Sale and leasebacks: sacrifice or a saviour?
The financial packages offered by the government to try to keep the economy afloat during the coronavirus pandemic, will provide much needed support for many businesses.
But for many, there is no support or the money will come too late to save them, with the Business Secretary acknowledging over the Easter that “more money needs to go out faster”.
Exploring alternative ideas to help businesses raise cash quickly, an old favourite from the commercial real estate world has re-surfaced – that of sale and leaseback. But what is it and how does it work?
The sale and leaseback
A sale and leaseback deal does very much what it says on the tin – if you own the property occupied by your dental surgery, you sell the property to another party and, as part of the transaction, you agree to take a lease of the property back immediately.
This approach can provide an alternative means of raising finance if you prefer to free up cash in the business rather than approach a bank for the money.
In addition, many property investors including large funds, private equity houses and smaller individual investors are looking at a range of opportunities and property owners should recognise there are people in the market who have cash to spend.
Many funds, unless they can negotiate or revise terms, may be bound by covenants to spend cash they have raised by a certain date; and individual investors may see little value in the interest rates offered by banks or not be prepared to risk the current volatility of the stock market.
Dental surgeries often involve longer terms than many other commercial leases. This gives the dentist long term security for their operation, but subject to the appropriate commercial terms could lead to a higher valuation as the investor is being provided with a rental income for a longer term.
Release of cash and existing debt
For many businesses a sale and leaseback allows them to convert an asset into cash without losing control of the business. Additionally, if bank debt is secured against the asset, the sale of that asset should enable a business to repay the debt and remove the ongoing cost of interest repayments.
Lower costs compared to traditional refinancing
You could engage with a bank to secure debt against an existing asset, but typically such a deal will attract higher transactional costs, including being responsible for valuation, arrangement, legal and bank commitment fees. Theoretically, each party bears their own costs in a sale and leaseback deal.
When certain conditions are met, the leaseback aspects of a sale and leaseback deal may be exempt from SDLT. This means the business will not pay any SDLT on the grant of the lease, but the sale element is likely to attract SDLT for the buyer.
Loss of value to the business and director’s duties
Before selling an asset, the directors must give it due consideration as it could reduce the value of the business in any future sale. Directors owe a duty to the company, but if it suffers financial difficulties and insolvency becomes a risk, those duties can extend to creditors.
In exercising these duties, directors must minimise losses, so any decision to agree a sale and leaseback, where the company is perceived to be struggling, should involve professional advice and a clearly documented decision-making process that shows why this approach was adopted.
Financial covenant and security
Investors buying any asset will require some certainty that they will receive the rent due. Some will worry that companies choosing a sale and leaseback deal are struggling financially and there is a risk of the rent not being paid over a long term.
In these circumstances, parties should consider whether any rent should be held back in escrow or in a rent deposit deed, to provide the investor certainty that an element of the rent is already held securely, should the tenant not perform as expected.
Depending how much rent is held this way the seller/tenant may be relaxed; from a cashflow perspective they know they won’t have to pay rent for a prescribed period, if it has already been escrowed.
If they have negotiated a rent-free period as part of the deal, this could leave the seller/tenant with a couple of years to focus on other parts of their business.
As with any transaction, particularly those involving business assets, it is important to consider a number of factors, but sale and leaseback might represent a sensible option for many dentists in what is likely to be a challenging economic environment for years to come.