Recently, I read my partner John Scibal’s blog titled “Should I Buy My Building?” It was an excellent piece where I found myself saying “preach it bro, preach it!” as I was reading it. I was immediately reminded of something that I learned years ago that I don’t think I would have ever been able to figure out on my own without experiencing it. That lesson was this: your lease is so significant that it alone could make your practice unsellable. No hyperbole here whatsoever.
To understand this we have to walk through a sliver of the practice sales process. The big picture of the sales process goes something like this most of the time:
- An interested buyer and seller get together and express interest in a sales transaction.
- Due diligence is performed by the buyer and the buyer decides to proceed and submit an offer.
- Negotiations occur until all the major terms of a purchase agreement have been decided upon.
- A purchase agreement is drafted by legal counsel, reviewed by both sides, details are finalized, and a closing date is set. This agreement has many components, including how the buyer is going to pay, what the transition period will look like, etc.
- The closing occurs and ownership is transferred.
- Drink scotch/whiskey to celebrate the occasion (this step is optional for you, however it is mandatory for the broker. At least in my world it is mandatory).
Lenders Will Not Lend Without
A key component of the purchase agreement has to do with the lease. A buyer can’t purchase a practice without knowing that it has a physical space to do business in, preferrably the same physical space the seller was operating in. Here’s where the lease, or more accurately, the landlord, comes in. If they decide for any reason that they do not want to negotiate a new lease with the buyer or allow a transfer of the existing lease, it is almost impossible for a deal to happen. Lenders will not lend without basic location assurances. Typically, lenders want to see a lease that matches the term of the loan (e.g. a 10-year note and a 5 year lease with a buyers 5 year option). A non-trivial part of the goodwill of a business is the ability to continue operations in the same location so that the established patient base knows where to find you.
The Devil Is In The Details
If the landlord is willing to transfer a lease or negotiate a new one with the buyer it’s all good…right? Maybe not. The devil is in the details that we call the “terms” of the lease. What if there is a landlord favored demolition clause (a clause that allows the landlord to terminate a tenants lease with a defined notice for the purposes of demolishing the building and doing something different with the land, often building a new building with different purposes in mind)? What if the triple net components of the lease are written in a way that allows the landlord to increase those costs to excessive levels making the true lease costs too high to be able to be profitable in that building? All of these are going to be of concern to lenders, buyers, and sometimes insurers alike. I’ve seen unfavorable lease terms drop the market value of a practice by as much as 40%.
The take home message here is simple: be weary of lease negotiations. The terms of that lease can have devastating consequences, including business failure, significantly reduced profitability, and even making your business impossible to sell. Get help with negotiating leases. You may think you are good at negotiations and you may even have experience negotiating commercial leases. Still get help. But that is not all. When you are doing a cost/benefit analysis for purchasing a building remember to add these factors into the equation. If you are the landlord you can eliminate the problems that a landlord can potentially cause you. That might just be the difference between being able to sell a business versus being able to sell off your equipment piece by piece. I am not saying that this makes owning the building a winner all of the time or even most of the time. As John said, the success of the practice is what comes first in that decision. I am saying that you should consider as many factors as you can when making such a decision.
And when you do sell, always, without fail, ask your broker what kind of whisky he/she likes. It’s standard operating procedure and you never want to violate that.
John McDaniel, OD, MLHR