape, and an underwrite of the credit of the guarantor, mission-criticality of the asset, and real estate fundamentals of the property. The focus is to create a compelling yet competitive offering that achieves your goals as the seller and provides attractive investment attributes to potential sale leaseback buyers. This of course includes evaluating pricing, but also includes coming up with a summary of rental rates, escalators, lease term, and other lease points that are workable for both the operating company and for the sale leaseback investor. In order to ensure that your target pricing and terms are achievable and optimized, it is crucial to engage a knowledgeable advisor who can structure an offering that not only attracts potential buyers but also maximizes returns for you and provides flexibility that meets the company’s goals, whether such goals need to be tailored for an upcoming exit, potential expansion, or other long-term plans for the facility or business.
Understanding All Implications
Two critical implications of a sale leaseback transaction involve 1) Tax and 2) Accounting. It is important to complete an analysis of the tax and accounting impacts of the sale leaseback based on the offered terms prior to launching the process. Being prepared in this way and leveraging the appropriate experts allows you to optimize the impact and structure for any preferred treatment at the right time during the process – not once it’s too late.
Gather Documentation Ahead of Time
Sale leaseback investors will require two “types” of information – information on the real estate and information on the operating business. Given these items are going to be required as part of any process, it is best to gather this documentation at the outset of your sale leaseback process to ensure a smooth process without delays. This also ensures that a robust dataroom can be provided to potential investors from the start of the process, preventing avoidable surprises from coming up later on. Additionally, having historical property documentation will almost always speed up the process of ordering new property reports during the due diligence period, which allows for quicker closing timelines.
Have Legal Counsel Ready
Once offers start coming in, it is important to have legal counsel ready to go. We recommend working with a firm that specializes both in real estate and in corporate finance / M&A to make sure we have the best legal experts on board to help negotiate the lease agreement and purchase and sale agreement, the two operative documents of any sale leaseback transaction.
Outline Your Salient Lease Points
We recommend discussing any lease provisions that will be important to you or the operating company as early on as possible – not waiting to bring these up once the lease negotiations have begun. For example – for many private-equity owned businesses, we spell out the preferred change of control and assignment language during the LOI stage given how critical these points are to a sponsor’s flexibility, versus leaving this point to be discussed later on during the due diligence process when we no longer have the same leverage with interested parties. Additionally, if your business is going to want to expand the facility in the near-term, we will incorporate a lease provision around expansion financing so that the lease is pre-wired for this structure when the need ultimately arises. It is important to have an understanding of what these more salient points are for the company so that we can structure this into the offering early on.
Generate a Competitive Marketing Process
The dynamics of a sale leaseback are typically best handled by an advisor serving as an intermediary negotiating and creating competitive tension among interested parties. The advisor’s role is pivotal in generating a competitive bidding process, leveraging their market knowledge and investor network to attract a diverse range of qualified offers. This sets the stage for maximizing the value of the transaction for the seller. Specifically, an advisor will customize a tailored marketing strategy to the sale leaseback investor universe of private buyers, high-net-worth individuals, family offices, real estate private equity funds, private REITs, public REITs, alternative asset managers, and others. This process fosters competition, as investors come in “best foot forward” with their most compelling offers during the bidding process, aware of the competition. On average, a process led by an advisor can result in more aggressive cap rates compared to working direct to a buyer, to the tune of around 50 to 100 basis points.
Negotiate Flexible Lease Terms
The economic terms are not the only important factor when it comes to sale leasebacks, but securing flexible lease terms and optionality for the business and sponsor can be just as important in ensuring optimal results from the transaction, post-closing. During the lease negotiation phase, it is critical to ensure that the lease agreement captures flexibility for the tenant around change of control and assignment clauses as they relate to potential business exits, substitution rights for portfolio deals, commitments for future expansion financing, and other terms especially those that are particularly relevant for private equity firms and financial sponsors.
Organize the Due Diligence Process
An intricate part of the sale leaseback process is managing the due diligence phase including environmental, technical, structural, and other property diligence providers. Advisors play a hands-on role in this step, ensuring vendor timelines are met and that all necessary information is provided seamlessly to the sale leaseback investor and their advisors. The sale leaseback advisor’s expertise in due diligence management ensures a smooth and thorough process, providing a steady hand for all parties involved. It is also important that the advisor effectively manages any nuances related to due diligence including confidentiality, sensitivity or discretion with employees and facility contacts, and other key considerations around having visitors on-site at the subject property.
Maintain Backups to Ensure Certainty of Execution
To mitigate potential execution risk, it is advised to always maintain a handful of potential backup buyers. This not only provides for a quick pivot if the selected investor cannot perform, but having backup buyers in the mix also keeps the selected investor honest, knowing the seller has leverage in maintaining alternatives if the buyer were to be difficult. Incorporating back-up buyers in the process ensures accountability from the selected buyer, minimizing the likelihood of complications during lease negotiations, unexpected surprises during due diligence, or deviations from the terms agreed upon in the LOI.
Conclusion
While the sale leaseback process might seem complex and overwhelming at first, with the right advisor and proper up-front planning, the strategy can provide great results without too much heavy lifting required by the company. At Ascension, we believe that a qualified advisor takes a comprehensive approach to the sale leaseback process, providing reliable guidance from start to finish. This includes providing a precise and honest valuation from the start, overseeing of the entire investor marketing process, leading of lease and PSA negotiations in collaboration with legal counsel, managing all due diligence processes, coordinating with external vendors, and handling all administrative aspects of the deal – from start to finish. The goal is to ensure that the sale leaseback is not a burden for the deal team or the management team, and to offer a seamless and efficient experience for the client.
Now that you have a good grasp on how to best be prepared for a sale leaseback transaction and how the advisor plays a crucial role in all of this, we recommend that you also check out the Team’s article “It Takes A Village”, which dives deeper into how other professionals and experts involved in the process collaborate to deliver the best outcome for you and your company.
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