Should I keep my building and lease it to the buyer?

You can sell the business and keep the building, with the buyer as your tenant. The buyer then prices the business on its earnings after a market rent, so the amount paid at closing drops by the building’s value and rent takes its place. A lease that runs as long as the buyer’s loan makes the arrangement financeable.

Whose name is on the title today

An owner who owns the building the company works from can sell the business and keep the building, with the buyer as its tenant. Whether that pays better than selling both comes down mostly to the rent and the lease. The first question is who holds the title.

Owners usually hold it in one of three ways. You may own it personally, or through a holding company that charges the operating company rent. Otherwise the operating company owns it and occupies it rent free. The question is the same for a manufacturer’s plant and for the yard where a landscaping business parks its trucks.

In the first two cases the building already sits apart from the business, and keeping it means signing a new lease at closing. In the third, a buyer of the shares receives the building along with everything else.

A building the company uses in its own business counts on the active side of the QSBC share tests, which the CRA’s capital gains definitions measure by the share of asset value used mainly in an active business. Moving it out before a share sale so you can keep it has a tax cost of its own, which belongs in the planning for the lifetime capital gains exemption and is worked out with your accountant early.

Market rent resets the earnings a buyer multiplies

A buyer values the business on its adjusted earnings, which are the profit with your own salary and personal costs added back, the measure explained in SDE or EBITDA. Rent sits inside that figure as an expense. Once you keep the building, the rent the buyer will pay under the new lease replaces whatever you charged yourself, and the earnings move with it.

Rent above market is added back for the excess, and rent below market is deducted from earnings, as the guide to add backs buyers accept sets out. A company that occupies its own building rent free has a full market rent deducted, the case worked through for a plant in selling a manufacturing business.

Take, as an illustration, a manufacturer whose books show $1,050,000 of adjusted earnings after paying $60,000 a year in rent to the owner’s holding company. A commercial appraiser puts the market rent at $150,000. Restated at that rent, the earnings are $960,000.

That $90,000 also takes the business below a size band in the valuation we run. Our engine adds 0.3 to the multiple for earnings of $1 million and above, the level most private equity buyers screen for. At $1,050,000 the manufacturing range of 3.0 to 5.5 times becomes 3.3 to 5.8, or $3,465,000 to $6,090,000. At $960,000 it stays at 3.0 to 5.5, or $2,880,000 to $5,280,000, with every other factor at its neutral setting.

The second range is the one a buyer works from in both cases. A buyer who also buys the building pays for it separately, as real estate.

$1.8 million at closing, or $150,000 a year

Continue the illustration. The appraiser values the building at $1,800,000, and the buyer will either buy it or sign a lease at the $150,000 market rent. Priced apart on the manufacturing row of the multiples our valuation uses, the two choices compare as follows, before tax and fees.

The second column gives up $1,800,000 at closing in exchange for $150,000 a year. Twelve years of that rent add up to the building’s price, before property costs and tax. At the end of those twelve years the building is still yours.

Selling the building brings a transfer tax for the buyer when title moves. In Ontario, land transfer tax on a $1,800,000 commercial building comes to $32,475 under the province’s formula, which the guide to selling a business in Ontario explains. British Columbia’s property transfer tax on the same value is $34,000, from the brackets set out in the guide to selling a business in British Columbia.

The lease also changes how much the buyer has to raise. BDC’s rule of thumb is a down payment of 20 to 30 percent of the price, as described in financing a business acquisition. At 20 percent of the low end, the buyer needs $576,000 of its own money for the business alone and $936,000 for both, so a lease lets buyers with smaller savings close the deal.

The lease your buyer’s lender will read

The lease is signed at closing, and the buyer’s lender reads it before it advances any money, since the business it lends against operates from your building. Four terms get most of its attention.

• The term, counting its renewal options, generally needs to run at least as long as the buyer’s loan, so the business keeps its premises while the debt is repaid.
• An assignment clause lets the tenant pass the lease to a later buyer of the business with your consent. Lenders also ask for the right to take over or assign the lease if they enforce their security.
• A personal guarantee puts the buyer’s own assets behind the rent. As landlord you may ask for one, and a guarantee that ends after a set number of years of rent paid on time is a frequent compromise.
• The rent review clause sets how the rent changes over time, either in fixed steps written into the lease or by a reset to market at each renewal, with an appraiser settling any disagreement.

Many lenders also ask the landlord to sign a short agreement, often called a landlord waiver, that lets them reach the equipment inside the building if the buyer defaults on the loan. Some buyers ask for a right of first refusal, which gives them the first chance to match any offer for the building. Settle the main lease terms in the letter of intent, beside the price.

Your tenant is the business you sold

Keeping the building makes the business you have just handed over the source of part of your income after the sale. If it struggles under its new owner, the rent is at risk. Where you also carry a vendor note, the note and the rent depend on the same business, so it is worth deciding how much of your retirement income should come from one tenant.

The building stays yours if the tenant leaves, and you can lease it to someone else or sell it. Owners in British Columbia planning their income after a sale will find the wider questions in the guide for BC business owners retiring.

If you own the building personally, the rent goes on your own return, and the CRA’s rental income guide explains how it is reported. The same guide states that selling a rental property for more than it cost may produce a capital gain. Capital cost allowance, the depreciation you claimed over the years, can also come back into income as a recapture when the sale price exceeds the building’s remaining undepreciated cost.

A building held in a holding company earns its rent inside that company. Your accountant can show how that income is taxed there, set against the tax on selling the building now.

Settle the building question before buyers see the profile

Decide what happens to the building before going to market, because the offer and the buyer’s financing both depend on it. The work runs in this order.

1. 01Ask a commercial appraiser for a market rent and a value for the building.
2. 02Restate your adjusted earnings at that rent, so your figure matches the one a buyer will use.
3. 03Draft the main lease terms, including the term and renewals, so buyers can read them in the first round.
4. 04Ask your accountant how the rent and a later sale of the building would be taxed, in your hands or in your holding company.

To see what the business alone is worth at a market rent, enter the restated earnings in the free valuation. It gives an early range in a few minutes, before you give anyone your name.

The adjusted EBITDA calculator restates rent paid to the owner’s property company at market.

Questions owners ask

Does keeping the building lower the price of my business?

The business is priced on its earnings after a market rent in both cases, so keeping the building takes only the building’s value out of the amount paid at closing. If you charged yourself rent below market, the buyer deducts the shortfall from earnings, and that lowers the price of the business as well.

What lease term will the buyer’s lender want?

Lenders generally look for a lease that, counting its renewal options, runs at least as long as the acquisition loan. They also read the assignment clause, and many ask the landlord to sign a waiver that lets them reach the equipment inside the building.

When is land transfer tax charged on a business sale?

It applies when title to the building moves to the buyer. In Ontario the tax on a $1,800,000 commercial building is $32,475, and British Columbia’s property transfer tax on the same value is $34,000. Keeping the building and leasing it leaves the title with you, so the tax stays out of the sale.

How does a building inside my company affect the capital gains exemption?

A building the operating company uses in its own business counts as an active asset under the QSBC share tests, which the CRA measures by the share of asset value used mainly in an active business. Moving it out before a share sale so you can keep it has a tax cost, best worked out with your accountant early.