Often when companies are acquired, they undergo financial due diligence where an external valuation expert assesses the value of the assets, liabilities, and equity interests. The results of this exercise can determine the ultimate sale price or settlement value of the company. While most sellers are keenly aware of the approximate values of tangible assets like owned real estate and equipment, the value of intangible assets is often opaque. Customer relationships, intellectual property, patents, and trade names are the usual suspects. However, operating leases are often overlooked, and they can be a great source of value in the deal.
1. Real Estate Leases
Real estate leases in a thriving market can create an intangible asset for diligence purposes. For example, consider a 20-year corporate headquarters office lease executed in 2008 (historical low point for the real estate market) for $100,000 per annum. During 2018, the Company is considering a sale and the headquarters happens to be in the hottest business district of town where a comparable office space would fetch $250,000 per annum.
The difference between the market rate and current rate of $150,000 represents an asset to the company. A valuation expert forecasts the $150,000 over the remaining 10 years of the lease and discounts that savings to the valuation date as an intangible asset. Theoretically, the buyer of the company would have to pay $250,000 if they did not acquire the company and decided to hang their own shingle. However, because they are acquiring an off-market lease as part of the deal, the seller should be compensated for this forecasted savings.
Another option that doesn’t involve selling the business is subleasing. Subleasing at the current market rate could generate a nice windfall, if space is available and the lease has subleasing provisions.
As you might suspect, the opposite is true in depressed markets. Therefore, it might make sense to renegotiate your contract before selling your business. Or perhaps have a lawyer scrutinize the transferability or assignment clauses within the lease. Either way, get ahead of it with the landlord early in the process. A cash settlement might be the easiest solution but having visibility into the looming liability from a valuation perspective will help you negotiate your cash settlement price.
3. Off-Market Leases
Off-market leases can also be present in capital intensive industries, like manufacturing. Leased equipment that is obsolete can generate intangible liabilities. At the very least, be aware of the market rates for similar properties. Whether you have an off-market lease that is favorable or unfavorable, being armed with this information will enable you to make better decisions and save money.